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When will we know there won’t be another meltdown?

As mentioned the other day, I will be at this year’s SWIFT Show SIBOS focused upon a dialogue around the Long Now. The aim is to find some big super-crunchy questions about the long view of banking and finance, and try to answer them.

What sort of questions are we thinking about?

Here are a few to kick off the grey cell processes:

  • When will we know that there will never be another systemic meltdown like the one we’ve just seen?
  • If India and China become the world’s leading economies, what will Europe and America be doing and how will financial markets change?
  • Can we foretell a future where a human right includes "to not be poor", and what happens to work, life and war if there is no poverty?
  • What would banks be doing if the movement of money as a value exchange died out tomorrow? Would banks be needed at all?
  • If the world really is in meltdown due to climate change, how will commodity trading change, for example, will there be wars over water?
  • Suppose we could travel around the globe in under three hours – just suppose man has created an engine that can get you 32,000 km in under three hours – woud that change anything in financial markets?

There’s a few more like these, and if you have any to add then just mail them to me.

Meanwhile, I thought it useful to start a series of blog entries giving my own perspective on these questions.

First, when will we know that there will never be another systemic meltdown like the one we’ve just seen?

We won’t.

I’ll tackle the next question next week.

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Oh, go on then, you knew I couldn’t give a short answer didn’t you?

For some years, it’s been well known that the markets rise and fall like breathing. For three to five years, you make profits and find good returns, for the next one or two years, the markets correct and you lose a bit. You win some, you lose some.

It’s an accepted way of doing things and the way the markets work.

But once in a while, a bubble forms that does not get reined. It steams and blows, and gets bigger and bigger until its fit to burst.

Imagine it is like blowing bubble gum.

You blow bubbles with the gum and most of them just go out and pop, or go out and come back in again.

Then you get a bubble that’s the biggest you’ve blown all day and you don’t know what to do with it, so you keep on blowing.

You blow and blow until the bubble is the size of your head.

Then the bubble bursts and splats all over your face.

Luckily that rarely happens but, when it does, it leaves a massive horrible mess all over that’s difficult to clean up.

That sounds pretty much like the financial markets.

So how do we ensure the bubble doesn’t grow so big or burst so messily again?

Well, it’s not a matter of regulation, but more a market-led model of effective risk management.

Now we thought we had that in place pre-2008, but it obviously was not the case in hindsight.

Pre-2008 we focused upon market, credit and operational risk; now, we focus upon liquidity risk; in the future, there has to be more focus upon systemic risk circuit breakers.

What do I mean by systemic risk circuit breakers?

Basically systems that can monitor the interlinkage between firms, instruments, portfolios and assets, and alert when a total trade position of a trader, institution or market is systemically important and at risk.

That’s what we should have had pre- the collapse of Long-Term Capital Management (LTCM), and it’s what we should have had pre- the collapse of Lehman Brothers.

However, the two collapses were caused by different circumstances using different instruments. This is why the systems need to monitor across asset classes, across markets and across regions.

I’m not saying that’s an easy thing to set up or introduce, although the single data repository of the DTCC is the first attempt to track such things.

But I don’t think we can truly feel that another meltdown like the last one can be avoided until we have true tracking of all risk exposures globally in real-time on a central platform.

Yow! That sounds far too much like Big Brother.

And yes, it would inhibit trading because you would be concerned about your market movements being tracked so studiously.

Equally, who’s doing the tracking?

An independent neutral body?

A government?

A regulator?

Nah … not sure if we’ll ever get to the stage where you could truly operate a capital market system with full pre- and post- trade transparency on a globalised basis through a single platform and view.

But, without that, we will never be certain that the markets can avoid another systemic meltdown.

Catch 22?

About Chris M Skinner

Chris M Skinner
Chris Skinner is best known as an independent commentator on the financial markets through his blog, the Finanser.com, as author of the bestselling book Digital Bank, and Chair of the European networking forum the Financial Services Club. He has been voted one of the most influential people in banking by The Financial Brand (as well as one of the best blogs), a FinTech Titan (Next Bank), one of the Fintech Leaders you need to follow (City AM, Deluxe and Jax Finance), as well as one of the Top 40 most influential people in financial technology by the Wall Street Journal’s Financial News. To learn more click here...

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  • Chris,
    You describe some key issues that should be addressed quickly.
    You may recall comments I made on a couple of your blogs last Spring about the importance of creating business clarity in the financial system by understanding precisely how data (money) flows.
    http://thefinanser.co.uk/fsclub/2009/04/who-caused-this-crisis-and-whats-next.html
    One comment concluded:
    “…Only by using methods and technologies to understand precisely how data flows will finance avoid further disaster…”
    I still believe that:
    “…We can think of the modern finance industry as one giant calculator with lots of feeds plugged into it. Data flows into the calculator along each ‘pipe’ and as long as all the values are accurate and they get there on time everything is ok. The trouble is traditionally the finance sector hasn’t known when a feed has become blocked or unplugged, so a value is missing or incorrect and the calculator produces the wrong answer as a result….”
    This is in contrast to industries like Oil & Gas and Nuclear where such understanding is critical – if a data flow stops things can go ‘bang’ in a big way. These industries know how everything is put together to make the business work. They have “joined-the-dots” of people, process and technology.
    My colleagues and I believe the first ‘flashcrash’ was caused by a single data feed somewhere in the complex matrix of the financial system being compromised or having stopped flowing for some time.
    http://think.obashi.co.uk/profiles/blogs/why-the-flash-crash-happened
    Finance is not alone. The vast majority of organisations/sectors do not know how everything is put together to make the business work.
    The reason so many public/private IT projects fail is that there is not enough clarity about how data flows through and between businesses – there are no standards for flows of data.
    But we have learned, to our cost, that the impact of a major data flow disaster in finance far outweighs those in other sectors.

  • Re your second question, what happens to China when everyone in Europe / USA has a factory in thier home…
    http://en.wikipedia.org/wiki/3D_printing