BA, Why Didn’t Anybody Notice?


Two letters from the British Academy addressing HM the UK Queen’s challenge to economists, delivered at LSE, November 2008.

British Academy Forum The Global Financial Crisis – Why Didn’t Anybody Notice? 22 July 2009

Many people did foresee the crisis. However, the exact form that it would take and the timing of its onset and ferocity were foreseen by nobody. What matters in such circumstances is not just to predict the nature of the problem but also its timing. And there is also finding the will to act and being sure that authorities have as part of their powers the right instruments to bring to bear on the problem.

But … most … believed that the financial wizards had found new and clever ways of managing risks. Indeed, some claimed to have so dispersed them through an array of novel financial instruments that they had virtually removed them. It is difficult to recall a greater example of wishful thinking combined with hubris. … These views were abetted by financial and economic models that were good at predicting the short-term and small risks, but few were equipped to say what would happen when things went wrong as they have.

All this exposed the difficulties of slowing the progression of such developments in the presence of a general ‘feel-good’ factor. … It was a cycle fuelled, in significant measure, not by virtue but by delusion.

Everyone seemed to be doing their own job properly on its own merit. And according to standard measures of success, they were often doing it well. The failure was to see how collectively this added up to a series of interconnected imbalances over which no single authority had jurisdiction. This, combined with the psychology of herding and the mantra of financial and policy gurus, lead to a dangerous recipe. …

[In summary,] the failure to foresee the timing, extent and severity of the crisis and to head it off, while it had many causes, was principally a failure of the collective imagination of many bright people, both in this country and internationally, to understand the risks to the system as a whole.

In November 1999 I was tasked with helping to assess UK preparedness for the possible impact of Y2k problems a few weeks later. What became clear was:

  • There were many people who had a reputation for expertise on financial and economic matters who were concerned about the possibility of a crisis at some point, whether triggered by Y2k or a bubble bursting. I naturally spoke to those whom I already knew or who could ‘speak maths’. As far as I can recall, all were concerned and felt frustrated at the lack of a ‘platform’, although they varied in their assessment of the likely impact.
  • In speaking to non-mathematical or mathematically naïve financiers or economists about risks the most common comment was that I didn’t know what risk was. I checked the definition of ‘risk’ in risk management and found that it was only concerned with ‘short-term’ risks, which excluded any consideration of a crash, even if it was likely tomorrow.
  • There was no shortage of mathematical models that gave insight – correct as it turns out – into the kind of things that could go wrong. It was simply that a generation of mathematicians, financiers, economists, politicians and pundits had focussed on the short-term, to the exclusion of considering ‘the system as a whole’.

By 2007 I was assisting in preparing EU accession states for possible crisis management.  As an example of a potential crisis with relatively few political ramifications, we chose a scenario in which a house building bubble burst, leading to crisis. Some key points:

  • A crisis of this kind, like many, can be anticipated, but only if you are looking for the right things.
  • In the pre-crisis phase conventional approaches seem to work, and in a sense are working in the short-run.
  • Initially, ‘the long run’ is a long way off in time, but it can easily approach un-noticed, so that the short-run may be shorter than you think.
  • If one is not watching the appropriate indicators, it may not be possible to predict what happens next, or when.
  • Even if one was all-seeing, one can have ‘critical instabilities’ where the future is inherently unpredictable, due to an extreme sensitivity to ‘noise’.
  • In other case, if one is not dominant then other actors have in influence too, and – depending on the nature of the game’ – the future may be inherently unpredictable for this reason too. (For example, where coalitions are potentially unstable.)
  • When the crisis hits, conventional rationality will fail, including the foundations of mainstream mathematical modelling.
  • The mainstream view at the time was that after a crisis a new normal would soon establish itself, so the pragmatic thing to do was to go along with mainstream thinking and then adapt to any crisis. But sometimes there may be no new normal, but something more ‘chaotic’. Hence, contrary to the prevailing dogma, horizon-scanning can be useful.

In this case a general discussion of the issues was found helpful. (I gave a paper on the subject at a conference on mathematics for finance. This has more details and references.)

British Academy Forum,  Financial and economic horizon-scanning: developing an early warning capacity. 8 February 2010

Horizon-scanning is distinct from forecasting. As we have seen in recent events, the challenge is about understanding discontinuities, and forecasts cannot cope with that. Creating scenarios has a role to play in emphasising that there are genuine uncertainties which cannot be quantified. But, for this to be effective, it is absolutely essential to ask the right questions and to have sufficient imagination. …

Besides the Treasury, the Bank of England and the FSA, other organs of government were voicing their concerns about unfolding events. In their major analysis of Strategic Trends published in 2003,the staff of the Ministry of Defence’s Joint Doctrine & Concepts Centre at Shrivenham (since relabelled as the Development, Concepts and Doctrine Centre) warned: ‘The relative risks of economic shocks having major detrimental impacts on states is likely to increase. This is one of the potential prices of globalisation. Difficulties in one part of the global system will have a wider impact due to deepening integration but equally the room for error in domestic policy decisions will reduce due to more mobile capital and more transparent information on national policy and performance. The impacts of such crises are likely to be increasingly severe in terms of national prosperity and potentially more likely to precipitate knock-on consequences for other closely dependent states.’ And in a 2006 paper ‘Financial Fragility Exposed by a Sudden Interest Rate Shock’, the Horizon-Scanning Centre of the Government Office for Science (now part of the Department for Business, Innovation and Skills) examined the dangers of ‘the explosive growth of the global capital market on the back of securitisation and derivatives which has meant that regulators have found it hard to keep up with the multitude of new instruments and the attendant risks involved.’ But, as we emphasised in our earlier letter, it is not enough to see the problem. It is essential to understand the timing and magnitude of likely consequences and to have a proper response to these difficulties prepared. And without an institution to draw together intelligence across relevant institutions, there was little scope for a complete picture to be formed.

Economies are inevitably unstable and it is a dangerous conceit to believe that economic cycles can be eliminated. However, it is essential for the organs of government to be readied and armed with the best intelligence.

All recognised the difficulty of scenario building in this area and the particular sensitivity of financial information. This has long bedevilled the wider dissemination of the most delicate economic information, for fear of both leaks and the consequences of such leaks (precipitating precisely those events the horizon-scanners and policy-makers most feared, in terms of runs on the currency or institutional failure).

[We] end with a modest proposal. If you, Your Majesty, were to ask for a monthly economic and financial horizon-scanning summary from, say, the Cabinet Office, it could hardly be refused.

This makes it clear that at least some bright people saw the problem, and the solution does not lie in just having better models (mathematical or otherwise) but in having appropriate institutions. The recommendation is that the Queen should have a standing question on the subject, to prompt her government (and academia) to horizon scan more effectively. This seems a little odd to me, in that the monarchy is the only part of government with a long-term ‘skin in the game’.

UK Privy Council

According to Wikipedia,

The Sovereign may appoint anyone a Privy Counsellor … .

Privy councillors swear that:

“And generally in all things you will do as a faithful and true Servant ought to do to Her Majesty.”


Each Privy Counsellor has the individual right of personal access to the Sovereign. … In each case, personal access may only be used to tender advice on public affairs.

Thus, institutionally, the privy council retains its ability to horizon scan and warn. Councillors swear to:

  … assist and defend all Jurisdictions, Pre-eminences, and Authorities, granted to Her Majesty, and annexed to the Crown by Acts of Parliament, or otherwise, against all Foreign Princes, Persons, Prelates, States, or Potentates.

While defence against delusions is not mentioned, it might reasonably be argued that her majesty should have been advised against foreign persons arguing for such delusions. Certainly, the privy council ought to have recommended the kind of action that the British Academy now is.

 See Also

Evidence to the Public Administration Committee discussing ‘horizon scanning’.

Dave Marsay


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