A failure of imagination

The Governor of the Bank of England gave a lecture last Wednesday night on BBC Radio 4 about the origins of the economic and banking crisis that consumed us all. You can listen to it or read the full transcript here.

Part of his analysis of why regulators did not do enough to stop the buildup of debt was that there was a ‘failure of imagination’. No one could see the dire consequences of the actions of banks leading up to the crisis.

At one level that is clearly not true. Some people did foresee it and made fortunes on the back of that insight (read The Big Short by Michael Lewis for an account of some of those soothsayers).

The problem was that the people who had the responsibility to regulate the banking system just did not think a crisis of the magnitude we have experienced was possible. It was a ‘thousand year storm’.

Some very influential people in the technology and telecoms industry did not think much of the iPhone when it was launched. Steve Balmer, CEO of Microsoft, is much derided for saying in April 2007 – ‘There’s no chance that the iPhone is going to get any significant market share. No chance.’

Whilst iPhone market share is relatively low I am sure Nokia did not see a future where the majority of profits in the mobile phone industry are hoovered up by one company and their company is sitting upon a ‘burning platform’.

In each case analysis of the past gave overly reassuring views of the future. Regulators could point to years of strong economic growth with low inflation. Mobile phone manufacturers could look back on years of relatively stable market shares in fast growing markets. And both were confidently looking forward to more of the same

It is the interconnectedness of people and institutions that drives the rapid change that we have seen in these two cases.

The chance of one bank getting into difficulty is low, so the probability of two doing so is very unlikely. The chance of the entire banking system going down is almost inconceivable. If these events are independent.

But they are not independent – they are highly connected. As are consumer markets.

The consumer in 2007 had a wide choice of mobile phones. But once some had bought an iPhone and their friends had seen what it could do a wave of connected events drove consumer uptake, which drove media coverage, which drove networks to demand it, which drove software developers to build a range of apps which drove more consumer uptake…

There was no single casual link – but a relentless series of feedback loops that transformed a marketplace at a speed that was unimaginable even 10 years ago.

So it was not a failure of imagination. It was an inability to appreciate or anticipate how the connectedness of things can drive sudden and dramatic change.

I am not saying that anyone could have predicted the launch of the iPhone. But once you had seen the product, and more importantly how early adopters reacted to it, it should have been possible to identify a scenario where it achieved what it has and put a probability against it. And plan accordingly to deal with the threat.

Thankfully banks and regulators are busily developing models that attempt to do just that for the banking system (see the Economist article and a specific project funded by George Soros’s Institute for New Economic Thinking).

Anyone responsible for strategic planning within an organisation should be doing the same for their markets.

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