Two mathematicians hope they are wrong about the financial crisis

Nassim Taleb (polymath, scholar of randomness, author of Black Swan in which a single observation destroys years of confirmation) and his mentor Benoît Mandelbrot (pioneer of chaos theory and fractal geometry) discuss the financial crisis as an intricate system in a state of turbulence.

Mandelbrot worked on cotton price surges and plunges and concluded that human systems were much more complicated than physical ones (in the ’60s this common-sense observation required empirical proof). Taleb worked on the ’87 stock market crash and analysed the death of hedge funds.

For this crisis they say we don’t have nearly enough data to predict the outcome but they fear the intricacy of the system in combination with ignorance about the system, an outdated economic structure, over-extension of credit and the concentration of the banking system (i.e. risk) with globalising effects. Current models are inadequate. Their prognosis – Taleb’s particularly – is a disaster far worse than the Wall Street crash.

This looks likely do for us this time in a way that it wouldn’t have previously. Taleb argues that a small shortage of oil or agricultural products can lead to huge spikes in price – that we are not as resilient as we used to be because we are ‘over-optimised’ – meaning a consolidation of industry (particularly banking) in the name of efficiency – which exascerbates the impact of mistakes (globalising – aka ‘network’ – effects again). Mandelbrot argues that the system is also turbulent – economic phenomena are highly unpredictable – but he doesn’t know whether the system is inherently turbulent or whether, if not, the circumstances in which, and speed at which, turbulence can occur.

Taleb refers to the recent $700 billion injected into the US economy as pocket-money. He predicts that banks will not lend to hedge-funds, hedge funds will be forced to sell off their positions, prices of other affected entities – supermarkets requesting loans against inventory to make payroll, for example – will spiral downwards, and those will fail.

Both of them say they are waking up at night fearing the future. Neither of them offer answers – perhaps because they are mathematicians – descriptive – and not economists.

This explains the tentativeness of the response. I suppose the implication of what Taleb says is that the efficiency drive inevitable in any market situation must be tempered with the spreading of risk. Changes in regulation, mixed economies and a sense of our economic environment – like our physical one – as an ecology which we need to care for.

To what extent this is an anti-globalisation thesis, I’m not sure. I’ll have to get one of those Oxford University Press Very Short Introductions.

Oh crapola – Globalization is in the Future Publications section.

2 thoughts on “Two mathematicians hope they are wrong about the financial crisis

  1. Interesting that two mathematicians foresee a systems collapse. That’s another way of saying the bubble bursts I suppose. This time the hedge funds are the bubble; at one time they were valued at ten times greater than the GDP of the whole planet. I understand they’ve shrunk a bit since.

    Interesting times.

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