What could trigger the next financial crisis?

London, UK - 18th November 2010, 17:45 GMT

Dear ATCA Open & Philanthropia Friends

[Please note that the views presented by individual contributors are not necessarily representative of the views of ATCA, which is neutral. ATCA conducts collective Socratic dialogue on global opportunities and threats.]

We are grateful for the many hundreds of detailed responses we have received to our key question from distinguished ATCA 5000 members worldwide -- including parliamentarians, central bankers and regulators, chairmen, chief executives, partners, principals, government officials, wealth managers and investors, technologists and academics, as well as press corps -- in regard to :

"Are the markets about to crash? Given the apparent ineffectiveness of QE2 reflected in treasury yields; Eurozone crisis coming to a slow boil; and US and China at loggerheads at G20... What are your views?"

Since we posed the direct question last week to 5,000 ATCA members and 1,000 Philanthropia members on Friday 12th November, based on alarms set off by our computer models suggesting high volatility ahead:

1. The China market has fallen by more than 10%;
2. Commodities including oil and gold have lost around 6%;
3. Many emerging markets like India have fallen by more than 4%;
4. The Western markets have fallen by around 2.5%; and
5. The US dollar has risen by around 3.5% against the euro.

These developments are consistent with the mi2g Intelligence Unit (mIU) and ATCA Research and Analysis Wing (A-RAW) computer model of financial markets and world trade, especially as the markets begin to gravitate away from speculation towards underlying economic fundamentals. What could turn these down swings into a full blown financial crash that leads to an exacerbated second phase of the global financial crisis? We note that the first phase of the The Great Unwind involving financial deleveraging, which began in August 2007, and The Great Reset in world trade, which began in September 2008, have not yet had an opportunity to come to any conclusion via the necessary catharsis. There is tremendous debt or leverage in the private sector and public sector which needs to be deleveraged and there is a massive imbalance between spare capacity on the supply side and significantly reduced demand.

Key Questions: What could trigger the next financial crisis as a result of another massive market crash? How important will it be? What will be the consequences?

The collective response of distinguished ATCA members suggests the pre-requisite for such an event to be the simultaneous manifestation of a low probability high impact event, an "unknown unknown" or black swan and for that matter, a perfectly white swan, that the markets have failed to take into account because of their day-trading myopia. Possible trigger events are exemplified in the following list derived from communications received from distinguished ATCA members:

. Unemployment rate continues to increase or stubbornly remains above a critical limit?
. Food and fuel inflation increases to the point that household consumption is crimped and costs to businesses eliminate profitability?
. Failure to address and to solve critical problems while pursuing measures to mitigate economic pain and to diffuse public responses to crises?
. Eurozone falls apart? Franco-German tension rises? North-South antagonism increases within Europe?
. Stagnation or resumed contraction in world trade?
. Computer driven High Frequency Trading (HFT) causes a major flash crash across world markets?
. An advanced financial cyber attack takes place with impact across a range of critical services and markets?
. An organisation manipulates the market by triggering an event that causes an extreme market swing?
. Advanced computing and globalisation risks escalate above a critical limit in a world of extreme inequality?
. Panic responses of investors and citizens to growing levels of debt of one or more nation state(s)?
. Disruptive technology causes security algorithms to become redundant?
. Contagion rises as an isolated, yet prominent, case of banking insolvency rapidly triggers multiple insolvencies like Credit Anstalt in 1931?
. Mortgage foreclosure black holes cause collapse of asset backed securities and insolvency of financial institutions?
. Large additional steep declines in commercial and residential property values?
. Mortgage backed assets lose significant further value?
. One or more financial trader mistakes on the scale of Barings?
. Blow up in derivatives market with large scale withdrawal of counter parties?
. Nation states enact laws or decrees to shield their own corporations from the negative effects of derivatives contracts that blow up?
. Multiple bubble bursts amongst emerging markets?
. Escalation of currency dispute -- particularly between the US and China -- potentially degenerating into broader economic and geopolitical conflict(s)?
. China, Japan and other sovereign investors stop buying US debt and begin dumping it?
. Escalation of differences between the US and the rest of the G20 to the point where positions become entrenched and irreconcilable?
. Critical world players walk away from global poker game leaving massive gaps in market liquidity and straining market functionality?
. Current economic downturn fails to respond to the recent Quantitative Easing or QE2 and disappointment evolves into renewed economic slump?
. OPEC stops selling oil in dollars?
. World abandons one currency as the world reserve currency but without coordinated agreement on appropriate alternatives?
. Breakdown of trust among principal players makes restoration of trust impossible, resulting in systemic breakdown?
. Geo-political conflict escalates: new military action involving China, North Korea, Iran and/or the US, or breakout of large scale extremism or action by “irregular” forces?
. Revival of historic territorial disputes to the point of open conflict?
. New extremist acts or natural events that are on the scale of 9/11 or the Icelandic volcano eruption stop air travel over many countries for a long period?
. Intelligent terrorism leads to blended attacks across multiple domains simultaneously?
. Extreme climate chaos caused by a number of factors including heightened solar activity leads to electronic disruption, flash floods or drought?
. Dirty bomb in one or more major financial centres?
. Very fast spreading pandemic goes out of control?
. Major accidents or events that stop the flow of a single rare but vital commodity?
. Single accidents -- like the Gulf of Mexico oil leak -- that paralyse an industry such as sea food and tourism?
. Major natural disaster like a tsunami that hits a populated coast of a major country?
. Extreme political or religious movement that gains strong acceptance like the Nazis in the 1930s?
. Severe droughts that put large populations at risk of famine and encourage violent response to secure food supplies?
. Systemic risk manifests because of the crash of the whole financial system as we know it today?
. Search for extra terrestrial intelligence yields results which are not benign?

There is an extremely large menu of extremely disruptive low probablity high impact events which carry a high element of surprise and this is not a comprehensive list.

Conclusion

Some distinguished ATCA members have suggested that there is simply too much liquidity thanks to low interest rates, QE1, QE2, etc, in the financial system for a crash to occur. It is not going to be in anyone's interest to allow any sovereign nation state, major corporation or financial institution with a trans-national remit to collapse. So long as no black swans or "unknown unknowns" come along, we may just be able to cope as a global community of nations working together. It is understood that governments across the world are continuing to do their best to avoid a financial crash.

As a senior European parliamentarian said recently, "Are we heading slowly, but so far surely, back to the 1930s?" At times, the world oligopoly of economic powers feels very fragile and delicately held together. Yet we must remember how fundamentally dynamic human beings are and their capacity to recover from virtually any crisis. They just keep innovating to stay ahead of the last, or next, big problem. However, the real fear is that if any mainstream economy goes off the rails the impact will not remain within the economic sphere but rather will take on a social dimension as in the 1930s. Empty stomachs lead to political extremism and all of the consequences which follow, so one can only hope that anyone mindful of triggering a collapse by wild financial speculation and short term profit motives recognises the much bigger consequences of their narrowly focused actions.

Although fundamentals point towards global slowdown we might be fortunate to experience a soft landing. Let us hope that this is the case, whilst preparing for the eventualities of "What could trigger the next financial crash?" We will shortly be hosting an exclusive roundtable in Canary Wharf, London, to look at these issues in detail. If you would like to take part please let us know.

[ENDS]

We welcome your thoughts, observations and views. To reflect further on this subject and others, please respond within Twitter, Facebook and LinkedIn's ATCA Open and related discussion platform of HQR. Should you wish to connect directly with real time Twitter feeds, please click as appropriate:

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Best wishes