Complexity and Volitility

It is sometimes difficult to keep up with all of the complex technological changes going on in our society.  Take Facebook, for example.

If you haven’t seen this illuminating diagram, which illustrates the changes to Facebook Privacy between 2005-2010, you might not fully grasp how easily your personal information may leak onto the world-wide web.  Facebook is constantly looking for ways to monetize the assets that they have, namely, your personal information.  Recently Facebook made another huge change, implementing a platform that they call Connections.  Here are some helpful warnings about Connections.  You may want to check your privacy settings, at a minimum.

James Kwak, co-author of 13 Bankers, as well as the blog Baseline Scenario, decided to delete all of his personal information from the site.  If you are unsure about how much gets onto the world wide web, just check out this site.

However, this phenomenon is not limited to Facebook.  Last week, the U.S. Stock market plumeted 700 points in a matter of minutes.  It partially rebounded, but at the end of the day, the heads of NASDAQ and NYSE were trading blame, and it appears that the smart people designing the complex electronic trading mechanisms do not fully understand them.

When told that 50-75% of all stock trades are High Frequency, automated trades, that transact by the miliseconds, Duncan Niederauer, CEO of NYSE said “everyone has to compete on technology, we’re all going to ask ourselves is how fast is too fast, when is enough enough.  But, as long as there is technologically-enabled market making out there, everyone has got to compete for that market share.”

Felix Salmon, financial blogger for Reuters, calls this a new era of volitility:

“The lesson to learn is that given the complexity of contemporary financial markets, correlations can pop up anywhere, and a relatively small uptick in something like Portugese CDS spreads can combine with a glitch somewhere in the equity markets to get magnified into an event which wipes out hundreds of billions of dollars in capitalization in the blink of an eye. Or maybe it was the UK election, or a butterfly flapping its wings in Kuala Lumpur: there’s no way of ever knowing.”

The complexity inherent in the stock markets is eerily reminiscent of the complex financial products which led to the collapse of our economy.  Some of the Collateralized Debt Obligations and Derivatives were poorly understood by the people in charge at firms like Bear Sterns.  As a result, they did not comprehend the risk those products held to our country.  For a good blow-by-blow account of how the people in charge at Bear Sterns were unable to grasp the complexity of those products, check out William Cohen’s House of Cards.

While Facebook and High-Frequency Trading are not obviously related, they both amount to systems that are inherently complex.  Our society will only become more and more automated, we cannot just accept that complexity, we must remain aware and vigilant.

UPDATE (5/28): This great column from David Brooks discusses how complexity and our inability to understand it played a huge role in the Oil Spill.


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