Think Another Crash Is "Impossible"? Think Again

Tyler Durden's picture

Submitted by Charles Hugh-Smith of OfTwoMinds blog,

The confidence that risk can be quantified and mitigated is misplaced.

If there are limits on what we can know of the future--and clearly there are--this sets limits on our ability to quantify and mitigate risk. Longtime correspondent Lew G. submitted this thought-provoking riff on the system's intrinsic capacity for cascading decisions (for example, selling everything not nailed down) that upend our understanding of risk.

Here is Lew's commentary on risk:

There is a tradeoff of importance, detail and distance into the future, sort of a Heisenberg's uncertainty principle. The cost of certainty and detail at any future time goes up as the economic importance goes up because so many more people are trying to understand and control that small part of the future. This introduces more variables and more uncertainty because many of those variables will be linked in unknown ways. (emphasis added by CHS)


Estimating risk is inherently a matter of dealing with those links. The number of paths through a net which must be evaluated to determine risk is exponential, as cascades can start from anywhere and rapidly take down connected nodes in the network.


One would expect that a bank's internal risk analysis programs will try to do some of this, but they can only know the bank's point of view, not the exposure of any other financial nodes in the network, or the fantasy level of their accounting.


Because everyone is super-optimistic in a boom, crashes are inevitable, and the size of the crash is proportional to the fuzz/misinformation in information flows, e.g. mark-to-fantasy entries in banks' assets, details of all the outstanding derivatives, swaps and contracts, etc.

Thank you, Lew, for describing the complex nature of risk. There are a number of ways to uncrate the dynamics of risk addressed here, and I'd like to address two specific instances.

1. Lew conjectures a risk-equivalent of Heisenberg's uncertainty principle, which holds that the more precisely the position of a particle is determined, the less precisely its momentum can be known, and vice versa.

In a financial setting, a great many analysts and programs are seeking precise forecasts on GDP, capital flows, future profits and revenues, valuations and so on--all the components needed to forecast the likely range of outcomes.

This information is needed to properly hedge risk, and to profit from markets moving in the anticipated direction.

But if Lew is right about a Heisenberg analog in finance, this suggests the greater the certainty in the forecast, the less precisely the risks can be accurately estimated.

This limitation in our knowledge of the future helps us understand why "impossible" cascades of selling and the implosion of "safe" assets occur with regularity, despite the widespread use of sophisticated risk-management tools.

(Given the concentration of talent seeking certainty in a narrow slice of financial data, the potential for group-think, both in humans and in the software written by humans, is another potential source of risk.)

2. If the linkages between variables and nodes are incompletely known or understood, disruptive cascades can arise in areas thought to be low-risk. As the cascade spreads through the network, it starts taking out nodes that participants suddenly discover are connected in unexpected ways to other nodes that were considered only lightly connected to risky nodes.

In a Heisenberg analog network, risk can never be nailed down with any certainty. The confidence that risk can be quantified and mitigated is misplaced. A system riddled with various forms of misinformation and links that are not apparent until the cascade has begun is intrinsically prone to crashes that take down every node in the network.

This is not "impossible;" it is an excellent description of what happened in 2008-09.

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
froze25's picture

This article is right on point and that is why central planning can't and will never work. The "living" market must be able to do its own thing and find it's own balances. The more you tinker with it the more you f'it up. But control freaks that think they are so smart will never figure that out because they think they are so smart. The pity is when they get humbled we all get burned. Almost forgot, Trump 2016.

NoDebt's picture

Bah!  It'll be fine.  You'll see.

MillionDollarBonus_'s picture

As Dr Paul Krugman has explained time and time again, the problem with our economy is a lack of demand. Without demand, sales continue to drop, credit continues to contract and eventually you enter a deflationary spiral that leads to an economic collapse. We need to follow the advice of our best economists and introduce further, more robust fiscal and monetary stimulus programs. If we fail to do this in time, and our economy takes a swing for the worst, we cannot claim that we weren't warned.

_ConanTheLibertarian_'s picture

There's no demand because the elite steals everything from you!

Now go fuck yourself!

SuperRay's picture

You can't trust the advice of a Meth dealer! :-)

ebworthen's picture

I totally agree.  This is why the next QE should be a tax-free bank deposit of $4 Million Dollars to each and every U.S. taxpayer.

This will immediately increase demand and sales in all products and economic quadrants, and the government revenue from sales and property taxes will bring about prosperity that funds free healthcare, college education, and government surpluses at the Federal and State level.

Send me my money FED!  Let the bailout of Main Street begin!

MillionDollarBonus_'s picture

Nobody is suggesting such an extreme measure. Monetary stimulus should be carried out via the proper channels with the help of primary dealer banks. In my opinion, a simple bond buying program would suffice, and could serve to support further fiscal stimulus programs. Another important policy recommendation proposed by many economists is to raise the minimum wage. Papers published by Professor Alan Krueger have demonstrated that increasing the minimum wage does not in fact have any negative effect on employment, yet many still cling to the notion that minimum wages make employers less likely to hire low-skill workers. It all comes down to simply listening to the advice of our top economists - why we continue to run our country without consulting our greatest economic minds is simply beyond me. 

New_Meat's picture


"Nobody is suggesting such an extreme measure."

Actually, Big Ben his own self did in '02.

- Ned

Puncher75's picture

Your jagoff "professor" DEMONSTRATED?? increasing the Minimum Wage does not IN FACT have ANY negative effect on employment?  Do tell.  Did he use a Bunsen Burner in this "demonstration"?  Was this demonstration in academia using fancy charts, assumptions, models, etc??  More nonsense from over educated useless people.  

True Blue's picture

Another important policy recommendation proposed by many economists is to raise the minimum wage. Papers published by Professor Alan Krueger have demonstrated that increasing the minimum wage does not in fact have any negative effect on employment

Even if it did not have a negative effect on employment -which it does- it will still cause inflation to the extent that any net gains minimum wage workers make will be wiped out by the increased cost of goods and services they pay for. Meanwhile, the rest of us sink closer to the poverty line as our wages and incomes do not increase, but the cost of living does.

Oh wait, it is MDB. Nevermind.

Syrin's picture

Who thinks another crash is impossible, especially here at ZH?   What a stupid headline.

JRobby's picture

Crash is a "Most Probable" event

The circumstances where the PPT's / ALGOs blow out all stops I think is an unknown for these "Genius Math Wonderkinds" who ultimately will take the fall as the destroyers, as the G6's are already on final approach to Paraguay.

Puncher75's picture

"Dr." Krugman is a RE-TARD.  He is not even an "economist"; not that this matters mind you.  

ToSoft4Truth's picture

' central planning can't and will never work'


It depends.  If you paid into Social Security, you do want the payout, right??  Well, Centralized Planning will work great.


Were you in a union and the company promised you a pension - later to only go tits up?  Well, Centralized Planning wll work great in this instance too.

Do you have a cancer and can no longer afford Chem - Centralized Planning is yer friend. 


Are your neighbors underwater on their mortgages thus crashing your property value - Centralized Planning will save you.


Feel the Bern.

froze25's picture

You are out of your mind, most of the solutions to those things you propose are caused by central planning. That's the problem with it. More central planning is needed to "fix" the problems of central planning. A viscous cycle.

froze25's picture

I am assuming I missed the sarcasm in your previous comment. My bad, My bad.

Syrin's picture

I was right there with you.   I assumed he was anotehr gov't disninformation bot/troll

JRobby's picture

Lets face it, we were frightened by the avatar.

Another insane hockey mask clown mother fucker we all thought......

CPL's picture

Yo DAWG, I heard you like plans so I put plans in your plans for your plans.  Wazzdat then!?  Plan-ception!

Tall Tom's picture

Formal Published Paper on the Heisenberg Uncertainty Principle application to Economics.



buttmint's picture

Heisenberg Uncertainty Principle in layman's terms:

No such thing as "objectivity." ALL is subjective. The act of OBSERVATION alters whatever is being observed as well as the OBSERVER. Fixed it for ya!

Madame Curie's studies on radium were landmark, yet her published results varied from lab to lab. Dr. Werner Heisenberg's calculus paved the way for unlocking the secrets of the atom. 

You notice a hot ass walking by...doncha think she knows as well? Decision time for BOTH parties. Heisenberg's Uncertainty Principle is observable in everything we do!

ToSoft4Truth's picture



- the view or theory that the self is all that can be known to exist.

froze25's picture

The down the rabbit hole series on Quantum physics does a great job teaching you about .

"No such thing as "objectivity." ALL is subjective. The act of OBSERVATION alters whatever is being observed as well as the OBSERVER. Fixed it for ya!"

LordBuckFast's picture

Crash 2 is already happening and the elite are ecstatic, as they will soon be looking to run and hide in those nice underground bunkers paid for with citizens taxes, after engineering a full economic collapse as well as starting WW3, plus they will make sure that there are enough Jihadi’s in the West to start a race war.

That should be enough to cover up the failed fiat ponzi scheme and take care of the ‘excessive’ population!

This lays out the elite's psychopathic agenda in minute detail......


hxc's picture

Not exactly crash #2, not even intentional crash #2, but you're right otherwise.

amanfromMars's picture

That is as may be, LordBuckFast, however ..... they are too late realising they are to be hunted to extinction because of their actions, by bodies and systems far smarter than theirs can ever be.

And everything they fear comes right out of nowhere, real fast and furious to engage no resistance.

Such a change requires, in order for them to both prosper and survive, that they engage with real fast and furious resistance movements/future operating systems ? .  Yes, it sure does!


J Jason Djfmam's picture

The "crash" happened 8 years ago.

This is a dead market walking.

NihilistZero's picture

This is the exact reason the vast majority will BENEFIT from the oncoming crash. This zombie finance economy has offered ZERO recovery for 80% of the populace if you don't hold RE assets or equities, if you don't work in finance or venture tech or are not a member of the rentier class (or their parasitic sycophants in the RE complex and similar paper pushing fields) you've seen your income drop while your fixed costs have skyrocketed. Most of the new jobs are unstable and lower paying and rely on consumer spending that a crash would likely boost! Give everyone a 25% cut in their housing costs and the velocity of money will increase. The entire asshole on his yacht may not like it, but fuck him anyway...

Kagemusho's picture

"Shoot the zombie in the head! Shoot it, shoot it!"

Bangin7GramRocks's picture

But one of those dead "market" pirates just bought 2 paintings for 500 fucking million fucking dollars. And one was from kindergarten paint spreader Jackson Pollack! Tell me again about this crash? Crash is chaos, desperation and violence. We aren't even close to that outcome yet. The fed will do the voodoo that they do so well for another decade.

J Jason Djfmam's picture

So we are being robbed.

Does that make it a market?

Bangin7GramRocks's picture

It certainly isn't a market. But it isn't a crash either.

_ConanTheLibertarian_'s picture

The crash already started 2x8 years ago but the housing bubble postponed shit.

Bangin7GramRocks's picture

I want to see CNBC puppet heads openly weeping on camera. I want to see hedge fund "superstars" and "legendary" investors visibly shaken with open collar shirts and messy hair on Bloomburg. I want to see a 5 inch headline on the Wall Street Journal that reads CRASH. I want to see "markets" drop 80% and housing prices 60%. Now that is a motherfucking crash. I'll be waiting a long time for that day.

hxc's picture

Actually, you shouldn't have to wait much longer.

deKevelioc's picture

Crash, you fucker.

TradingIsLifeBrah's picture
TradingIsLifeBrah (not verified) Feb 19, 2016 9:41 AM

So three days ago everything was fixed for the market and in the last two days everything is not?  Mr. Market needs to be put to sleep if he's become this bipolar.

101 years and counting's picture

bear market "rallies" are vicious.  meant to get rid of bears so bears dont make money on way down.  problem for mr market: when there are no bears, and selling accelerates, there are fewer "natural" buyers at the lower levels.  ie, the stage is set for a bigger drop than otherwise would happen.

Insurrexion's picture


Bullshit scaremongering.

Crashes (the straight down verticle type) do not happen.

Even the last "contraction" took a year to develop.

This contraction is slower and longer, over many years.

WTF is Lew G.? and why do we fucking care?...and

I never trust a man with a hyphenated name.

Francis Marx's picture

If it a progressive 45 degree downward slope by noon, that always a sure sign of all day selling till the end

vq1's picture

the end being 2:30pm 


after that point is "adult swim" time in the pool for CBs

buzzsaw99's picture

the world owes cohn reasonable clearing prices

the price is wrong bitchez

LawsofPhysics's picture

Bullshit.  Does anyone really think that there is less manipulation today then there was in 2008? or 2001? or 1987 (when we actually put bankers in prison)...

Please, yes this time is differnent, so no crash, this time it will be Global Weimar!

autofixer's picture

Is Weimar a brand of wiener?