Too complex to exist

The article posits that certain parts of our societal ecosystem are getting so complex that failure has catastrophic consequences and gives two examples: power grid failures and failure of the financial system. It goes on to propose that if something is too big to fail, break it up. to wit, enforce antitrust when something is too big to fail. While antitrust and limiting size is part of the arsenal of solutions, it is incomplete.

It is not a solution to eliminate complexity. The electrical grid is an example as is the financial system. If we pave over New Mexico to generate green solar power, we need a complex electrical grid to deliver the power to the users, otherwise we all have to move to New Mexico. The power grid problem is a need for redundancy. Parts will always fail. We need to have enough redundant capacity to route the power around the failed component. The Internet is robust because it has lots of redundant switching capacity.

The financial system is a different animal. Its problem is not one of single point of failure, typical of physical systems, but one of systemic failure, algorithmic failure. It all breaks in the same way because everyone is using the same algorithm, whether it be everyone invests in real estate using the greater fool theory, or everyone uses the same risk management model, or everyone writes derivatives without enough reserve. The savings and loan crisis of the 80's wasnt the failure of a few big players, it was the failure of lots of local players. Back to engineering, these are failures of positive feedback loops. What is needed is negative feedback, something that pushes back in the opposite direction. In the case of derivatives, a reserve requirement is a negative feedback.

I think the financial system also needs the equivalent of the CDC to watch for viral memes. The South American loan defaults, the savings and loan crisis, the near failure of Lehman Brothers in the 80's all should have vaccine against over speculation among the financial community. It didnt. Instead we got Alan Greenspan.

I think in both cases the best solution is to somehow mandate slack. The temptation is to run both the financial system and the electric grid as hot as possible. In the grid case, this means that the grid is running at 100% and if anything goes wrong, the whole thing just unravels as nobody can pick up any slack. In the financial world, this manifests as leveraging as much as possible to grab as much positive investment as possible, and when the investment ticks even the slightest bit negative you get total, massive bankruptcy and unpayable debt.

In both cases, if we didn't leverage so much or run the grid so hot, a failure is much more likely to be contained. The downside is that it is more expensive, you're leaving money on the table or putting up more power capacity than you really "need"... but it only takes one financial disaster to pay for years of slightly less growth, and only one total power failure for an extended period to suck as much value out of the economy as you would have put into building more capacity. If you don't account for the possibility of disaster it looks like a terrible investment, but factor that in and it looks downright prudent.

Look at the stock value graphs of the past 30 years; would you trade a lesser growth rate for not having the past year on your graph? I sure would!

The primary problem as I see it is the question of how you mandate financial slack. Mandating excess power capacity would be relatively straightforward (though it blends with "green energy" initiatives very poorly as they tend to add virtually no baseline power to the grid), but even defining financial "slack" is a challenge, let alone making the system robust. There are just so many games that can be played with paper that it may not be actually possible to prevent huge leverage.

The article assumes that these institutions are truly too big to fail. But what would have happened if they had been allowed to go into traditional bankruptcy?

Alternately, what would have happened if they had been allowed to fail in a controlled way, something similar to an FDIC takeover rather than the "bailouts" that were done?

Are there any good resources or analysis on it? I would be highly interested.