Category Archives: General

Modelling leverage and the financial crisis

Science reports on agent based models of financial leverage –Leverage: The Root of All Financial Turmoil:

Given that in the buildup to the recent global economic meltdown hedge funds had been leveraging their deals by ratios of 30-to-1 (that is, borrowing $30 for every $1 of their own that they put in), it may seem obvious that massive leverage leads to trouble. But Stefan Thurner, an econophysicist and director of the complex systems research group at the Medical University of Vienna, Austria, and colleagues say their model shows that many of the distinctive statistical properties of financial markets emerge together as rates of leverage climb. “Leverage is the driver,” Thurner says. “That wasn’t obvious.”

Financial markets behave in ways that, econophysicists say, classical economic theory cannot explain. Classical economics assumes that the fluctuations in stock prices conform to a so-called Gaussian distribution—a bell curve that gives little probability to large swings. In reality, the distribution has “fat tails” that make big changes more likely, and the shapes of those tails conform to a mathematical formula known as a power law. Classical economics assumes that the fluctuations are uncorrelated from one moment to the next, whereas big swings in prices tend to come together in the so-called clustering of volatility.

To try to explain those characteristics, over the past 5 years Thurner and colleagues have developed an “agent-based model” of a market. In such a computer model, virtual agents of various types interact according to certain rules, like robots playing a game. The researchers included hedge funds that could borrow to make their investments; banks to loan the money; “noise investors” who, like day traders, simply react to the market and have no other insight into the value of assets; and general investors who played the role of, for example, state pension funds.

The model contains more than a dozen adjustable parameters. However, Thurner and colleagues found that the maximum level of leverage exerts a curious, unifying effect. If they forbade leverage, the market behaved largely as classical economics would predict. But as they increased the maximum leverage, the characteristics of real markets emerged together. “We can explain the fat tails, the right [power law], the clustering of volatility, all this,” Thurner says. And when the leverage limit climbed to levels of 5-to-1 and beyond, the market became unstable and hedge funds went bust much more often.

“I thought it was rather brilliant,” says Christoph Jan Hamer, an econophysicist with Solvency Fabrik in Köln, Germany. Hamer says he was impressed with a detail of the model: If leverage is high, then a tiny fluctuation created by the noise traders can trigger a much bigger swing. But Christian Hirtreiter of the University of Regensburg says, “I would think that leverage itself is not the problem. I would think it is a symptom of the problem.”

Thurner, who managed a hedge fund that tanked, says that limiting leverage should help prevent crashes. He admits, however, that he would not have embraced that idea when the market was still going strong.

Resilience: the Next Big Thing in Foreign Policy

Jamais Cascio, who is really writing a lot on resilience these days, writes in Foreign Policy magazine The Next Big Thing: Resilience.  He provides a good summary introduction to resilience, using definitions very similar to those we use in the Resilience Alliance.

Sustainability is a seemingly laudable goal it tells us we need to live within our means, whether economic, ecological, or political but it’s insufficient for uncertain times. How can we live within our means when those very means can change, swiftly and unexpectedly, beneath us? We need a new paradigm. As we look ahead, we need to strive for an environment, and a civilization, able to handle unexpected changes without threatening to collapse. Such a world would be more than simply sustainable; it would be regenerative and diverse, relying on the capacity not only to absorb shocks like the popped housing bubble or rising sea levels, but to evolve with them. In a word, it would be resilient.

Resilience … accepts that change is inevitable and in many cases out of our hands, focusing instead on the need to be able to withstand the unexpected. Greed, accident, or malice may have harmful results, but, barring something truly apocalyptic, a resilient system can absorb such results without its overall health being threatened.

Like sustainability, resilience encompasses both strategy and design, guiding how choices are made and how systems are created. Stripped to its essence, it comes down to avoiding being trapped or trapping oneself on a losing path. Principles of resilience include:

  • Diversity: Not relying on a single kind of solution means not suffering from a single point of failure.
  • Redundancy: Backup, backup, backup. Never leave yourself with just one path of escape or rescue.
  • Decentralization: Centralized systems look strong, but when they fail, they fail catastrophically.
  • Collaboration: We’re all in this together. Take advantage of collaborative technologies, especially those offering shared communication and information.
  • Transparency: Don’t hide your systems transparency makes it easier to figure out where a problem may lie. Share your plans and preparations, and listen when people point out flaws.
  • Fail gracefully: Failure happens, so make sure that a failure state won’t make things worse than they are already.
  • Flexibility: Be ready to change your plans when they’re not working the way you expected; don’t count on things remaining stable.
  • Foresight: You can’t predict the future, but you can hear its footsteps approaching. Think and prepare.

Ultimately, resilience emphasizes increasing our ability to withstand crises. Sustainability is a brittle state: Unforeseen changes (natural or otherwise) can easily cause its collapse. Resilience is all about being able to overcome the unexpected. Sustainability is about survival. The goal of resilience is to thrive.

Caribbean reef fish decline in wake of coral collapse

A recent paper by Paddack et al in Current Biology (doi:10.1016/j.cub.2009.02.041) that shows that observed declines in fish populations in the Caribbean are  consistent across all subregions of the Caribbean basin (2.7% to 6.0% loss per year) and appear to be linked to coral reef collapse.  In Science Jackie Grom reports on the paper in Reef Fish Threatened by Coral Loss:

Ecologist Michelle Paddack, a postdoctoral student at Simon Fraser University in Burnaby, Canada, teamed up with an international group of scientists to find out. They analyzed data from 48 studies, including peer-reviewed papers, government and university research reports, and unpublished data sets, that covered trends on 318 Caribbean coral reefs and 273 species of reef fish over a 53-year period. Today in Current Biology, the team reports that reef fish populations were relatively constant from 1955 through 1995 but then plunged by about 3% to 6% each year through 2007. The declines occurred in three of six dietary groups, including those that fed primarily on algae, invertebrates, or a combination of fish and invertebrates. The loss of algae-eating fish, such as parrotfish and surgeonfish, is worrying, says Paddack, because they help the reefs thrive by clearing away algae.

The declines don’t appear to be caused by overfishing, because the losses were similar for fished and nonfished species. Paddack says that doesn’t mean fishing doesn’t have an impact but that something even bigger is influencing the entire sea. The researchers suggest that the culprit is unprecedented loss of coral reefs over the past 3 decades. Even though the reduction in fish populations lags nearly 20 years behind the coral loss, the consistency in fish declines across a wide range of species points to the loss of coral as the cause, they say.

“We’ve known that corals are declining and fish are declining, but boy, I think it’s powerful just to see the patterns at the regional scale,” says marine ecologist John Bruno of the University of North Carolina, Chapel Hill. Biologist Richard Aronson of the Florida Institute of Technology in Melbourne says that the suggestion that coral reef loss is behind the declines in reef fish is intriguing. But to nail down the link, he’s hoping to see studies that relate fish declines to the time it takes for the reefs to structurally deteriorate after they die. “I liked this paper a lot; it got me excited [about coral reefs] all over again,” he says.

Stockholm Resilience Centre is looking for Seven new PhD students

The Stockholm Resilience Centre a joint centre of the Stockholm University, the Royal Swedish Academy of Science and the Stockholm Environment Institute, is looking for seven transdisciplinary PhD students who are interested in working on resilience issues in sustainability science.

The positions are:

These students will all be part of the new Resilience Graduate School which will help build the next generation of transdisciplinary thinkers and doers in sustainability science. The program will explore resilience theory and research methodologies, adaptive governance, and social-ecological transformation.

The application procedures are formally run by collaborating departments at Stockholm University.  Final date for applications  is between May 2-4th, 2009.

For further information on the PhD positions see:
www.stockholmresilience.su.se/graduateschool

The Way of All Debt

payback-bookBritish political philosopher John Gray reviewed Margaret Atwood‘s prescient book Payback: Debt and the Shadow Side of Wealth in the New York Review of Books article The Way of All Debt:

One of the many impressive features of Margaret Atwood’s new book is its almost eerie timeliness. Consisting of five chapters that were broadcast in November 2008 by the Canadian Broadcasting Corporation as the Massey Lectures, a series intended to provide a radio venue for the exploration of important issues, Payback appeared in print last October. The book must have been written some months earlier, but there is no sign that it was composed in haste. Atwood examines the role of ideas of debt in religion, literature, and society; she discusses the nature of sin, the structure of plot in fiction, the practice of revenge, and the ecological payback that occurs when human beings take from the planet more than they return. A celebrated novelist, poet, and critic, Atwood has combined rigorous analysis, wide-ranging erudition, and a beguilingly playful imagination to produce the most probing and thought-stirring commentary on the financial crisis to date.

Atwood’s project is to show how human thought has been deeply shaped by notions of debt. It will be objected that she is merely spinning out an extended metaphor suggesting analogies between debt and noneconomic phenomena that are only vaguely analogous. In fact she is advancing the contrary and more interesting claim that economic activities involving borrowing and lending are metaphorical extensions of an underlying human sense of indebtedness. Beliefs about get paid debt are not shadows cast by processes of market exchange. They are presupposed throughout much of human activity. Economic life invokes a sense of order in human affairs, widely dispersed throughout society.

There is another, larger obstacle to restoration of the American economy. The level of consumption achieved in America in recent decades did not depend only on a high level of borrowing from China. It also involved running up a large debt to the planet. In the last chapter of Payback, Atwood imagines an amusing and enlightening dialogue between a latter-day Scrooge—”Scrooge Nouveau,” a self-centered hedonist who believes he owes nothing to anyone else—and “the Spirit of Earth Day Past.” The Spirit’s message to Scrooge is that there are limits to the expansion of production, consumption, and human numbers:

Mankind made a Faustian bargain as soon as he invented his first technologies, including the bow and arrow. It was then that human beings, instead of limiting their birth rate to keep their population in step with natural resources, decided instead to multiply unchecked. Then they increased the food supply to support this growth by manipulating those resources, inventing ever newer and more complex technologies to do so…. The end result of a totally efficient technological exploitation of Nature would be a lifeless desert: all natural capital would be exhausted, having been devoured by the mills of production, and the resulting debt to Nature would be infinite. But long before then, payback time will come for Mankind.

Atwood puts into the mouth of the Spirit a “limits-to-growth” argument of a sort that is nowadays highly unfashionable. Contemporary evangelists of the free market, Marxian social critics, many religious fundamentalists, and most development economists are at one in believing that neo-Malthusian claims about the scarcity of resources are groundless; and that a mix of moral regeneration, institutional reform, and technological innovation can overcome natural limits to growth.

Yet Atwood seems to me to have the truth of the matter. Global warming as we observe it today is a byproduct of the industrial expansion of the past two centuries.

If Atwood’s Payback contains a lesson it is that debts must be repaid. The type of political economy that operated in the US over the past twenty years, which some imagined would spread throughout the world, was based on the belief that this old-fashioned maxim no longer applied. A new era had arrived, in which sophisticated techniques of financial management could transform debt into a means of wealth creation from which even the poor could benefit.

The new era turned out to be short-lived, or else nonexistent. America was able to live on credit only by borrowing from other countries, above all China. With the bursting of the bubble it has become less clear whether America’s creditors will continue to commit funds on the required scale, while the claim of American finance capitalism to be a universal economic model has collapsed. Along with other governments, the Obama administration is faced with the task of dealing with the danger of recession turning into something worse. A large-scale monetary and fiscal stimulus will be administered in order to stave off depression. We must hope the stimulus has the desired effect. Whether or not it succeeds, it involves a redistribution from savers to borrowers that does not square with traditional values regarding the payment of debt. In order to resume economic growth, past debts will be devalued and new debts incurred.

That does not mean payback will be avoided. Returning to the levels of consumption of the recent past means running up an ever-larger environmental bill. As Atwood argues, there must eventually be a reckoning; the ancient conception of a link between human society and the natural world has not been rendered obsolete. If humanity is unwilling or unable to pay back its debts, the planet will surely collect.

Suggested by Brian Walker

Ecology and Wikipedia pt 2

To follow up on my post Wikipedia and ecology, the ESA blog EcoTone has posted an interview with the authors of the recent TREE paper on wikipedia (DOI:10.1016/j.tree.2009.01.003):

Why don’t you think more scientists contribute to Wikipedia?

EB: I know exactly why they don’t contribute. It’s because they don’t get any credit for it. We get credit for certain things to get promoted in science, and writing Wikipedia entries isn’t one of them. We work on an incentive system, and the incentive isn’t there.

Touché. What are some incentives that could be added?

EB: At a university, the ways to get credit would enhance your publication record, enhance your teaching program, and — if you’re at a land-grant university — enhance your extension program. Incorporating revision of Wikipedia entries into classes is a really creative way to get these entries revised. Students are on the cutting edge in terms of knowledge of the literature and they can further practice their writing by editing entries. Assigning them as projects hits all those goals we have as teachers: writing, critical thinking, and revisions of the literature. And it also gets that quality of thinking and writing out there for everyone else to see.

Kristine, as a student, what was your most valuable experience with this project?

KC: We were much more motivated to do a good job than if we were just turning this assignment in to a professor. This was going to go out to everybody, so we wanted to triple-check everything and make sure that it was exactly the way that we wanted it. If you’re just doing a term paper, sure, you do a good job, but it only influences your reputation with the professor. Not only did we learn something, but we also gave back to society. Also, we didn’t just learn how to publish, but we learned how to publish collaboratively. It’s very easy when there are just two or three authors on a paper, but …how many did we have, twelve authors?

EB: Fourteen. There were fourteen student authors on the paper, besides me.

KC: It’s a whole new ball game when you have fifteen different authors trying to agree on things.

So, given your experience, how would you convince scientists that they should contribute to Wikipedia?

KC: No matter where you publish, even if you’re publishing in Science or Nature, you’re not getting your research out to as many people as you will through Wikipedia. And it’s so important today because so much of the general public doesn’t understand or appreciate the science that goes on. Disseminating knowledge can really help motivate more appreciation and more funding for the sciences. If we continue to publish only in journals that scientists read, the public will continue to be in the dark.

EB: It’s a way to do the things that we want to do as teachers while also doing the things that our universities want us to do for the public.

Wikipedia and Ecology

Journal Watch Online reports on a recent TREE paper Callis et al Improving Wikipedia: educational opportunity and professional responsibility (DOI:10.1016/j.tree.2009.01.003 ) in Open Source Ecology

A University of Florida professor directed those energies towards a more noble cause: surveying and improving Wikipedia entries on ecological topics. The graduate students, enrolled in a seminar on plant-animal interactions, found the entries on frugivory, herbivory, pollination, granivory and seed dispersal to be lacking in breadth, and sometimes sidetracked by irrelevant topics (they were especially piqued by a long discourse about fruitarians – humans who choose a fruit diet — in the frugivory entry).

In Trends in Ecology and Evolution, the class reports that, although occasionally frustrated by other authors determined to repeatedly delete their changes, improving the entries was a valuable educational experience not too much different than writing a term paper.

They argue that updating Wikipedia, an increasingly influential public information source, is among the civic duties of scientists and should be an activity incorporated into student coursework, professional meetings, and even the peer-review publication process

Comparing Panarchy and Pace Layering

On the EcoTrust web magazine People and Place Howard Silverman compares Stewart Brand‘s concept of Pace Layering with Panarchy in Panarchy and Pace in the Big Back Loop:

“The back loop is the time of the Long Now,” writes Resilience Alliance founder Buzz Holling. It is a time “when each of us must become aware that he or she is a participant.”

“The trick is to treat the last ten thousand years as if it were last week, and the next ten thousand as if it were next week,” advises Stewart Brand in The Clock of the Long Now. “Such tricks confer advantage.”

Though Brand’s book precedes Holling’s “Complex Worlds” paper, their dialog runs pretty much like that. And the discussion turns on a pair of interrelated metaphors: panarchy and pace layering.

Mapping Metaphors
Holling and colleagues represent a familiar pattern of growth, conservation, release and renewal in the model of the adaptive cycle. A layering of adaptive cycles becomes a panarchy. The panarchy represents evolving interactions across ecological and social scales of time and space from, say, the pine cone to the forest to the forest products company.

Brand’s metaphor is pace layering, “the working structure of a robust and adaptable civilization.” Organized fast to slow, the layers are: fashion, commerce, infrastructure, governance, culture, and nature. With a nod to Holling, Brand writes, “The combination of fast and slow components makes the system resilient.”

What can we learn by mapping pace against panarchy? Picture a stack of adaptive cycles, with frantic fashion at the bottom, and nature’s biophysical processes, broad and slow, at the top. Reaching from each cyclic layer down to the next is an arrow labeled “remember,” for memory is an important influence that slower cycles exert on faster ones. And stretching from each cycle up to the next is the arrow “revolt,” representing the actions that, in the time of the back loop – of release and subsequent renewal – can enact structural shifts in the cycles above.

Thanks to Buzz Holling for the pointer.

More on Iceland and the Financial Crisis

Michael Lewis writes vividly about Iceland, fishing, and its financial crisis in his Vanity Fair article Wall Street on the Tundra:

Iceland’s de facto bankruptcy—its currency (the krona) is kaput, its debt is 850 percent of G.D.P., its people are hoarding food and cash and blowing up their new Range Rovers for the insurance—resulted from a stunning collective madness. What led a tiny fishing nation, population 300,000, to decide, around 2003, to re-invent itself as a global financial power? In Reykjavík, where men are men, and the women seem to have completely given up on them, the author follows the peculiarly Icelandic logic behind the meltdown.

Fishermen, in other words, are a lot like American investment bankers. Their overconfidence leads them to impoverish not just themselves but also their fishing grounds. Simply limiting the number of fish caught won’t solve the problem; it will just heighten the competition for the fish and drive down profits. The goal isn’t to get fishermen to overspend on more nets or bigger boats. The goal is to catch the maximum number of fish with minimum effort. To attain it, you need government intervention.

This insight is what led Iceland to go from being one of the poorest countries in Europe circa 1900 to being one of the richest circa 2000. Iceland’s big change began in the early 1970s, after a couple of years when the fish catch was terrible. The best fishermen returned for a second year in a row without their usual haul of cod and haddock, so the Icelandic government took radical action: they privatized the fish. Each fisherman was assigned a quota, based roughly on his historical catches. If you were a big-time Icelandic fisherman you got this piece of paper that entitled you to, say, 1 percent of the total catch allowed to be pulled from Iceland’s waters that season. Before each season the scientists at the Marine Research Institute would determine the total number of cod or haddock that could be caught without damaging the long-term health of the fish population; from year to year, the numbers of fish you could catch changed. But your percentage of the annual haul was fixed, and this piece of paper entitled you to it in perpetuity.Even better, if you didn’t want to fish you could sell your quota to someone who did. The quotas thus drifted into the hands of the people to whom they were of the greatest value, the best fishermen, who could extract the fish from the sea with maximum efficiency. You could also take your quota to the bank and borrow against it, and the bank had no trouble assigning a dollar value to your share of the cod pulled, without competition, from the richest cod-fishing grounds on earth. The fish had not only been privatized, they had been securitized.

It was horribly unfair: a public resource—all the fish in the Icelandic sea—was simply turned over to a handful of lucky Icelanders. Overnight, Iceland had its first billionaires, and they were all fishermen. But as social policy it was ingenious: in a single stroke the fish became a source of real, sustainable wealth rather than shaky sustenance. Fewer people were spending less effort catching more or less precisely the right number of fish to maximize the long-term value of Iceland’s fishing grounds. The new wealth transformed Iceland—and turned it from the backwater it had been for 1,100 years to the place that spawned Björk. If Iceland has become famous for its musicians it’s because Icelanders now have time to play music, and much else. Iceland’s youth are paid to study abroad, for instance, and encouraged to cultivate themselves in all sorts of interesting ways. Since its fishing policy transformed Iceland, the place has become, in effect, a machine for turning cod into Ph.D.’s.

Thanks to Arijit Guha for the pointer.

A report from Copenhagen

Climate change blues: how scientists cope a report from the recent Research Congress on Climate Change in Copenhagen:

Being a climate scientist these days is not for the faint of heart, as arguably no other area of research yields a sharper contrast between “eureka!” moments, and the sometimes terrifying implications of those discoveries for the future of the planet.

“Science is exciting when you make such findings,” said Konrad Steffen, who heads the Cooperative Institute for Research in Environmental Sciences (CIRES) in Boulder, Colorado.

“But if you stop and look at the implications of what is coming down the road for humanity, it is rather scary. I have kids in college — what do they have to look forward to in 50 years?”

And that’s not the worst of it, said top researchers gathered here last week for a climate change conference which heard, among other bits of bad news, that global sea levels are set to rise at least twice as fast over the next century as previously thought, putting hundreds of millions of people at risk.

What haunts scientists most, many said, is the feeling that — despite an overwhelming consensus on the science — they are not able to convey to a wider public just how close Earth is to climate catastrophe.

That audience includes world leaders who have pledged to craft, by year’s end, a global climate treaty to slash the world’s output of dangerous greenhouse gases.

It’s as if scientists know a bomb will go off, but can’t find the right words to warn the people who might be able to defuse it.