Discussing the origins of the financial crisis with a group of academics at the London School of Economics, in November 2008, Britain’s incredulous Queen asked how the financial crisis had managed to catch us all by surprise.1 The story is oft retold and a responsive letter to Her Majesty has become well known.2
In July 2009, the British Academy convened a forum of industry veterans, regulators, academics, and government figures to discuss how the Queen’s simple question might best be answered. “Risk calculations were most often confined to slices of financial activity, using some of the best mathematical minds in our country and abroad,” the group explained, “but they frequently lost sight of the bigger picture.” Though some had sounded warning, “most were convinced that banks knew what they were doing,” the letter continued. Alas, the risk management orthodoxy in which a generation of bankers and economists was steeped had left them convinced that their math had mastered risk. And they were wrong, the letter explained. At bottom, the British Academy group concluded, the crisis reflected “a failure of the collective imagination of many bright people, both in this country and internationally, to understand the risks to the system as a whole.”
Less well known is another responsive letter to Her Majesty, penned a month later by Professor Geoffrey M. Hodgson, a specialist in institutional and evolutionary economics. Unsatisfied with the response posed by the British Academy group, Hodgson wrote the Queen to complain that “the narrow training of economists — which concentrates on mathematical techniques and the building of empirically uncontrolled formal models — has been a major reason for this failure in our profession.”3 Economists had limited themselves to an overly narrow reference narrative, that is, robbing them of that “species of judgment, attainable through immersion in a literature or a history, that cannot be adequately expressed in formal mathematical models,” Hodgson wrote. These models are valuable, he allowed. “But given the complexity of the global economy, what is needed is a broader range of models and techniques governed by a far greater respect for substance, and much more attention to historical, institutional, psychological and other highly relevant factors.”
We extend on Professor Hodgson’s argument herein, expressing Our View with Scott Page, a University of Michigan professor of complexity, social science, and management. [See the Our View Article The Complexity of Regulation] “Models force us to clarify assumptions, to think logically, to question data, and to test causal and correlational claims,” Page writes. But to rely on any single model invites disaster, he warns. Page encourages us to adopt what he calls a “many-model” approach to assessing risk and uncertainty alike. This is particularly important for industry supervisors, who “never step in the same river twice.” Models that may have served in the past are not to be relied upon blindly going forward. “The risk management and supervision practice that could be called ‘narrowly we roll along’ must change,” Page urges. We must extend our thinking more broadly and marshal many models if we hope to scan the broad landscape of risk and uncertainty with greater success.
Other Articles in the Comments, Contributions, and Conclusions Series“What is it that distinguishes the thousands of years of history from what we think of as modern times?”
Hidden inexactitudes
“Radical Uncertainty”
"Why did no one see it coming?"
The real trouble with this world of ours
More meaningful metrics
“Too Big to Manage”
Drifting into failure
“Lying to Ourselves”
"We have literally no time even to be astonished."
“We need to develop a culture that empowers supervisors to act in the face of uncertainty.”
“Culture, more than rule books…”
“Proactive identification of threats to trust in banking.”
Blitzkrise
The illusion of control
What is Conduct Risk
“Changing banking for good”
Outcomes oriented
Achieving foresight
Trust matters
Mapping and tapping workplace networks
“An Epidemic of Loneliness”
The fourth wave
System shifts
Conduct: the new prudential risk
The costs of misconduct
Has banking changed for good?
Tribulations, and trials
Audit Quality Indicators
Shared interest and collective action
Nothing ventured…
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