Friday, September 26, 2008

Systemic failure and financial firewalls

I caught an MPR Midday conversation on my drive home - MPR: Another bank bites the dust Broadcast: Midday, 09/26/2008, 12:00 p.m.

It featured Chris Farrell, who usually represents my team -- the rational left. The odd bit was the other guest, Louis Johnston. I suppose he was there to represent the right -- but he was rational too.

A discussion between two rationalists is probably a bit bland for the masses, though I much appreciate it.

Early in the program, there were some interesting themes. Chris spoke of systemic failure and of regulatory failure, and in another context both spoke of firewalls and hurricanes.

That suggests, as they probably intended, that even if there are deeper economic and cultural failures, there are also more straightforward firewall failures in our current crisis. These are usually called "regulatory failures" but regulation can come in many forms. I think the most interesting forms are those that are designed to stop the spread of contagions.

Fires, seizures, epidemics, hurricanes and financial crises are all, famously, "chaotic". They have non-linear perturbation sensitivities, and they can roar up and die down in ways that are only loosely predictable.

Excepting hurricanes, we have firewalls for these things. In our brains are systems to dampen seizures should they arise, and, we think, to limit where they spread. In our buildings we have, well, firewalls. In public health we find immunization rings, targeted interventions, quarantine and the like.

Firewalls are probably a fundamental requirement for all systems sufficiently complex to be interesting (insert Godel reference of choice). I think even the GOP House would agree things are interesting now.

Firewalls don't show up, to my knowledge, in classical economics. I'm sure they show up in modern economic models of regulation and in studies of "complex adaptive systems" [1]. Maybe this latest crisis will bring models of financial system firewalls, like the mourned Glass-Steagall act, to the level of popular economics.

Brad, over to you ...

[1] Unfortunately in English we use the same word for computer network security tools as for the broader concept of things that prevent spread. So a search involving the word "firewall" doesn't work too well. Interestingly the "same" search would work much better in a language with different homographs.

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