During the summer so far, I’ve been able to get a lot of reading done. Recently, I’ve been reading a lot of books about risk, and have come to see that there are some especially troubling and deeply flawed aspect of how our financial and economic systems function. At the same time, I’ve realized how applicable the basic concepts of sustainability are to economics and financial markets and how integrating them be could be highly beneficial.
Antifragile, by Nassim Nicholas Taleb, is an excellent and comprehensive work focusing on the widespread, and often misunderstood, risks and rewards of our society. Taleb compares two main systems. The first has constant, but mild, volatility. The second experiences rare, but violent and influential shocks. He advocates the importance of embracing the first system. Unfortunately, the financial system of the U.S. is most like the second system: highly fragile and unsustainable in the long-term.
Over the past fifty years, the U.S. has seen significant and impressive economic growth. However, amid this growth, there have been multiple intense recessions. Every 7-10 years or so since the 1970s a strong period of growth (in the stock market, for GDP, in the job market, etc.) has been interrupted by some type of adverse shock that throws the country into a recession and erases nearly all gains achieved over the period. In my lifetime alone, there’s been the dot-com bubble of the early 2000s and the most recent subprime mortgage crisis of 2007. Prior to each crash, the country and the stock markets had seen relatively undeterred positive growth for an extended period. But suddenly, as had happened before, the tides turned and all gains that had been accumulated over a number of years vanished. For instance, from the trough of the dot-com recession in mid-2002 to the height of the recovery in mid-2008, the S&P 500 nearly doubled. These 6 years of consistent growth were quickly wiped out with the subprime mortgage crisis, as the index plummeted, losing over fifty percent of its value in less than two years. The same thing occurred with the dot-com bubble.
I find it astounding that after multiple intense recessions, it seems that we never seem to learn. There is always a large positive boom followed by an often larger bust. Would it not be better to have a more fluid and smoothly operating financial and economic system that grows at modest rates and sees more frequent, but less intense downturns? We certainly wouldn’t have a recession every 5-7 years as we have for decades.
So what has been at the root of these booms and busts? I think at the heart of the problem is the widespread short-term thinking that exists throughout society. For the most part, people only consider actions and the consequences of their actions in the near term. In the housing crisis, banks did not think about the possible implications of providing housing loans and mortgages to practically anyone that walked through the door. They didn’t consider how pervasive the fallout from their fraudulent behavior would be and how many people it would adversely affect. The U.S. government tried to improve growth and quality of life of the country using an approach that was bound to fail. Providing cheap credit to millions of unaccredited borrowers did boost home ownership, which is a positive outcome. But, it all came crashing down when defaults began to pour in. The government’s plan had worked well for a few years, but its solution wasn’t a long-term one. It was merely a band-aid that could only post immediate results for so long. These kind of short-term actions needs to change.
As Taleb voices, we need to reduce the fragility of our systems (financial and otherwise) and work to transition towards more antifragility, more robustness. I think the way to achieve this is to start acting with a larger focus on long-term solutions that have long-term outcomes. While changing to this kind of approach will be difficult and might yield fewer immediate results, I would certainly argue that long-term gains with more distributed volatility are better than periods of growth bookended by devastating losses.
Sustainability is all about preparing for the long-term and perhaps making some short-term sacrifices to achieve long-term vitality. As a society we do not currently function this way (the government is only one example). Lamentably, the way it looks right now, with financial markets inflated once again (to an even larger extent than in the past) we could be heading towards another crash after nearly 5 years of practically constant growth.