Diversity and Resilience: Lessons from the Financial Crisis

Abstract

It was everyone's worst nightmare; the spectre of systemic collapse. And this time, everyone was in it together. The complexity of modern financial instruments was one obvious culprit. Centuries old legal principles, such as the notion of "insurable interest", were also cast aside; old fashioned "gaming laws" which had once served to dampen the worst aspects of irresponsible speculation no longer operated. And, unlike financial products of the past, these new inventions linked ho-hum retail banking directly to supercharged capital markets, Main Street to Wall Street. This was not just a housing bubble bursting; it was not just a credit crisis; it was not just a stock market crash. The new hybrid financial products, by linking heretofore loosely correlated markets, became purveyors of systemic risk.

Chaos theory, as applied to financial systems, would suggest that crises, like hurricanes, are predictable. The question then is why so many were caught unawares by this one. In particular, the Financial Stability Forum(FSF), created in the aftermath of the Asian financial crisis specifically to detect "vulnerabilities" in financial systems and serve as an early warning system, was caught flat-footed. The widespread adoption of top-down, assumption-riddled, standards and their use as indicators of potential financial instability, as promoted by the FSF, failed to signal or avert the crisis.

The seeming resilience of some economies to the financial crisis may also put into question the desirability of the international best practice and international standards approach propagated by the international financial institutions. Although it maybe too soon to judge whether such resilience is real or a temporary mirage, it does suggest that diversity, like the rain forest for the planet, is a good thing for financial systems.

With the benefit of recent hindsight this paper will explore some of the immediate causes of the global financial crisis, document its origins and investigate why some economies like Australia appeared more resilient to its effects than others.

Keywords: financial crisis, chaos theory, financial stability forum, international standards

JEL Classification: F3, G2, G28, K2, K22, K23, N2