This blog continues the short series on the new book, Navigating Uncertainty: Radical Rethinking for a Turbulent World. In the chapter on Finance and banking, I look at the 2007-08 financial crash and how particular models and regulatory practices created a false sense of security through the practices of risk management, when in fact uncertainty and ignorance prevailed.
As the book notes, “The arrival of high-speed Internet had made financial transactions almost instantaneous, and the old-fashioned style of traders and brokers exchanging across the floor, over the phone or in a bar after work had long gone. Rapid, impersonal trades were the standard, guided by complex algorithms and carried out on computers connected internationally. CEOs, central banks and governments had little clue how everything worked, yet mistakenly trusted the system and the light-touch regulation, while enjoying the profits.
At the centre of this complex web were mathematical models generating operational algorithms that were used to manage such interactions. In the period leading up to the crash, the now notorious Black-Scholes-Merton equation dominated the way financial interactions were understood and a massive derivatives market based on options trading was created.” As the mathematician Ian Stewart explains:
The Black–Scholes equation changed the world by creating a booming quadrillion-dollar industry; its generalisations, used unintelligently by a small coterie of bankers, changed the world again by contributing to a multitrillion-dollar financial crash whose ever more malign effects, now extending to entire national economics, are still being felt worldwide.
This article is from Zimbabweland, a blog written by IDS Research Fellow Ian Scoones. Zimbabweland focuses on issues related to rural livelihoods and land reform in Zimbabwe.