Risk Management: Why a Strong Memory is Essential to Prevent Market Shocks

Financial Contagion: Lessons from the Past

As we look to the next decade, one pressing question remains: how effectively can we contain financial contagion should another shock occur? Current responses from Western regulators might suggest a high level of confidence due to significant reforms implemented since the 2008 financial crisis.

Over the past 15 years, the Western governments have dedicated substantial resources to learning critical lessons, creating new regulations, ensuring compliance, and promoting cultural shifts within financial institutions.

The recent collapse of Silicon Valley Bank (SVB) highlighted both progress and lingering vulnerabilities.
Although regulatory errors and managerial oversights contributed to SVB’s downfall, the fallout from this crisis was successfully contained, avoiding a broader market collapse.

The Importance of Memory

However, it is vital to approach the future with caution.
Discussions among financial historians at the London School of Economics have underscored two often-overlooked areas: memory and political hegemony in finance.

Memory plays a critical role in risk assessment, which is not as objective as traditional economic models suggest.
Instead, humans perceive risk through narratives shaped by personal and collective experiences.
Historical events, such as the 1929 financial crash, illustrate this point.
Economists Tobias Pforr and Giuseppe Telesca reveal that public memory of 1929 was fluid and contentious, contrary to regulatory beliefs that it was universally acknowledged.
Such fluidity is beginning to shape perceptions of the 2008 crisis as well.

Recent surveys conducted by researchers Youssef Cassis and Bruno Pacchiotti indicate that while a significant portion of financial executives view the 2008 crisis as traumatic and impactful on current risk management policies, the persistence of these memories may not last.
As they pointed out, as the current workforce ages, the direct recollections of past crises may fade, raising concerns about future generations’ understanding of past lessons.

Geopolitical Dimensions

The second crucial aspect highlighted is the geopolitical environment.
Economist Elise Brezis explored whether financial contagion varies in times of peace versus conflict.
Her findings suggest a distinct correlation; during periods of hegemony, countries wield significant political and monetary power to mitigate shocks.
This was evident historically during the British Empire and the American-led liberal economic order.

However, when power dynamics shift and conflicts arise, countries may engage in intense political battles that inhibit coordinated responses to financial crises, as seen between the world wars.
Brezis warns that current geopolitical tensions, especially toward American dominance, could trigger similar challenges, jeopardizing our ability to respond effectively to future crises.

Some might argue that not all financial crises fit this model, as conflicts can also precipitate economic shocks.
Nonetheless, as global interdependencies deepen amid rising tensions, we must anticipate the ramifications of potential crises—especially if they originate in unstable regions.

Looking Ahead

The critical question pertains to our ability to assimilate historical lessons and whether there will be a unified commitment among future leaders to implement necessary measures effectively.
The experiences of the past, particularly the lessons learned during the turmoil of the early 20th century, should resonate strongly as we navigate the uncertain financial landscape ahead.

Investors and regulators must heed the lessons of history—ignoring them could lead to dire consequences as we approach a new era fraught with potential financial upheaval.