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Connectivity, Organization Behemoths and Systemic Risk

Connectivity in financial markets is creating OB and providing the seeds via the imitation process for systemic risk or catastrophes. The same forces that I discussed earlier in Chap. 3, network effects and information cascades, are at play in the financial environment. Financial institutions being behemoths are not the problem - it is that they are too similar.

The problem of imitation arises where each node influences, and in turn is influenced by, the decisions made by other nodes - in other words, imitation or copying. Connectivity due to the Internet drives information sharing and cooperation, which then extends to collaboration and copying. Copying is to be interpreted broadly in that one node’s behavior may form the template for another node’s actions. The underlying logic is the fear of missing out (FOMO) from a rewarding outcome by not adopting a certain behavior.

Among the multiple causes of the potential “global financial meltdown” in 2008-2009, Alan Blinder lists three that have relevance here: the housing bubble or inflated asset prices, excessive leverage throughout the financial system and novel mortgage lending practices [90]. All of these had one factor in common: copying.

Bubbles, according to Blinder, are “a large and long-lasting deviation of the price of an asset from its fundamental value” [90].4 The belief that house prices would continue to rise was based on observing and copying the actions of previous home buyers, who had accrued financial rewards. Blinder extends this argument as follows:

You allegedly couldn’t lose by investing in houses - which would rise in value by 10 percent or so a year forever... So too many American took on too much debt to buy houses they couldn’t afford - and then refinanced them several times to pocket capital gains. The media fed the beast by hyping the good real estate news. [90]

There can be a tremendous impact of the network on social and economic processes by influencing decision-making. First, feedback effects, with individuals copying each other, can arise spontaneously or by design. Second, copying can arise from the benefits, or network effects, of joining a group. When the network shares a common product or characteristic or idea, network effects can also explain the diffusion of innovations and ideas. And third, the most extreme form of copying leads to power law effects, where all nodes congregate at some hub, adopting the same economic responses leading to catastrophic situations.

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