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Interdisciplinary Approaches to Financial Stability

Interdisciplinary Approaches to Financial Stability

By Katie Vloet
October 28, 2015

A conference at the University of Michigan Law School presented interdisciplinary approaches to financial stability, drawing from fields as diverse as complex systems and infectious diseases to gain a better understanding of why financ​ial systems fail—as well as how to prevent a repeat of the financial crisis of 2008.

The Oct. 22-23 conference, “Interdisciplinary Approaches to Financial Stability,” featured regulators, policymakers, financial market participants, and academic researchers from a broad range of disciplines. Participants explored how methods from diverse fields, such as system analysis, agent-based modeling, and data visualization and security, can be used to better identify, measure, monitor, and mitigate risks in the financial system.

They also examined how risk is measured, monitored, and mitigated in other sectors and contexts, such as supply chains and electrical grids; how stakeholders make tradeoffs between stability, efficiency, and innovation in these contexts; and how lessons from these contexts can be applied to the financial system.

“An expert on complex systems—who helped to improve the safety of space-shuttle tiles—spoke about the ways that risk-analysis models fail to show everything that can go wrong. An epidemiologist talked about how contagion in the financial system resembles contagion of disease,” said Michael S. Barr, the Roy F. and Jean Humphrey Proffitt Professor of Law at U-M Law School and a nonresident senior fellow at the Center for American Progress and the Brookings Institution. Barr was a key architect of the Dodd-Frank Wall Street Reform and Consumer Protection Act. He directs the U-M Center on Finance, Law, and Policy, which co-hosted the conference with the federal Office of Financial Research.

“A number of senior people said to me afterward that the conference helped them to think about financial stability in completely new and different ways,” Barr said.

In the keynote conversation, Lawrence H. Summers, president emeritus and Charles W. Eliot University Professor at Harvard University, and former secretary of the U.S. Department of the Treasury, spoke with David Wessel, director of the Hutchins Center on Fiscal & Monetary Policy at the Brookings Institution. The financial system “has, with substantial frequency, failed,” Summers said, leaving people’s lives “hugely disrupted.” The most important lesson of the 2008 crisis, he added, is that the financial system can’t become “a source of instability that screws up the lives of millions of people.” Economic crises will continue to happen from time to time, he said, but “a great success would be turning a once-in-a-century event into a once-every-four-century event.” He said that the financial system is safer because of the enactment in 2010 of the Dodd-Frank Act and changes to global capital rules.

Andrew Haldane, chief economist and executive director of monetary analysis and statistics at the Bank of England, spoke in a keynote address about the need for interdisciplinary approaches in the financial sector—much like the patchwork of laws of nature detailed in the book The Dappled World (Cambridge University Press, 1999). With regard to making sense of the financial industry, “we are only beginning to scratch the surface of what might be possible,” Haldane said.

Richard Berner, director of the U.S. Office of Financial Research, spoke about four financial stability analysis tools derived from other disciplines: data visualization, stress tests, network analysis, and agent-based modeling. He also pointed out that financial shocks can’t be predicted or prevented. “Rather,” Berner said during his keynote, “financial stability is about resilience. We want to be sure that when shocks hit, the financial system will continue to provide its basic functions to facilitate economic activity.” Since the financial crisis of 2008, financial regulators have improved their ability to spot vulnerabilities and threats, he said, but more needs to be done.

It is important that financial systems not just manage boom cycles, but also that “the busts don’t bring the ceiling down,” said Sir Paul Tucker, senior fellow at the Harvard Kennedy School and former deputy governor of the Bank of England. Tucker spoke during his keynote address about the need for a standard of resilience—that is, the size of shock we want the financial system to be able to sustain—and what is meant by dynamic macroprudential supervision.

The conference was co-hosted by the federal Office of Financial Research and the U-M Center on Finance, Law and Policy, with support from the Smith Richardson Foundation, the U-M College of Engineering, and the U-M Ross School of Business. The Center also received support from alumni Paul Lee, Stef Tucker, Ron Glancz, and Bill Marcoux.

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