I continue to study previous panics and depressions and the search for pictures to illustrate this blog has been an education. There is a paucity of images from depressions previous to the 1930’s, which limits my choices. It is the sheer pace of economic events that astound, not so much the actual events themselves. I must now veer off the path of pattern comparisons of the Panic of 2008 with other panics and today focus on what I see as a great danger and I will be wandering in areas out of my realm of competence into for example systems theory, economics and networks. Simply put I think the two greatest risks to our economic and financial system is the near instantaneous pace at which information is exchanged, and the complexity of the components. Systems theory began almost 100 years ago as a way to try to explain the interrelationships within biological organisms. It developed legs and began to be utilized to explain non-biological systems and it spawned many related disciplines and in turn was influenced by them. A biological organism has many systems. Let us take the example of the cardiovascular system. There are redundancies built into this system. In the heart for example oxygen can be carried to the same area of heart muscle by several blood vessels. It has redundancy. If one vessel becomes blocked by a plaque or clot, the redundant vessel will carry the blood and the heart muscle will not be damaged. In this sense, the cardiovascular system is not optimized. It is not efficient. But by virtue of redundancy, the heart has protection from failure. A network is a collection of nodes linked together by pathways. If there is just one pathway from one node to another, failure of that pathway is catastrophic much the same way if one city has only one road to an adjacent city, failure of that road is catastrophic to transport. It is more efficient to have just one road. If you need more transport density, it is more efficient to build one very large multilane fast road than a myriad of little roads but failure of the one optimized efficient road collapses the system. So system speed trumps system stability. Our current economic system is a tightly coupled, optimized and interrelated network of financial nodes linked by high-speed connections. Money isn't money the way it was in 1930 or 1873. Money and capital is an abstraction, a digital abstraction. Mortgages and credit and debt are abstractions. George Bailey doesn't hold your mortgage at the Building and Loan as was portrayed in the Capra movie It's a wonderful life. Everyone knows by now what happens to mortgages. They are sliced and diced and bundled into securities that might pass thru Freddy and Fannie and be sold to the Norwegian Teacher's Union. That mortgage ahs become not a obligation to pay off a debt but a security, much like a stock but it is a type of structured investment vehicle. I am using this example to show how the mortgage market is now very much more complex than it was in the time of George Bailey. It's not efficient to hold millions of mortgages in thousands of Building and Loans when Goldman Sachs can do the whole thing with a few dozen servers and a few thousand computers. But in this process a simple system has been optimized and made more complex and more fragile. It is more fragile for a variety of reasons among them cybernetic. Cybernetics is a broad field but in a general sense studies structure and regulation in systems. The feedback loop is one of those regulatory mechanisms. By shipping and slicing and packaging mortgages, a hugely important feed back loop is lost. In fact one of the most peculiar and absurd features of this CDO market has been the discovery by lawyers that finding who actually holds the mortgage can be impossible. So say the lawyers and the judges in defending some clients, "You want to foreclose? Produce the Mortgage!" In many cases this has brought the foreclosure process to a standstill.
Banking and finance has become globalized and financial transactions and information is exchanged worldwide at the speed of light. It is a fast and complex system and it is layered with risk derivatives from interest rate and currency derivatives to credit default swaps(CDS) and many others totaling in the trillions of dollars! None of which would have been possible without high-speed computers and acres of server farms all over the world. This is not George Bailey’s world. It took a long time for a bank run to develop at the Building and Loan. Now collapse of banks and countries can occur almost in the blink of an eye. I contend that our next depression will be blazing fast. In 1929 the stock market crashed. It took years for the bottom to be reached in 1932. People had time to prepare and consider their options. In the optimized linked globalized economy of today, collapse could be very rapid, much like a tsunami. . The water recedes and villagers rush out to see what is happening and suddenly a wave appears on the horizon and all are swept away.
I do not of course know how this recession will play out and whether it will progress to a depression but I do contend that we have an overly complex world financial system, which is teetering, and if collapse ensues, it could be very rapid.
Iceland has just concluded the tenth annual Iceland airwaves music festival that had to be a welcome break for that besieged nation. But Iceland’s problems are in no way unique and as someone said, “What happens in Iceland does not stay in Iceland.”
Similar fires are popping up seemingly everywhere: Belarus, Ukraine, the Baltic, Pakistan, and Argentina. The list keeps growing. IMF firefighters will be busy.
Now as the natives in SE Alaska used to say “I jokes……”
What is the worst hit sector in employment in Iceland? Bank robbers.