DataPoints: Another Normal Accident
You know we've reached a turning point when the financial mess is being analyzed as a physics problem:
This is meant to illustrate the credit-default swap market, highlighting the intense interconnectedness of what's been estimated at $60 trillion-plus worth of contracts among banks, hedge funds, insurance companies, etc. Pull out one node (say, Lehman Brothers) and you may cause untold havoc among the adjoining nodes, which spreads to their neighbors, etc. etc.
This is why the Fed and Treasury have been willing to commit billions of public dollars to the bailouts of Fannie, Freddie, AIG -- and now possibly the whole shootin' match via a new incarnation of the old Resolution Trust Corp.
All of which put me in mind of Charles Perrow's book from 1984, "Normal Accidents." Perrow, a Yale sociologist, wrote the book as a way of understanding what went wrong at Three Mile Island in 1979. When the Challenger blew up in 1986, journalists looking for intelligent analysis turned to him as well. I'm straining my brain a bit, but as I recall, the simple idea behind "Normal Accidents" was that, at some point, any system that grows overly complex can't be made safer by unless it is made simpler.
Three Mile Island, to take Perrow's prime example, was like most nuclear plants of the 1970s: All during and after its construction, safety systems were added on to meet the growing concerns of government and the public. Each safey system made the plant more complicated. Yet at some point, the whole exercise became futile, because every additional another backup device, redundancy or layer of protection just created more ways for things to go wrong. As they did.
Does this sound familiar? Mortgages used to be relatively simple. Then someone came up with the very good idea of the secondary mortgage market. That was later refined into the mortgage-backed security, which started out as a single pool of loans but then split into tranches, which later got resliced into collateralized mortgage obligations, packaged with insurance wraps which in turn were traded as credit-default swaps, and on and on.
The system grew so fragmented, with so many moving parts and layers upon layers, that what was thought to be a grand system for managing risk made risk essentially unmanageable.
