I am one of those who believes that we cannot possibly meet the challenges presented by the modern financial system, whether global or domestic (it’s almost all the same now), by using the traditional precepts of regulation. These precepts presuppose unrealistic methods of diktat, they involve static views of the agents that operate withing the financial ecology, and they take a artificially linear view of the activities of the marketplace. The financial ecology, as many have long recognized, is a complex adaptive system. To maintain its robustness, let alone understand it, requires a systemic comprehension and an acknowledgement that regulators, as much as the regulated, are interactive agents too. We have much to learn from complexity sciences as disparate as network science, immunology, game theory, to mention only some. Nicholas Taleb’s sweeping work on the randomness and The Black Swan is perhaps the most well known illustration of the power of complexity thinking in the turbulent and complex arena of financial risk management.
Now Daniel Carpenter, one of the most prominent writers on regulation and scholarship on the subject I greatly admire, has endorsed the application of complexity theory to the understanding and reform of regulation (hat tip, Ed Balleisen). In a new book review entitled Systemic Failure: How to think about financial regulation in an era of systemic risk, he discusses the shortcomings of traditional approaches to financial regulation and reviews the possibilities offered by a complexity approach. Writing in praise of the approach taken in a new book I have not yet seen (THE SUBPRIME VIRUS: RECKLESS CREDIT, REGULATORY FAILURE, AND NEXT STEPS, by Kathleen Engel and Patricia McCoy, O.U.P 2011), he notes that “[t]he critical and oft-neglected fact of the crisis rests in the deep connections between the worlds of consumer risk and systemic risk,” and that “[a] world of deep connectivity requires a different kind of regulation.”
This is a glimpse into what the language of regulatory reform will look like in the future.