Riding The Risk

25. April, 2011

It’s a general misconception that if a human can’t see something, computers can’t either. From my experience, it’s usually one or the other. Or both.

When the financial system crashed, humans knew in advance. Well in advance. Everyone involved knew. The question wasn’t “Will it crash” but “When”. Those behind the bubble made a fortune by riding it. And they still do.

The computers didn’t see it coming because they weren’t meant to. That doesn’t mean it’s not possible, it means that the people, who make fortunes from these events, don’t like the idea of a computer telling the authorities what will happen and when. Especially not when a) they can’t make their fortunes first and b) everyone else has to pay the bill. Bonuses are back at the pre-crisis level. I wonder how that could happen.

Prof. Didier Sornette, Professor on the Chair of Entrepreneurial Risks of the ETH works in statistical models which predict bubbles and crashes. One way is actually pretty simple: If the growth of a market grows exponentially  (i.e. when x in 1^x starts to grow with 1^y where y > 1), there is a bubble forming.

So the problem were facing isn’t “we don’t know” but “we want lots of money.” Lots of money always comes at a risk. If nothing happens, people start to forget that. Or ignore it. Even if they know better. So laws and regulations which “harm the free market” are abolished. Until the next bubble when we all have to learn again why those laws and regulations were in place.

Computers can see things that we’d like to ignore.

I’m not saying computers should make the decisions; what I’d ask is this: When the computers predict a crash, everyone involved should be asked to sign an innocent little extra agreement that reads

In the case of a crash, I’ll be held liable for any damages caused by the crash, personal and fully, with all my wealth.

I’m not saying people want the crash. All I’m saying is that they have little reason to avoid it. It’s their job to make money. To make a lot of money, you need to accept a lot of risk. That’s OK. The problem is that there is no reason not to take intolerable risks. “It’s not my money”, “everyone is doing it”, “everyone makes lots of money, why not me”, etc. That’s human nature. And it’s human nature to start to think as soon as you get hurt personally when it goes wrong.

So let’s add some hurt to the system.

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