Processing Knowledge

Benoît Mandelbrot is widely known for his mathematical analysis of chaos and complex systems. In this book, “The Misbehavior of Markets“, he wrote “Bit by bit, from a bad seed a big but sickly tree is built with glue, nails, screws and scaffolding. Conventional economics assumes the financial system is a linear, continuous, rational machine and these false assumptions are built into the risk models used by many of the world’s banks. As a result, the odds of financial ruin in a free global market economy have been grossly underestimated. By using such methods there is no limit to how bad a bank’s losses can get. Its own bankruptcy is the least of the worries; it will default on its obligations to other banks – and so the losses will spread from one inter-linked financial house to another. Only forceful action by regulators to put a firewall round the sickest firms will stop the crisis spreading. But bad news tends to come in flocks and a bank that weathers one crisis may not survive a second or a third.”

Such views are not only being shared by financial analysts and bloggers but are also being activelt written by columnists. All of them converge on one point that the greed and myopic vision of the visionaries heading the large financial institutions coupled with false assumptions made in their mathematical models are the root cause of the current financial chaos. It is sad that this behavior was made publically available half a decade ago but was largely neglected due to the apathy and laziness of some economists.