Nuclear power is scary, because of the fear of radiation (radiation itself doesn’t seem to be as bad for you as you might think) escaping and contaminating all around. But is it as scary as banking? There was an absolutely fascinating piece by Tim Harford in the Financial Times last weekend. It was called “What a nuclear reactor can teach us about the economy“, and it draws parallels between the way engineers build safety systems for nuclear reactors (broadly speaking, by applying science and learning from mistakes) and the way that regulators build safety systems for the banking system (broadly speaking, by making things up and not learning from mistakes). The key observation is that the banking system is complex:
It might seem obvious that the way to make a complex system safer is to install some safety measures. Engineers have long known that life is not so simple.[From What a nuclear reactor can teach us about the economy]
What Tim is saying is that financial products such as Collateralised Debt Obligations (CDOs) and Credit Default Swaps (CDSs) appeared as safety systems (for spreading risk) and then, just like the coolant filter that got dislodged and jammed the coolant flow thus causing a partial meltdown of the Fermi reactor in Detroit, they blew up the system they were supposed to stabilise.
So what can the financial sector learn from the nuclear reactor sector, given this analogy? Well, using the example of Three Mile Island, Tim explains that one of the key reasons that the reactor came close to meltdown was that the operators couldn’t understand all of the dials, lights, warnings and other signals. As a consequence
since Three Mile Island, much attention has been lavished on the problem of telling the operators what they need to know in a format they can understand.
When the financial system started to melt down, regulators were faced with the same problem: given all of the warning lights flashing, given all of the alarms sounding, what was actually going on?
Andrew Haldane, director for financial stability at the Bank of England… argues that the same technologies now used to check the health of an electricity grid could be applied to a financial net- work map, highlighting critical connections, over-stressed nodes and unexpected interactions.
This analogy is imperfect in a couple of ways, of course, because banks can create money from nothing whereas electricity costs money to create and because electricity substations don’t lie to the national grid in order to get a bigger bonus, but you can see his point.
There’s one aspect of this that Tim didn’t explain though. Engineers don’t forget things, but financiers do. Once engineers have learned, for example, how not to build a bridge, then they stop building bad bridges. But bankers don’t work that way. They would stop building bridges that way for a short time, and then simply go back round and starting building collapsing bridges again a few years later.
What does this have to do with payment systems? I’d like to highlight two points: complexity and decoupling. We need to beware of complexity, to treat it as an enemy (the current case study of EMV illustrates this perfectly), and we need to decouple so that parts of complex systems can fail without bringing down to whole of the system. It seems to me that this prescription provides a pretty clear manifesto for payments: separate the payments systems from the banking system and have a lots of simple payment systems instead of a small number of complicated ones.
Dave, don’t forget about the cockpit crew of that Qantas A380. In finance and in Homer’s nuclear power plant, when the melt-down light flashes, how do the controllers behave? In an aircraft, there is a bit more motivation to bring it down safely. Have a look at Atul Gawande’s ‘Checklist Manifesto’.
During centuries of global economic development, understanding precisely how business interacts with flows, firstly of water – then steam – then electricity – then oil, petroleum, and components – has been vital for businesses, the economy and society.
Over time, the professions of architecture and engineering, and various sciences, co-operated to develop standards and practices of measurement, management, safety, optimisation and valuation to accurately understand these various flows.
The result was clarity about how the business worked.
This created trust.
That is why huge industrial plants are often sited relatively close to centres of population. It is why we don’t think twice about starting a car, switching on a kettle or lighting a gas ring.
There is always operational risk. But all over the modern world, no matter the political system, no matter the economic system, no matter the regulatory regime, the above holds true. The understanding of flow is critical to understanding how the business works and to creating trust.
And where there is trust people are more likely to do business.
Today, most business sectors rely heavily on IT and flows of data.
In finance, over 90% of money exists as data. But unlike, for example, the utilities, finance does not know precisely how data (money) flows through the assets of the business.
There are many technical and business reasons for this circumstance, but in a nutshell, in today’s world finance doesn’t have enough understanding of how everything is put together to make the business, and the financial system, work.
More on this in ‘Finance and data flows’, which I think will be of interest you.
Thanks for the point to the manifesto, will check it out.