Nov 29, 2008

Global Economic Meltdown, SNA-BNA , MAI, Sarbanes Oxley, Cynefin & ACTKM 2008

I found the recent ACTKM 2008 conference in Canberra to be incredibly interesting, especially as it was set against the unfolding global economic crisis.

Of course the question in everyone's minds was - how could it have occurred? Why didn't all the governments do something? And it occurred to me that many of the concepts covered in the conference certainly helped me in my personal sensemaking of it all. In particular, David Snowden's Cynefin and storytelling perspectives, plus the social network analysis and business network analysis approaches covered by Laurence Lock Lee and Graham Durant-Law. In particular the disintegration that they both identified could occur when a node in a network is removed - and how sometimes a seemingly minor node (Iceland's economy or Lehman Brothers ?) can indeed be far more crucial than previously recognised.

On personal basis I found David Snowden's Cynefin approach to complexity & chaos-crisis not a bad start for me in achieving some sensemaking of these situations reeling out of control. David Snowden also made the observation that in influencing strategic decisionmaking, that stories convince people, whereas data and statistics do not. He also spoke of the "dominant narrative" in the public's mind, citing UK Prime Minister Gordon Brown's oscillating public standing as a good example. "Markets can stay irrational longer than you can stay insolvent" was just one of the "stories" of an internation global economic "storyteller" from an earlier era, John Maynard Keynes (New Scientist 18 October 2008).

' "stories" had long since been ditched from their dominant (or master) narrative status (more views on Keynes - anyone who has been in a political election campaign can vouch for the media's fixation with the "dominant narrative" (nb I was a candidate in four local council elections in the 1980's -1990's - successful in 3 - including an unwinnable election - and so can attest that it even operated at that level!) . So Keynes' "stories" were jettisoned for those of a new "storyteller", Dr Alan Greenspan, who as the international global economic "storyteller" & head of the USA's Federal Reserve, was considered to be infallible for over 20 years, until late 2008. He told members of the US House Committee on Oversight and Government Reform "that he was 'partially wrong" in not having to regulate the market for credit-default swaps. ... Dr Greenspan conceded a more serous flaw in his own philosphy that unfettered free markets sit at the root of a superior economy ....."I made a mistake in presuming that the self-interests of organisation, specifically banks and others, were such that they were best capable of protecting their own shareholders and their equity in the firms.' ... Dr Greenspan said he was in "a state of shocked disbelief" about the breakdown in the ability of the banks to regulate themselves." (refer Sydney Morning Herald Oct 25-26 2008 & The Australian - Wall Street Journal Oct 25 2008). Thus was Greenspan's view on the expected behaviour of markets and banks, and it was the dominant narrative for decades.

Key aspects of the unravelling of Greenspan's dominant narrative : there was not clear disclosure of the make-up of bank assets and of the assumptions backing their valuations, and thus many banks became radically undercapitalised with highly optimistic risk weightings, according to James Ferguson, Pali International (New Scientist 18 October 2008).

Ten years ago there had been a huge antiglobalisation movement aimed at stopping the Multilateral Agreement on Investment, aka the MAI. The fear had been that in setting up this treaty that individual nations would have to water down their own sovereign legislation covering industrial relations, social policy, environment protection and much more. Opposition forces were drawn "a broad church" from the political left across to the religious Christian right wing groups, who whipped up fear that it would herald the arrival of the New World Order. Also opposed was Pauline Hansen and One Nation suppporters. A very broad church indeed!

Ultimately the formal treaty did not proceed. However at the time some socially progressive economists did admit that there were merits to the MAI - provided an appropriate set of rules and governance principles were incorporated into the treaty. However virtually any set of rules and governance were considered an anathema and too restrictive at the time, especially by the World Trade Organization, WTO. That was of course prior to the Enron situation in the USA and the subsequent introduction of the Sarbanes-Oxley legislation, which was initially supported and later opposed by Dr Greenspan . It introduced stringent new rules with the stated objective: "to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws". In Australia, the MAI preceded the HIH & One-Tel corporate collapses. Nevertheless various world trade negotiating rounds continued on, eg Doha, and in fact there was considerable cross border investment activity. Individuals, businesses and various tiers of government alike traded, invested and borrowed globally. - thus leading to an ever increasing connectedness.

Perhaps there may be a need for a new Bretton Woods system to create a new global economic architecture for the 21st Century. This possibility was raised by Professor Geoffrey Garrett, CEO of the US Studies Centre, University Sydney, in his Sunday Telegraph newspaper column "New World Order" 26/10/2008. Garrett claimed in his column that "Today's global economy is de-centred, full of different views amont the many players."

However there is some dissent from this view. Debora Mackenzie, in New Scientist Oct 25 2008, in asking the question "How do we re-engineer it so that breakdowns don't happen again? "

What ? Go to a science magazine to explain economic meltdowns and to find solutions to our global crisis ? .. I queried.

However Mackenzie reported that "one place to start is the science of complexity itself" .... shades of David Snowden and Cynefin, it seemed to me, and also of Nassim Taleb's "Black Swans". Mackenzie goes onto explain that "existing economic policies are based on the theory that the economic world is made up of a series of simple, largely separate transaction markets" (sounds a bit like Professor Geoffrey Garrett?). Mackenzie goes further however and that according to complexity researchers ... "This misses the fact that all of these transactions affect each other. ... Instead they see the global financial system of complex interrelationships, like an an electrical grid .... apparently unimportant changes ... crept into the global financial system ... none on their own seemed big enough to trigger a response ..... So how exactly has the financial system come to be so vulnerable ? One key factor is that money can now flow more easily from country to country. This has stimulated trade and prosperity throughout the world., but it also means that an upset in one place can have severe and unpredictable consequences elsewhere." In fact Nassim Taleb's essay "THE FOURTH QUADRANT: A MAP OF THE LIMITS OF STATISTICS" is an interesting critique with his view "let's face it: use of probabilistic methods for the estimation of risks did just blow up the banking system."

This reminded me of the old "Chaos" theory of the 1960's & promoted greatly in the 1980's.

Mackenzie also reported that Paul Krugman of Princeton University & NY Times columnist, winner of the 2008 Nobel Prize in Economics had only recently "published an analysis which concluded that the rapid increase in cross-border investments since 1995 is what allowed a local shock - the collapse in inflated US real estate values - to propagate globally, especially through highly indebted investment firms that can respond to a loss of money in one place by pulling back credit anywhere in the world.... Krugman noted that 'these channels are not yet part of the standard analysis'. This is exactly the kind of linkage that the complexity theorists say economists have been missing." Mackenzie also refers to Johan Rockstrom of the Stockholm Environment Institute, who claimed that "one of the key ways in which diversity was lost arose from the uniformity of criteria that have been used to judge economic success ... when use of (these measures sic) was proposed, critics argued that this would encourage herd behaviour, with banks rushing en masse to sell off assets what were depressing their 'VaR' numbers, but their concerns were ignored. "

I wondered then if perhaps Geoffrey Garrett's view that "Today's global economy is de-centred, full of different views amont the many players" is not quite so.

And then I thought of the work done on social network analysis and business network analysis covered by Laurence Lock Lee and Graham Durant-Law at ACTKM 2008. Both had focused on interconnectedness and what could happen if key nodes were broken in the network. They both emphasised that removing a seemingly minor node, connecting two other large sub networks, can indeed be far more crucial than previously recognised. Perhaps Iceland's economy or Lehmen Brothers could be considered as such individual nodes. Lock Lee, together with Cai Kjaier and Barbara Nedderfield had developed strategies as to how organisations might become more resilient to the effects of losing a single node. Such a proactive approach if extrapolated could provide a starting point for future goverance of international financial systems.

Graham Durant-Law also indicated that the approach was challenged in providing an accurate analysis when applied to larger systems. Nevertheless to me, "sensemaking" of the crisis became 'personally possible" by putting it through the "SNA-BNA lens in a Cynefin approach".

Perhaps those feared a "MAI on steroids" back in the 1990's had some justification. But to ignore the immense benefits that globalised markets can bring is equally naive. There seems to be merit in Geoffrey Garrett's view that "may be a new Bretton Woods system to create a new global economic architecture for the 21st Century ". However it would need to be subject to rigorous analysis encompassing a "complexity theory's" take on network analysis methodologies, a super SNA-BNA approach. And perhaps the lessons from SNA about how to improve a system's resilience in the context of nodes being removed should be considered. Absolutely essential as well the "dominant economic narratives" and their storyteller(s) should not be regarded as infallible, but rather as a best approximation, needing to be subject to test and verification. This is probably going to inevitably involve increased governance to protect banks and markets against themselves ... just as the anti-MAI movement had clamoured for in the late 1990's. And Herman Daly, former senior economist to the World Bank & now Professor of Ecological Economics at the University of Maryland, would argue that economists must also factor in the Environment, and that our world view must be one of an ecosystem (New Scientist 18 October 2008). But how long will it take our governments to build this new system?

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