This type of reckless behavior has resulted in chaos, wrecked the dam, destroyed crops and obviously reduced the value of the dam, while increasing the cost of liquidity!

These people should be going to federal prison!

One of the things that helps to enable non-linear behavior in a complex system is promiscuity of information (i.e., feedback loops but in a more generalized sense) across a wide scope of the system.

One way you can attempt to stabilize a complex system through suppressing its non-linear behavior is to divide it up into little boxes and use them to compartmentalize information so signals cannot easily propagate quickly across the entire system.

This principle has been recognized in the design of software systems for several decades now, and is also a design principle recognizable in many other systems both natural and artificial (c.f. biology, architecture) which are very robust with regard to exogenous shocks. Stable systems tend to be built from structural heirarchies which do not share much information across structural boundaries, either laterally or vertically. That is why you don’t die from a heart attack when you stub your toe, your house doesn’t collapse when you break a window, and if your computer crashes it doesn’t take down the entire internet with it.

Glass-Steagall is a good example of this idea put into practice. If you use regulatory firewalls to define distinct investment sectors and impose significant transaction costs at their boundary that will help to reduce the speed and amplitude of signals which will propagate from one sector to another, so a collapse in one of them will be less likely casue severe problems in the others.

It worries me that we’ve torn down most of these barriers in the last several decades in the name of arbitrage, forgetting that the price we paid for them in inefficiency was a form of insurance against the risk of systemic collapse. This is exactly what I would do if I wanted to take a more or less stable, semi-complex system and drive it in the direction of greater non-linearity.

I think this was to some degree inevitable – it is a symptom of the decay and loss of trans-generational memories from our last great systemic shock in the 1930s. I suspect that something like this is bound to happen every 3-4 generations as we unlearn the lessons our grandparents and great-grandparents learned to their cost.

-Anon2:56

You complex systems comment is an important observation. Can you elaborate? Thanks.

Even more ironically, the long term effect of attempting to use excessive liquidity to transmorgify risky illiquid assets into the equivalent of cash has been to transfer risk from the former to the latter. We started out trying to make buying houses as safe as holding dollars, and ended up making holding dollars as risky as buying a house.

Perhaps a lesson to be learned here is that liquidity acts as an efficient conductor of risk. It doesn’t make risk go away, but moves it more quickly from one investment sector to another.

From a complex systems theory standpoint, this is exactly what you would do if you wanted to take a stable system and destabilize it.

To me, much of the distorted thinking regarding liquidity has its root in the tortuous notion that there is no distinction between price and value. If transactions are based on accurately assessed and stable values, than liquidity is a good, and one should presume that said liquidity in executing transactions closely tracks the inherent risk of the assets and terms involved. But if liquidity is based on price, stability and risk are inherently obscured—and too easily and too often forgotten altogether.

Consider our present situation: government intervention in the financial markets has indeed provided liquidity, but with valuation discovery, counterparty risk, and systemic stability all still deeply obsured we have little in the way of transactions. Soooo . . . valuation does appear to matter after all, what?

I’ll repeat this because it has been so often dismissed and remains obscured: Where valuation is transparent, liquidity—high or low—corresponds directly and closely to it. That kind or liquidity, but _only_ that kind is good. HIghly liquid but value-obscured assets or transactions, are, well, vaporous and combustible, as we now see.