Markets have been in turmoil for much of the year on concerns the global economy is heading for another recession. The suspected culprits are many: the plunging price of commodities and oil, crisis in the Middle East, a slowing China and other emerging countries, and weak prospects for financial markets in general.
Coming less than a decade since the global financial crisis dealt a devastating blow to economies around the world, the current challenges raise the question of how resilient our societies are to such shocks.
In our own research, we pondered a different question: what factors make one region more resilient than another? The answer could help us understand how to make our economies better able to resist the next shock, be it financial, a natural disaster, or something else.
We need a better way to help the banking industry and its regulators make decisions based on sound information and avert another near-collapse of global financial system, says John Lietchy, marketing professor in Penn State’s Smeal College of Business, in the April 12 issue of Nature.
To make his point more understandable to the non-specialist, Liechty compares the global financial system to a shopping mall that requires customers to buy tickets in order to enter and exit the mall. A statistical model can be built to track and predict door traffic – when and where and how many shoppers enter and exit the mall. But what happens if a store in the mall catches fire and shoppers rush for the exits and the ticket-takers are overwhelmed? A fire in the mall, Liechty says, is analogous to a credit-confidence crisis, when banks are unwilling to make loans or accept collateral in exchange for securing debts.
The models now in use, he says, are fine for measuring risk when financial markets act conventionally, i.e., when the mall is operating normally. But current models lack crucial data — about the interconnectivity between financial houses, for example, and the capacity of markets to execute trades — that undermines their reliability in times of crisis, i.e., when the mall catches fire.
The question is, can new scientific models be constructed that predict shopper behavior (how banks and other financiers will act) when a fire (a credit-confidence crisis) breaks out? Liechty offers some interesting thoughts.
Liechty knows his way around banks and their regulators. The Office of Financial Research, a new federal oversight agency established by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, grew from an idea that he outlined at a February 2009 conference on financial risk.