AXA, Perpetual, Challenger - As the backloop grows stronger it draws more entities in
Well, what a week. If you ever wanted proof that the global economy is a complex adaptive system, and that new thinking is required to tackle wicked problems, this month has provided it.
The Australian government this week stepped in to guarantee bank loans and deposits. This was implemented as a solution to bank liquidity, and one that is being adopted around the world. The rationale for this was simple enough, lenders and depositors have been spooked by the prospect of defaults, and therefore this measure is aimed to give investors and banks confidence to do business with each other again, and not withdraw existing business. In other words, get credit flowing again, and make sure there isn’t a run on the banks.
This solution was adopted in many countries, and to some extent they had no choice. As part of global system, if you get a state change in one country, you’d better follow suit or end up out in the cold (no Iceland reference intended). And at first blush it seems to have worked. But in Australia, like other countries, this intervention has had unintended consequences. The security provided over bank deposits has effectively created two tiers of security – deposits guaranteed by the government (bank deposits), and everything else.
During the course of the week one analyst put a hold rating on Australian mortgage trusts, resulting in a run on Challenger’s funds, then Perpetual and AXA. By mid-week the phone lines were running hot by depositors to see if they could withdraw their money. The answer to which was clearly “no” – those funds don’t maintain that level of liquidity. To quote Perpetual’s CEO on Sunday “On Friday I’ve never seen a call centre like it.”
More crisis meetings have happened at government level, and the guarantees are being capped, emergency meetings are being held next week with the mortgage trusts, more tinkering is likely and those sitting on the sidelines take pot shots at those in charge.
Meanwhile in the United States, former Federal Reserve head Alan Greenspan was summoned to Washington to face accusations by a Senate Banking Committee that he was partially responsible for creating this mess. His response was humble compared to previous appearances as illustrated in the quotation below:
“A critical pillar to market competition and free markets did break down. I still do not fully understand why it happened.” Greenspan said. When asked about whether there were flaws in his model, he responded “You know, that’s precisely the reason I was shocked, because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well.”
Clearly, this is different from other downturns and is requiring a different response. We’d suggest that different thinking is also required.
A resilience perspective
Here’s a few of my casual observations from the week’s events using some of the RFN thinking and process. If you haven’t been through the process or want a refresher before diving into this, you might want to watch Larry’s recent video first (27m 14s).
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Those who have been following some of my posts will note my suggestion that global markets operate as a complex adaptive system (CAS) ie. something that operates more like a biological organism than a predicable piece of mechanical engineering. You’ll also know that trying to influence the operation CAS is a wicked problem, and cannot be performed by tame solutions. Attempting to do so will result in unintended consequences and iterations. The impact on mortgage trusts this week is demonstration of this, and I’m confident we will see more of this in coming weeks.
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In times of crisis, fixed action patterns emerge and people start “snapping to grid” using existing thinking models almost like a tic. Did you notice the rhetoric about market interventions being akin to the work of the devil or communism? How about calls for the reinstitution of the Breton Woods system, in other words, fixing currencies and “unfloating” currencies like after World War II? Reading the letters to the editor section of newspapers and hearing responses from the sidelines is very entertaining at the moment. I can’t wait to see what’s suggested next week, we’ve got ideologies coming out of the woodwork that I thought were dead and buried decades ago.
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Economic models based on historical empirical data are not good predictive tools when there have been significant changes in conditions, even when based on 40 years of data. Beware of confidence based on history. Circumstances change. To thrive and prosper, you need a deep understanding of these.
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Financial and economic models are usually based on concepts like “all things remaining equal, if we do X, then Y will occur.” Of course other things don’t remain equal as there are systems within systems – and a plexus of networks. If you need evidence that this approach doesn’t work, just look at commentators who were surprised at how much the financial markets and the real economy were linked, or to the plethora of alternate tame solutions being proposed by commentators and politicians all over the world. A whole of systems understanding is required.
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Greater connectivity causes acceleration in effects (online 24 hour news and trading systems allow a backwash around the world of exponential proportions), accelerating forward loops and back loops even more so (see graphic above).
- Those entities with attributes of resilience such as redundancy and without single points of failure will be best placed when circumstances change. In this case the key dependency was capital. You only have to look at those able to pick up assets at fire sale prices, and those who ended up having to put themselves on the block to see this happening. Industry consolidation by resilient entities will be enormous, creating less resilient markets for their customers.
Without resilient thinking in policy development, we will work our way through to economic recovery by trial and error – which is what we’ve done in every other recession in the past.
Now we can’t say we foresaw what happened, nor that we have the solutions, but what we can say is that winners and losers will be determined by those with strong knowledge of conditions and aspects of the resilience model baked into their business or cause. If you haven’t assessed the resilience of your organisation or cause, you may be a putting them at risk, and perhaps joining the list of leaders being held to account as being reckless.
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October 27th, 2008 at 6:48 am
Great quote today on the front page of the Australian Financial Review from the Chairman of investment firm GMO. “This is a panic in the way of the fine 19th century panics, where we all run aound like headless chickens. I have been in the business for 40 years and I have never seen anything like this.”
Time for some new thinking anyone?
October 27th, 2008 at 10:51 am
Todd,
As always I find your posts very interesting.
Two quibbles about this post.
First - I am of the school of thought that EVERY entity has a single point of failure. For some it is very obvious and very real. For others distant and abstract. But there all the same. If this is the case then is there indeed such a thing as a resilient entity?
Second - you have used the word plexus in the wrong context!
Keep pushing the boundaries.
Tom
October 27th, 2008 at 12:51 pm
Thanks Tom.
I agree with you entirely on point 1. My hypothesis is that many entities don’t know what their failure points are, and this is why organisations keep on getting into trouble. Hence the reason in my mind that this sort of thinking is necessary to effective risk assessment. I’ll put more out on this shortly.
On point 2, I was referring to a plexus as an element of systems thinking rather than in it’s usual usage. See point 1 of this post for that one: http://www.resilientfutures.org/2008/04/four-traits-of-resilience/
I suspect this actually means we’re in agreement.
November 6th, 2008 at 3:11 pm
Good article Todd.
And, if only we could get this thinking into financial markets. I think we would not be having this disruption if we had done this thinking some time ago.
It just reinforces why we need to start now in getting aligned to the conditions and potential state changes that afre coming.
Not sure if I know what Tom refers to? A plexus, in RFF terms, is a ‘network of networks’ - or a network of nested networks - also, sometimes called a complex.
I understood what Todd meant - but not sure what its ‘usual usage’ is’?
Toddy, I also notices you had CS Hollings ‘adaptive cycle diagram in this article. Good stuff. But would be good to explain it more and to put the idea of panarchy to this group.