Sustainability and livability in the 2007 banking crisis: A failed transition to a low gain system

Abstract

AbstractThere is a contrast between the role of complexity in enabling value creation and market growth and its role in limiting sustainability. This contrast can be understood by using the concept of low gain systems, which are relatively elaborate and sustainable, and the concept of high gain systems which are concerned with the immediacy of actually living rather than longer‐term sustaining. This paper analyses the recent banking crisis to develop a framework that weaves together the many suggestions that have been made to fix the banking system and to look for a root cause. The root cause of the banking crisis was in the increased complexity of the supply chain that linked more borrowers to more investors. This complexity enabled the aggregation and customization of debt product for specific investors, which grew the market. But it was not elaborate enough to preserve information that was required to manage the quality of these debt products. So the negative feedback of toxic debts poisoned the system in a high gain manner rather than being filtered out in a low gain manner. This was allowed to happen because of missing elements at the global and national levels of the regulation system which did not spot this filtering problem or were unable to constrain the lower levels of the regulation system to options that would fix it. The implications for regulating future system elaboration attempts are also discussed. Copyright © 2010 John Wiley & Sons, Ltd.