[Editor’s Note] So where does the next financial crisis begin? From a highly interdependent, non-linear, in-deconstructable network of claims, obligations, and obtuse financial transactions and instruments. Good luck putting Humpty back together again.
from Working Paper #383 (Prasanna Gai and Sujit Kapadia):
In modern financial systems, an intricate web of claims and obligations links the balance sheets of a wide variety of intermediaries, such as banks and hedge funds, into a network structure. The advent of sophisticated financial products, such as credit default swaps and collateralised debt obligations, has heightened the complexity of these balance sheet connections still further. As demonstrated by the financial crisis, especially in relation to the failure of Lehman Brothers and the rescue of American International Group (AIG), these interdependencies have created an environment for feedback elements to generate amplied responses to shocks to the financial system. They have also made it difcult to assess the potential for contagion arising from the behaviour of nancial institutions under distress or from outright default.