The ButterflyEffect and Wall Street

So it's been a while since I posted - believe it or not, I've been busy! It's amazing how busy one can get with a house, spouse, three kids, two cars and a job. . .

That hasn't stopped me from keeping up with the daily flood of news about the financial crisis. While things seem to have stabilized a bit and we aren't seeing 400 point swings in the Dow daily, it's still a roller coaster ride on a daily basis and the U.S. government continues to roll out more guarantee's. Not good.

On that point, I watched a terrifying segment on PBS tonight. The nightly Business Desk interviewed Nassim Taleb and Benoit Mandelbrot. . .who are they, you ask? Well, Benoit Mandelbrot is a french mathematician and the father of fractal geometry. He is better known for his groundbreaking work supporting chaos theory, better known as the "Butterfly Effect":

The flapping of a single butterfly's wing today produces a tiny change in the state of the atmosphere. Over a period of time, what the atmosphere actually does diverges from what it would have done. So, in a month's time, a tornado that would have devastated the Indonesian coast doesn't happen. Or maybe one that wasn't going to happen, does.

Nassim Taleb, on the other hand, is a former finance manager who has written significant financial analysis books based on the Butterfly Effect, notably a book called the Black Swan. He is also known for predicting 2 years ago much of the current financial crisis, in particular the breakdown of the international banking system.

They are both very worried about the financial crisis and don't believe we've seen the end of it. Their premise is that the current series of worldwide financial stimulus are susceptible the butterfly effect, an unpredictable chain of events that result in unintended consequences. Worse, the efficiency of our global markets, the speed with which transactions move throughout the world, can amplify events within the chain, rapidly making them much worse. Finally, the network effect of global interconnected markets also amplifies consequences (and mistakes) globally. Further, they believe that due to the rapid speed of the crisis (due to the efficiency of our markets) global leaders have simply not had time to analyze the potential impacts of their actions. As a result, they fear that while we've avoided a meltdown now, the butterfly effect will kick in viciously down the road. The saving grace is that none of their theories clearly predict human behavior, and our uniqueness and oddness may save us all. Ironically they are also very concerned about the recent consolidation within the banking system since it will concentrate risk to a few large firms, amplifying mistakes (such as the recent $800 million dollar bad trade made by a French bank resulting in it's near failure).

If you are interested, go here to listen.