We live in a closed loop ecosystem – that much we know for sure.
What we can now also learn is that we live, work, find our shelter, grow our food and energy and create our life security in a financial system that is also a closed loop ecosystem. And a highly unstable one at that…
And this financial ecosystem is at grave risk same as the Amazonas, the Siberian or even Java’s Indonesian rainforest. And as we are experiencing now constant failures with the largest asset class – that of sovereigns, and their debts failing — we have to grudgingly admit that this financial ecosystem we all idolize, is actually more like a very fragile jungle rather than any other stable ecosystem.
But there is a silver lining in this cloud too. And this is the realisation that will allow us to create new models and prevent future melt downs.
This new realization of the parallels with a critical fragile ecosystem, is what may actually save the financial system from disaster in the future. That is only if we apply these learnings…
And we can do this simply because an ecological theorist and the Bank of England’s head of stability have teamed up to show that if you apply the mathematical models used in modern state of the Art ecology to financial systems, then the financial ecosystems start predictably behaving much like manageable ecosystems. And fortunately or unfortunately they are loaded with the very same risks of collapse and regeneration. Or not. An example of unintentional biomimicry at work perhaps…
Surprisingly, current leading national and multinational banks and all major bankers now use old modeling that does exactly the opposite and thus increases all those risks of collapse exponentially.
Because up all through the first half of the previous century and all the way up to the 1970s, yesteryear ecologists believed that the more complex the ecosystem, the more stable it becomes. Worryingly they had made the false assumptions and thought that if you lose one species all the rest of the remaining species will fill in.
But then Robert May from the University of Oxford, and many other mathematical ecologists showed that such complex systems have critical points at which a change in one species can have dramatic and non-linear effects on all others. Losses can propagate, and even cause collapse. The stronger the connections and fewer differences there are among species, the greater the risk.
By substituting various kinds of lending and assets for predation, cooperation and competition, May and banker Andy Haldane show that the global financial system might behave similarly (Nature, DOI: 10.1038/nature09659). Yet bankers still think like 1960s ecologists, they say.
Banks maximise their connectivity and similarity in an effort to increase stability, when in fact this may do the opposite. Pricing models for financial products called derivatives, central to the 2008 crisis, also wrongly exclude non-linear effects.
However we think that the use of more ecological financial models might stave off another crisis.
Yours,
Pano
PS:
This has become crystal clear with CDSs and other credit default swaps mechanisms and bank hedging tools that bet on catastrophe. And there is some divine justice in that, since punishment meted out on latter day Cassandras, the greatest innovators in this catastrophe exploiting field, is that they will have bitten off their own heads. Vain men and women like Paulson and his Goldman-Sachs cohorts that guaranteed doomsday hedge funds, they are eating off their own heads like praying mantis and their mates.
And that should clearly put us off old modeling praying that other’s disaster can benefit your own particular species, because the best method of ensured survival and your own species’ continued existence is harmony, balance, peaceful coexistence and co-operation.
