Greenspan, sub-prime and tipping points

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Interesting to hear Alan Greenspan lay the blame for the scale of US troubles right at the door of the sub-prime idiocy. Since I commented on this, others have insisted it’s much more complicated than this – maybe , but don’t underestimate the power of that much misunderstood phenomenon – tipping points.

As commonly understood, and indeed as explained in Michael Gladwell’s popular book, it’s all about the take-off of self-reinforcing effects. But there’s a much more powerful source of tipping points – threshold effects. To take a simple example – a service team can cope just fine if calls are 80, 90 or 99% of its capacity to respond, but at 101%, performance collapses. There are many other examples, including economic cases – e.g. when the Indonesian economy fell back by a few percent in the late-90s downturn amongst the Asian tigers, demand for new cars fell – not by a few percent, but by more than half!

So .. just how much damage could a 3% increase in sub-prime mortgage defaults do to the US financial system? [see Randall Dodd, Subprime: Tentacles of a Crisis] .. depends just how close key parts of the system had been taken to critical thresholds, and hence to powerful tipping points. Greenspan made a further point – that he [and we] had assumed banks sought to protect their investors from risk, but that seems not to have been the case over the last 5 years – instead, they took us all just that bit too close to those thresholds.

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