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Networks and the 2008 Financial Crisis

We are at 6th anniversary of the 2008 financial bust that rocked the world economy. The September 15th, 2008 bankruptcy of Lehman Brothers is for many the defining moment of the crisis. This is thus a particularly apt time to look at some of the structure underlying the crisis.

In his work : Financial Crisis and Global Governance: A Network Analysis, Andrew Sheng writes the role of networks in understanding financial crises, particularly the most recent one. In a global economy that is increasingly interconnected, network theory can be a powerful tool in understanding how a downturn in the housing market in the US can lead to most of the world being plunged into such an event as we saw. Sheng writes about 7 main contributing factors to the recession and analyzes the role of networks in each. Some of these hinge on aspects of networks such as the complexity and thus fragility of ties, and the creation of large hubs, such as Lehmann, to which many other institutions were created. He also identifies the flow of information through the network as a factor, arguing that the flow of too much information that could not be perfectly understood, along with a positive feedback mechanism in the system, played a crucial role in the crisis.

The inter-connectivity of the global network is also explored to some extent in the BBC documentary For the Love of Money : The Bank that Bust the World. It chronicles the events around the collapse of Lehman, and how the crisis resulted from it. At one point the documentary talks about the Mortgage-Backed Securities (MBS’s) and their spread to banks throughout the world. It can be regarded as a contagion phenomena where following the path of the MBS’s after the collapse led many to be shocked at the extent to which these were distributed across the world. A recent article by authors from Caltech, Harvard and Stanford examines the response of networks to contagion in greater mathematical detail.

(Also, a shout-out to the three part documentary, For the Love of Money. An excellent explanation of the crisis. Linked above.)

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