node created 2012/06/17
last changed 2013/02/04
The conclusion to be drawn from [the Bank of England’s executive director for Financial Stability Andy] Haldane's work is that an out-of-control financial sector is eating out the modern market economy from inside, just as the larva of the spider wasp eats out the host in which it has been laid.
So what I’m proposing is that finance, and indeed consumer Internet companies and all kinds of other people using giant computers, are trying to become Maxwell’s demons in an information network. The easiest way to understand it is to think about an insurance company. So an American health insurance company, before big computing came along, would hire actuaries to set rates. But the idea of, on a person-by-person basis, attempting to decide who should be in the plan so that you could only insure the people who need it the least on an individual basis, that wasn’t really viable. But with big computing and the ability to compute huge correlations with big data, it becomes irresistible. And so what you do is you start to say, "I’m going to..." — you’re like Maxwell’s demon with the little door — "I’m going to let the people who are cheap to insure through the door, and the people who are expensive to insure have to go the other way until I’ve created this perfect system that’s statistically guaranteed to be highly profitable.”

And so what’s wrong with that is that you can’t ever really get ahead. What you’re really doing then is you’re radiating waste heat. I mean, for yourself you’ve created this perfect little business, but you’ve radiated all the risk, basically, to the society at large. And if the society was infinitely large and could absorb it, it would work. There’s nothing intrinsically faulty about your scheme except for the assumption that the society can absorb the risk. And so what we’ve seen with big computing in finance is a repeated occurrence of people using a big computer to radiate risk away from themselves until the society can’t absorb it. And then there’s some giant bailout and some huge breakage. And so it happened with Long-Term Capital [Management] in the ’90s. It happened with Enron, and we saw a repeat of it in the events leading to the Great Recession in the late aughts. And we’ll just see it happening again and again until it’s recognized that this pattern is just not sustainable.