The financial system failed to foresee crisis because its risk theory denied catastrophes
Evidence
So, why didn’t anyone see this coming? Queen Elizabeth asked the British economists assembled at the London School of Economics in 2009, who, like analysts everywhere, had failed to see the crisis coming. The answer lies in the way banks measure and manage risk, the third of our seemingly unrelated elements that together generated the crisis and that are quintessentially private-sector, not public-sector failings. Repo runs can start it, and derivatives can amplify it, but to be truly blindsided by a crisis of this magnitude you need to have a theory of risk that denies that catastrophic events can happen in the first place, and then leave it entirely to the self-interested private sector to manage that risk. Unfortunately, almost the entire global financial system worked with just such a theory of risk management. — Mark Blyth, Austerity, 100
Categorization
- XREF: The risk-management paradigm that ‘denies catastrophic events’ echoes Taleb’s Black Swan critique and Minsky’s argument that stability breeds instability. — connects to: Efficient market theory could not imagine internally-generated systemic crisis — Mark Blyth, Austerity: The History of a Dangerous…, 130; Neoliberals reject market-failure theory, so they cannot see crisis as market glitch — Philip Mirowski, Never Let a Serious Crisis Go to Waste, 154; Neoclassical economics had no framework for deflationary crises — Mark Blyth, Austerity: The History of a Dangerous…, 158 (+8 more)
Broader Connections
- Orthodox economics models structurally excluded the possibility of major crises
#corroborates(0.85) — Philip Mirowski, Never Let a Serious Crisis Go to Waste, 491 - Neoclassical economics had no framework for deflationary crises
#expands(0.82) — Mark Blyth, Austerity, 158 - Neoliberals reject market-failure theory, so they cannot see crisis as market glitch
#expands(0.80) — Philip Mirowski, Never Let a Serious Crisis Go to Waste, 154 - The efficient-markets hypothesis simultaneously justifies state failure and enabled the financial crisis
#expands(0.75) — Philip Mirowski, Never Let a Serious Crisis Go to Waste, 150 - Claiming that correlated market crises are statistically impossible is plainly false
#exemplifies(0.72) — Mark Blyth, Austerity, 104