Epsilon Away from Wipeout

By Sean Carroll | September 14, 2008 3:29 pm

Everything I know about the global financial system comes from cartoon stick figures. Still, this doesn’t sound good. (Via, via.)

Nouriel Roubini | Sep 13, 2008

It is now clear that we are again – as we were in mid- March at the time of the Bear Stearns collapse – an epsilon away from a generalized run on most of the shadow banking system, especially the other major independent broker dealers (Lehman, Merrill Lynch, Morgan Stanley, Goldman Sachs). If Lehman does not find a buyer over the weekend and the counterparties of Lehman withdraw their credit lines on Monday (as they all will in the absence of a deal) you will have not only a collapse of Lehman but also the beginning of a run on the other independent broker dealers (Merrill Lynch first but also in sequence Goldman Sachs and Morgan Stanley and possibly even those broker dealers that are part of a larger commercial bank, I.e. JP Morgan and Citigroup). Then this run would lead to a massive systemic meltdown of the financial system. That is the reason why the Fed has convened in emergency meetings the heads of all major Wall Street firms on Friday and again today to convince them not to pull the plug on Lehman and maintain their exposure to this distressed broker dealer.

The Fed doesn’t want to simply bail out Lehman Brothers, as they did Bear Stearns, for a bunch of reasons — including, it appears, that it doesn’t set a good precedent to keep failing out banks that take crazy risks and then fail. Also because Lehman is in worse shape than Bear — insolvent, not just illiquid.

So will anyone step in and save Lehman? Signs point to no.

Unable to find a savior, the troubled investment bank Lehman Brothers appeared headed toward liquidation on Sunday, in what would be one of the biggest failures in Wall Street history.

Should we be surprised to learn that many of Lehman’s problems stem from worthless mortgage-related assets, known colorfully as “toxic waste”? Probably not.

Lehman put itself on the block earlier last week. Bad bets on real-estate holdings — which have factored into bank failures and caused other financial companies to founder — have thrust the firm in peril. It has been dogged by growing doubts about whether other financial institutions would continue to do business with it.

Everything is connected, which is why we can’t just let bad banks fail and to hell with them. My cartoon-based knowledge of the economy doesn’t accurately predict what will happen if banks start falling like dominoes, but it can’t be good, right?

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  • http://orbum.net/mark Mark R

    Well, it happened at the start of the Great Depression. Lots of great big public works projects happened after that, building our infrastructure. Then again, people were homeless and starving all over the country, too.

    It did result in us starting to regulate financial institutions, however. We figured out that their money lust wasn’t always lined up well with the greater picture of reason and ethics. It also resulted in us having the FDIC, where the government guarantees deposits in some banks up to a certain amount, so that people’s money they deposited in banks won’t simply vanish one day. That’s nice.

    Who knows what will come from this? Advocates of a deregulated free market might be seen like advocates of Supersymmetry and the LHC. That is, even if the LHC doesn’t show Supersymmetry, the advocates will just say the conditions were such that you couldn’t say one way or the other.

    What you can count on is that people with a passion for something will always seek ways to increase their rolling around in the tub with it. Oftentimes without regard for longer-term considerations and consequences, for themselves and others. A little like addiction.

  • hmmm

    What about the failure of regulation and oversight?

    Some people are always going to be greedy, and CDOs sounded like a great way to distribute high risk products into layered tranches.

    Why should the government be willing to take the word of Fitch and Moody seriously? They missed the risk due to suddenly high foreclosure correlation (or worse, wilfully ignored it) in rating the lower tranches as AAA. The govt did nothing because it increased liquidity in the low-deposit mortgage market.

    Banks should be allowed to make bad choices but ultimately the failure here is political.

    You surely aren’t contemplating banning derivatives; what we need is risk measures that are robust in low liquidity; high vol high correlation situations. VAR models just don’t cut it because they are overwhelmingly based on historical data.

  • http://orbum.net/mark Mark R

    Yes, it is interesting thinking that as we deregulate, we should also alter the predominant methods we use to analyze the flow of money, and associated risks.

    Something is unclear to me, though: “Banks should be allowed to make bad choices but ultimately the failure here is political.”

    It seems this is arguing for tighter/better regulation. However, at the same time, allowing banks to make big mistakes seems to be arguing against regulation.

    I can’t seem to follow the logic in saying the failure was ultimately a political one. Unless, by political, you are also including the “private” politics inherent within the financial industry.

  • http://medgeek.livejournal.com Amy Wing

    Considering my understanding of economics is probably not even to the level of stick figures, I hope this doesn’t sound TOO ignorant, but why is it that when individuals make bad judgement calls in debt/asset management, they lose their assets/homes… but when BANKS (who should KNOW better, in my mind, than offering obviously predatory loans to underqualified buyers) make “poor judgement calls,” the government bails them out?

    Maybe I should take a class or two in economics…

  • hmmm

    I mean, it was legal for banks for do what they did. If they make these bad choices within the legal framework then let them fail. Yes, the consequences will be ugly, but that is exactly what counterparty risk is all about. You pay a premium for whatever product because your counterparty might default.

    But the legal framework should be tightened so that risk isn’t encapsulated in simplistic metrics. And the government failed, partially, I contend, because it was politically convenient to do so.

    In short, therefore, I think Lehman should be allowed to bankrupt itself, but it’s sad and a testament to bad government as well as bad banking that it was preventable.

    Derivatives have done great things for the economy, and it is wrong to say they should just be banned.

    It is impossible to anticipate all the risks which will arise, but it is feasible for “worst-case scenario” models should take the unknown into account, and it is feasible to ban extreme leveraging without having far greater capitalization ratios (only in the form of US government bonds, no “equivalent” “AAA” products) to finance it. The rationale: if the US government is about to default there are frankly far larger problems than investment banks failing.

  • Ziusudra

    @ Amy Wing

    Because while the individual loses their own assets the banks lose their customers assets. If an individual goes broke it has little if any effect on the economy, however thousands and thousands of investors can have enough of an effect that bailing out the bank is required to prevent a larger collapse.

  • http://orbum.net/mark Mark R

    Which means, of course, you have to trust the people running the bank to “do the right things”. Either that, or watch them like a hawk, and carry a big stick.

    They don’t like being watched, though. And they really hate big sticks. It distracts them – hinders them.

    Which leaves us with trust.

  • spyder

    Down down down Lehman goes:
    http://www.cnbc.com/id/26708143
    CNBC has confirmed press reports that Lehman Brothers is likely to file for bankruptcy protection as soon as Sunday evening.

    But then Lehman didn’t exactly help its case when DoJ and IRS discovered their tax dodge schemes.
    http://www.forbes.com/business/2008/09/11/senate-dividends-tax-biz-beltway-cx_ar_0911divtax.html

    And the dominoes fall one by one:
    http://seekingalpha.com/article/95396-lehman-spelling-trouble-for-the-dollar-and-carry-trades
    http://www.bloomberg.com/apps/news?pid=20601087&sid=aRVspw_Rse64&refer=home

  • Lawrence B. Crowell

    We appear to be witnessing a slow motion disintegration of the financial system in this country. In the space of a week F.Mac/S.Mae were bailed out, largely because they are the system which effectively manages our foreign debt, and now Lehman has tanked. Over the last 6 months we have witnessed a chain reaction ever since Bear Sterns. I’d be surprised if we have seen the last of it.

    Curiously back in the 1920s it was thought that the market would work everything out. It didn’t, collapsed and constraints had to be placed over it. Then in the 1980s we were told again that markets could do it all, as Milty Friedman won a Nobel and Reagan’s “rocket scientists” under Stockton said that market logic was supreme. Now we might be back again to learn the same harsh lesson one more time!

    Lawrence B. Crowell

  • joe

    Are you suggesting the government should bail out these private banks? Why should taxpayers pay for the mistakes of rich guys who took bad risks and are now suffering the consequences of their short-sighted greed? I think it would do the financial system some good if a few bankers had a bit of trouble affording their Hannakuh presents this winter.

  • http://orbum.net/mark Mark R

    Eew! Lawrence, not the “F” word! I’ve always felt really sorry for the University of Chicago because of that man, and feared it a little, too. He did some really great stuff for South America, too… years ago. We really should pay attention to experimental evidence.

    I don’t know if it matters, if we learn any lessons from this, this time. People seem always more apt to listen to spin and marketing, rather than examining history. Rather than to exert any effort at all. Hopefully, I’m overly pessimistic.

  • Ijon Tichy

    Welcome to the Anglo disease. Hopefully this will spell the end for the dominance of financial capitalism.

  • drunk

    This is the beginning of the end of investment banks in the US. When the dusts settle, all the famous names – Bear Stearns, Leyman Brothers, Merrill Lynch, Morgan Stanley, Goldman Sachs, etc, all will disappear. Some will go Chapter 11, but most will be absorbed by commercial and retail banks.

    The destruction of these Wall Street rackets is a very good thing for the USA and much of the world. With each going down, I open a good wine to celebrate.

  • Aaron Bergman

    Nobody’s talking about the really important aspect of this. Who’s going to hire theoretical physicists who leave academia now?

  • http://orbum.net/mark Mark R

    The Discovery Channel?

  • Haelfix

    Damn Quants and their risk assessment models that managed to create massive and irrational leverages for poor unsuspecting banks.

    Whenever there is a problem in the world, it always comes down to theorist hubris~

    I take that as an axiom.

  • John Merryman

    The problem with the private capital model is that to save money, it must be invested and in an atomized economy, with everyone needing their envelope of wealth, lending standards were relaxed to accommodate that much wealth. The debt bubble expanded till it burst.

    Money is not just an accounting of wealth, but primarily a public medium of exchange, like a road system. We are going to have to do away with the private banking system and make it a public institution, local, regional and national. Since the public is responsible for the risk, it may as well benefit from the rewards. This would lower taxes as well.

    How about the brilliant idea of privatizing Social Security? So who do we let manage our retirement savings? Merrill Lynch? Society invests in its old age by taking care of its elders and safely raising and educating its young so they will do the same. That’s investing for the long haul.

    Political power was originally a function of private initiative, but it became necessary to make it a public trust. Today, few people want to return to a monarchy. It is time to make economic power a public trust as well.

    Since my ideas don’t get much traction, here is someone making the same argument:
    http://webofdebt.wordpress.com/monetary-proposal/

  • http://orbum.net/mark Mark R

    That’s just it, John. People are very quick to extol the virtues of a free market unhindered by regulation. The freer, the better.

    If you look at people that way, you end up with anarchy.

    And in anarchy, there’s always someone who wants to be the big guy to lord it over on others, for one reason or another (or no reason but self-interest).

    You end up with power clustered around a small number of individuals that way. The same seems to hold true with financial markets.

    It’s basically back to feudalism.

  • John R Ramsden

    John (#17), yes private enterprise has its faults; but nationalization leads inevitably to long term decline and failure. This has been proved time and time again, but is something naive and idealistic socialists can never grasp.

    One problem is that muddleheaded politicians and civil servants, largely ignorant of the businesses they oversee, impose goals and limits inconsistent with the needs of the business to flourish or even survive without massive and ever increasing subsidies.

    Also, a monopoly (which with all banks nationalized they would essentially become) engenders arrogance and high-handed behaviour by the bosses _and_ the staff. I presume you still favour a democratic society, and don’t propose to shoot strikers; but if so, in your new utopia I’d be prepared for lots of strikes and walk-outs at the drop of a hat.

    That’s what happened in the UK with miners and dockers and postal staff and airlines, etc etc, in industries foolishly privatized by a socialist government (Labour) after WW2, until Maggie Thatcher blew away all the cobwebs and sold off the lot to private enterprise.

    I thought most Americans instinctively understood all this, but evidently not.

  • Lawrence B. Crowell

    Mark R on Sep 14th, 2008 wrote: Eew! Lawrence, not the “F” word!

    Yep!, It find it too bad he died before he could see the bitter fruit of his life’s work. Of course since he and his Chicago school mafia worked with Pinnochet he might not be so concerned.

    The current (Friedmannian) market ideology suffers from the delusion that any complex self-adaptive system can regulate itself. A lesson from biology is in order, for there are webs of molecular pathways which regulate a cell cycle and cell growth, or on a larger scale a healthy ecological system is one which has a diversity of species. If this is not the case then some molecular process, say a loss in the regulation or negative feedback on the activity of a tyrosine receptor for cell growth, will lead to runaway cell cycles. This is a mechanism for transformed cell growth or cancer. The loss of preditors in an ecological system can lead to population booms of other species or the run-away spread of “weeds,” or the explosion of algae and so forth. By the same token the market system needs to have external structures which act as negative feedbacks.

    Of course corporations are not happy about this idea. A negative feedback amounts to limits on profits. Besides, with the ecological analogue we have some problems as well on that front. Come to think of it, there are few negative feedbacks on us human beings. We have been pretty good at getting rid of them ever since our Australopithicus ancestors started taking themselves off the menu. We seem “wired” for this!

    “Spaceship Earth to Houston, we have problem!”

    Lawrence B. Crowell

  • http://backreaction.blogspot.com/ B

    Money is nothing but a promise. Exchanging it is a tool we use to optimize distribution of resources and future investments. Events like this and the panic they cause signal that were not capable of properly using this tool.

  • jim

    Aaron,

    Now those former academics might become teachers instead of quants. This may be good for our educational system. Or I may be delusional. :)

  • John Merryman

    John R,

    The intersection of economics and politics is more complicated and controversial than the simple dichotomy of socialism vs. democratic capitalism and this probably isn’t the best forum for that discussion. That said, society is a relationship between top down order and bottom up growth. The most ordered society on earth is likely North Korea and the least ordered is likely Somalia. The trick is structural flexibility that enables healthy growth, which requires the feedback mechanisms Lawrence mentions, in order to mitigate some of the more corrosive aspects of growth. The very top down processes which tend to squash our individuality are the very same natural evolutionary tendencies which evolved multicellular organisms in the first place. Your own body is a function of this relationship between top down order and bottom up growth. When the order overwhelms the growth, you get old and die, but if the growth rejects the order, you get cancer and die. So the issue is how to further develop our economic and political systems to be able to survive the current problems and build a better model from the lessons learned. The fact is that there is no going back because the old model is broken. Whether they want to, or not, governments are going to find themselves in the position of nationalizing the banking systems. Many people are going to be crying foul, but the public is ultimately responsible for the health of the monetary systems on which a modern economy depends. I, of all people, am not advocating any form of totalitarianism, either of the socialist or fascist persuasion, nor am I a particular fan of anarchy. There is no happy medium either, as that’s another form of stagnation, so there will always be a swinging between varying poles and preferences. Rather than look to the past, consider the future: The banking system is broken. It will be propped up by government to whatever extent is possible. Rather then cry socialism, do you have any ideas? Should we return banking to a private profit system, or would it be to the larger interest to try it as a public function. Think in terms of other public functions, the roads, the courts, the military, legislative and executive branches, etc. How many of those would you want to see run as private enterprise? It is possible to have effective public sector functions. In fact the private sector depends on them. Consider the court system: Do you think a viable society could exist with a private legal system? How about the military? The fact is that our military has become privatized and from what I’ve read, I find it disturbing, to say the least. I could go on, but you get the idea.

  • John Merryman

    P.S,

    Keep in mind that issuing currency is a public function which has been effectively leased to what amounts to a GSE, the Federal Reserve System, which is owned by its member banks and pays its primary profits back to the Treasury, but not those earned through fractional lending by the member banks. I’m saying that the function of banking could be incorporated into all the various levels of government, from small banks at the county and town level, up through state and regional banks, to various national banks. They would feed their profits back to the levels of government at which they are incorporated, as a form of community income. This would maintain a serious level of competition between communities as they seek to develop the most desirable standards of living and outreach to local businesses, because people and businesses would migrate away from poorly run communities.
    Rather then go back to systems of local currencies, which do have their benefits, continuing to use a national currency would maintain a general interconnectivity and prevent isolationism.

  • drunk

    All economic ideologies will fail if not managed in ways required. Only ‘hubris theorists’ engaged in endless arguments about this or that -ism being better.

    Wall Street investment banks fail because they engaged in practices far beyond sense, way into gambling, with vast unregulated powers, driven by unlimited greed. In short, they used their banking power to create trillion of dollars of private money (in the form of credits) by taking a meager amount of real capital and leveraged it to an insane proportion. For a while they got away with it by sheer complexity of their products, aided no less by an army of physicists and mathematicians, Trojan Horse racketeering, and secrecy. For a while they paid themselves salaries and bonuses so great it makes King Louis IV boil with envy.

    Have no pity for these asshole executives and ‘financial engineering’ con artists. They came, they screwed, and now they got screwed.

  • John

    We all suffer in this, it affects all of our retirement portfolios, it hurts the dollar, and will lead to much tighter credit and money. That can only stifle economic growth. There are more failures to come, and I am glad to see that the Feds are standing back more than they did with Bear Stears and Fannie/Freddie. But a total global meltdown is still not impossible.

    The blame for all this goes squarely on the free wheeling deregulation of the financial industry spearheaded by Phil Gramm in 1999. This is the architect of McCain’s economic policy program (assuming he still has one – we haven’t heard much in the way of specifics for several months…)

  • http://kea-monad.blogspot.com Kea

    Retirement portfolios? Hah, hah! So all those skills I’ve learned from years and years of poverty now come into their own. Life is looking good at last. Learn the hard way, suckers. I’m going to join the guy drinking that fine wine – which I’m sure my country won’t stop producing.

  • changcho

    A question and a comment:

    (a) Roubini wrote “…other major independent broker dealers…”. Dumb question: independent from what?

    (b) “Everything is connected, which is why we can’t just let bad banks fail and to hell with them…” Ok, but if this is the case, why do we accept the goverment’s over-hyped praise of the free- market? It is hypocritical (the goverment’s praise, I mean).

  • drunk

    changcho:
    Let me give your questions a crack:
    (a) Independent broker/dealers, such as Leyman Brothers and others I listed, are strictly speaking not banks. Experts call them shadow banks. They do not accept deposits and they don’t have retail operations. As such they are not regulated by banking laws, have no access to the Federal Reserve’s various ‘facilities’, and have no insurance by the FDIC. They make their money by trading financial stuff. Thus they are independent from the normal banking system.

    (b) Everything is not that connected. As I said, independent broker/dealers are not connected to the normal (FDIC insured) banking system. And that is why the bailout of Bear Stearns by the Federal Reserve using $29B of taxpayer’s money (Bear Stearns not even a member bank) is such a profound corruption. The government (mostly the Bush administration executives) implementation of a free-wheeling no-regulation ideology under the guise of ‘free market’ eventually led to Wall Street broker/dealers running their businesses, and your money, like a casino. The FDIC banks, strictly regulated by banking laws, dared not go to the same extent for fear of criminal implications.

  • http://valatan.blogspot.com bittergradstudent

    changcho:

    I think the main problem is that there isn’t a voice for any of this. The US government’s (I assume you’re American) blind priase of free market capitalism comes from the fact that there are very few politicians willing to stand up and say that Ronald Reagan was wrong, that Reagannomics set us down this road of spiraling deficits, credit crunches, low savings, a massively expanded military industrial complex and bank bailouts.

    Until someone is willing to directly say that Reagan was wrong, and that his economic policies have lead to nothing but ruin, we’re just going to repeat this over and over. Perhaps, if Obama wins big, we might get something like that. I’m not holding my breath.

  • http://www.dorianallworthy.com daisy rose

    Who Can You Trust ?

  • Thomas Larsson

    An alternative for theoretical physicists would be to start their own businesses. Who could be better suited to be entrepeneurs than the smartest people with the best and longest education?

  • http://orbum.net/mark Mark R


    An alternative for theoretical physicists would be to start their own businesses. Who could be better suited to be entrepeneurs than the smartest people with the best and longest education?

    Oh, dear.

    Who is better suited to make money than highly educated, smart people? My bet’s on the outlandish, brazen, manipulative and ruthless people who can afford lots of lawyers, and who give money to highly educated, smart people to do their bidding.

  • John Merryman

    drunk,

    At some level, everything is connected. Investment banks were leveraged 30 to 1, while commercial banks are leveraged 10 to 1, so at some level of loss they are all under water. Then the question is at what level the FDIC is leveraged at. I think it is at something far more than 10 to 1. After that, it’s the Treasury and after absorbing Fannie and Freddie, it is already under water. Paulson had a bazooka, but it only had one shot.
    After the financial system itself, the corporate world applies the same “just in time” leveraging to its finances, as to its production models.
    Then there are credit cards…..
    It is all one big bubble and it popped.
    Think of the subprime crisis as the planes flying into the WTC. Yesterday was when they started to collapse.

  • nano
  • Pingback: To visit again when I have time to make … « Exactly;()

  • Chris W.

    At some level, everything is connected.

    Yup. At this level:

    On Monday, New York Gov. David Paterson tried to give the company some breathing room by allowing AIG to access some $20 billion of capital in its subsidiaries. That might not be enough.

    “I think AIG has a day” to get a deal done, Paterson told CNBC on Tuesday morning. “I don’t know if anyone is really understanding the ramifications of this crisis. We’re in a terrible situation if we let the world’s largest industrial and technical insurance company go down.”

    Experts agree that the failure of AIG would have tremendous consequences for the financial industry. It has insured some $441 billion in fixed income assets for banks and other investors. Because of that, most major banks have significant exposure to AIG.

    Again, the theme: Instruments ostensibly introduced to manage and hedge against risk have become the risk, on a gargantuan scale. As economist Robert Merton said in a recent interview for Technology Review, the trouble is, when you give people an SUV instead of a compact sedan, some of them think they can take risks on the highway they never would have taken otherwise. Throw in greed, relentless selling, and free market snake oil, and here we are.

    (Actually, those people didn’t just get SUVs, they got buses—full of passengers.)

  • Chris W.

    PS: This just in; the Fed is providing AIG with an $85 billion bridge loan.

  • Pingback: The Subprime Primer — eightandfive Archive()

  • John Merryman

    Not only is the government going to own a bankrupt banking system, but they seem to be on the hook for a bankrupt insurance system. Of course, that’s where the derivatives market came from in the first place. This will be a very large tail wagging a small dog, given that the derivatives market has grown from 6 trillion in 1990 to 455 trillion today.

  • http://voicesofreason.info Neil B. ?

    And here is the price we pay for Republican-preferred economic anarchy (imagine, if Social Security had been privatized and invested in the stock market.) McCain is now paying catchup concern troll:

    http://news.yahoo.com/s/ap/20080916/ap_on_bi_ge/bank_deposits_safety

    Federal bank insurance fund dwindling

    By MARCY GORDON, AP Business Writer Tue Sep 16, 7:49 PM ET

    WASHINGTON – Banks are not the only ones struggling in the growing financial crisis. The fund established to insure their deposits is also feeling the pinch, and the taxpayer may be the lender of last resort.

    The Federal Deposit Insurance Corp., whose insurance fund has slipped below the minimum target level set by Congress, could be forced to tap tax dollars through a Treasury Department loan if Washington Mutual Inc., the nation’s largest thrift, or another struggling rival fails, economists and industry analysts said Tuesday.

  • http://tyrannogenius.blogspot.com Neil B. ?

    Oh the irony. Look at http://biz.yahoo.com/ap/080918/wall_street.html?.v=44, “Stocks surge on report of entity for bad debt”
    September 18, 3:37 pm ET, By Tim Paradis, AP Business Writer (was on Drudge literally within a few minutes.) It is telling and weird, how the stock market, the “nerve center of American capitalism”, goes up and down in rapid swings depending more than anything on whether the government is offering some way to cover for what is happening.

  • Chris W.

    Indeed. Capitalism has always depended on government to protect it from itself. I guess we’re learning that all over again—the hard way. The only way capitalism could function independently of government would be if it took complete responsibility for its own systemic health and stability. That would require establishing and accepting what amounted to governmental oversight, even if it was embodied in nominally private institutions. (Credulous or corrupt bond rating agencies don’t count.)

  • http://eleanoreats.blogspot.com/ Eleanor

    My boss (I work in risk management at an investment bank) has postulated that the crisis of the last few days is due to the LHC. When they switched it on there was some sort of black hole created and we are now living in a hellish parallel universe created by it. :-)

  • http://www.dorianallworthy.com daisyrose

    Everything is so complicated because no one knows what securities they really hold i- derivatives = toxic waste? – Trading *models* – developed by QUANTS – Same kind of over achieving – parent pleasing – non creative types. They hail from the same schools – they hang out together. make the same trades – they are arrogant – self centered – and they dont give a damn about anyone but them selves. No big Picture idea – they make 10$ someone else loses 20 – no problem!

  • Chris W.

    From a reader review of Richard Bookstaber’s A Demon of Our Own Design:

    Another serious problem is Wall Street’s deeply ingrained tendency to push the envelope. (Richard Lowenstein put it exceptionally well in his book Origins of the Crash: “Finance has its own Peter Principle, by which a successful model will be adapted to progressively riskier causes until it fails.”)

    In this habit of fighting for every inch of profit, Wall Street is like a self-evolving animal overquick to embrace the particulars of its immediate environment. The more precisely an animal is attuned to a particular “fitness landscape,” the better that animal can thrive… in the short term at least, as long as everything stays just so. To be exquisitely adapted (as opposed to robustly adapted) is to be vulnerable to the slightest change.

    Thus when the fitness landscape does change—as it inevitably will—the heavily specialized competitors tend to get crushed (if not go extinct). If a strategy-gone-sour broadsides a large enough group of market participants, the entire financial ecosystem can be thrown into turmoil. When the turmoil from this upheaval spills into the broader economy, wreaking havoc in its wake, the “demon” spoken of in the book’s title is unleashed. (As this reviewer interprets it anyway.)

  • John Merryman

    Chris,

    The more accurate biological example is of a population depleting its resource base and crashing, which is a matter of measured inevitability, rather than potential failure. The paper bubble was being inflated and each tear was papered over with ever thinner paper. It wasn’t a change in circumstance, but reaching the limits of the circumstance.

    Neil,

    The irony is delicious. After years of privatizing every possible public asset in the name of “greater efficiency,” while squeezing out every drop of profitability, the “free markets” rejoice when the mess is nationalized. Fear and greed are all that really matters.

  • http://tyrannogenius.blogspot.com Neil B. ?

    Well, it seems a wipeout was narrowly averted (so far), at least “according to the market” – see, in this economy the stock market is “the” market. Why? Because “we the people” had the burden placed on our long-suffering shoulders, that’s why. As for what we should get in return, well here is my post from a thread in Brad DeLong’s literate and fascinating blog:

    Since the public is basically bailing out “the financial system”, then: the public should, in some sense and to a substantial extent, be given “ownership” of the financial system. I don’t mean just ordinary individualized market participation (which they already have, however mangled) or just “the government” acting as a government (especially considering that the G. is largely, effectively owned by the same sort it is bailing out the most.) I mean literally “as” the public, in a communal effective way similar to what being in a genuinely employee-owned company is like. Reflect on that and hash out what it should consist of in particular, the thrust of it cannot morally be denied. The people should demand it, they will if they appreciate what happened to them and respect their interests.

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Cosmic Variance

Random samplings from a universe of ideas.

About Sean Carroll

Sean Carroll is a Senior Research Associate in the Department of Physics at the California Institute of Technology. His research interests include theoretical aspects of cosmology, field theory, and gravitation. His most recent book is The Particle at the End of the Universe, about the Large Hadron Collider and the search for the Higgs boson. Here are some of his favorite blog posts, home page, and email: carroll [at] cosmicvariance.com .

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