There’s been a lot of talk (and blogging) this week about the Milken Global Conference that’s going on in Los Angeles. I wasn’t able to attend in person this year, but, after looking at their website, I’m amazed at how much of the conference can be experienced virtually. The majority of the sessions are posted to their website within a few hours of their completion. After looking around, I was struck by the connections you can make at the Milken Global Conference. I’m not talking about the networking type of contacts – networking from 1,700 miles away is difficult, at best. No, I’m talking about how the conference’s melding of business, political, and academic leaders can serve to demonstrate the similarities in our experiences, whether they’re separated by thousands of miles or millennia.
As an example, I watched a panel discussion called “The Rise and Decline of Nations and Civilizations,” whose participants included Pulitzer Prize-winning author and UCLA professor Jared Diamond, and best-selling author and Harvard professor Niall Ferguson. While the discussion was ostensibly about the factors that lead to growth and decay on the grand scale of nations (like the U.S.S.R.) and civilizations (like the Maya of Central America, or the Rapa Nui of Easter Island), I was struck by how much the discussion sounded like a description of economic growth and financial crises.
Niall Ferguson began his portion by discounting what he called the “cyclical theory of history” – that civilizations followed a smooth arc from birth, through growth, and finally to decay and disappearance. Rather, Ferguson claimed, complex systems like civilizations were prone to rapid rises and steep drops. Further, he said that small perturbations can cause these “complex systems” to collapse. To my ear, this sounds strikingly similar to economic phenomena like the housing bubble (rapid rises) and its subsequent crash (steep drop). Something like a trading algorithm (small perturbation) can cause a “Flash Crash” like the one in 2010 or the Knight Capital fiasco in 2012.
Jared Diamond focused much of his time on the impact of diseases on the fate of human populations. His mentions of “infectious diseases” reminded me so much of all of the recent talk of “market contagion” and how one European country’s problems could infect its neighbors In his Pulitzer Prize-winning Guns, Germs, and Steel: The Fates of Human Societies, Diamond demonstrates that progress can carry with it its own pitfalls in the form of unintended consequences. Diamond writes that the domestication of animals was one of the precursors of successful human societies – by domesticating animals, humans could have a much-needed source of protein close at hand, a tremendous benefit over hunter-gatherer societies, which saw greater cycles of feast and famine. However, domesticating animals brought humans and their new “livestock” into greater contact. This led to bigger outbreaks of disease as microbes leapt from their animal hosts to human ones – i.e. a new benefit can harbor its own significant risks.
Compare that now with the development of mortgage-backed securities in the latter half of the 20th Century. By assembling mortgages into bundles through a process called securitization, the intent was to spread the risk of mortgage prepayment or default, and provide investors with a new source of yield. However, few people suspected that mortgage-backed securities also contained the seeds that would sprout into the global financial crisis of 2008 and 2009.
In fact, at the Atlanta Fed meeting I attended last month (click here and here for a couple posts about that), complex connected systems were also brought up as ways to assess risk in financial markets. Epidemiologists model social networks to understand how diseases may be transferred in a society. You can do the same in financial markets to assess how – let’s say – sovereign defaults may transmit across different nodes within financial systems.
Another theme that was brought up at both the Atlanta Fed Meeting and at this Milken panel was one of political institutions. At the Milken panel, the third participant, James Robinson, discussed how the interaction between political and economic institutions may set up a society for success or failure. At the Fed Meeting, Charles Calomiris discussed how political institutions set up a banking system for either stability or instability.
Like societies and humans, financial markets are complex systems. Endogenous or exogenous factors can trigger unexpected crashes or melt ups. The governing institutions of financial markets may help enforce stability or create incentives for instability. As for the past, as Mark Twain said, “History does not repeat itself, but it does rhyme.”
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