This is an interesting piece, written by an obviously very smart person. But the argument really seems to reduce to:
> The simple fact is that anybody who thinks they know what is going to happen is dangerous, because they are messing with something that is very powerful that they don’t even remotely understand, or understand how it will change in response to meddling.
Or, more specifically, there are economic reasons why the network formed the way it should so we disturb it at our peril.
Huh?
First of all, this line of argument would seem to doom any attempt to regulate the economy whatsoever. One can always say: but the market is really complicated and it has developed the way it has for good reasons so its dangerous to mess with it.
He's right that this will always raise the possibility of Unintended Consequences. So it's a welcome point. But he's also discounting the fact that, given people's level of expertise, and the sometimes dismal status quo, it's hardly self evident that regulation is never the right move. Returning to this case: it's the obvious response that the network may have evolved the way it did for good economic reasons, but we have good reason to doubt that these reasons adequately include the safety of the financial market as a whole in the very long term? This, of course, is why we have regulators in the first place: because the aggregate interests of private actors in the market do not always correspond to our collective social interests.
> One major problem–which I’ve been on about for years, and which I am quoted about in the Nautilus piece–is that counterparty credit exposure is only one type of many connections in the financial network: liquidity is another source of interconnection.
> As a practical example, not only does mandatory clearing change the topology of a network, it also changes the tightness of the coupling through the imposition of rigid variation margining. Tighter coupling can change the probability of the failure of connections, and the circumstances under which these failures occur.
> Another problem is that models frequently leave out some participants. As another practical example, network models of derivatives markets include the major derivatives counterparties, and find that netting reduces the likelihood of a cascade of defaults within that network. But netting achieves this by redistributing the losses to other parties who are not explicitly modeled. As a result, the model is incomplete, and gives an incomplete understanding of the full effects of netting.
> Thus, any network model is inherently a very partial one, and is therefore likely to be a very poor guide to understanding the network in all its complexity.
FWIW, I think he's right to bring this up, as there are things that we already know of that the topology model doesn't cover.
> The simple fact is that anybody who thinks they know what is going to happen is dangerous, because they are messing with something that is very powerful that they don’t even remotely understand, or understand how it will change in response to meddling.
Or, more specifically, there are economic reasons why the network formed the way it should so we disturb it at our peril.
Huh?
First of all, this line of argument would seem to doom any attempt to regulate the economy whatsoever. One can always say: but the market is really complicated and it has developed the way it has for good reasons so its dangerous to mess with it.
He's right that this will always raise the possibility of Unintended Consequences. So it's a welcome point. But he's also discounting the fact that, given people's level of expertise, and the sometimes dismal status quo, it's hardly self evident that regulation is never the right move. Returning to this case: it's the obvious response that the network may have evolved the way it did for good economic reasons, but we have good reason to doubt that these reasons adequately include the safety of the financial market as a whole in the very long term? This, of course, is why we have regulators in the first place: because the aggregate interests of private actors in the market do not always correspond to our collective social interests.