Managing sudden phase transitions in complex adaptive systems: lessons from the financial crisis

Following a period of almost unbroken growth from 1998 to 2007 the Global Financial System suffered a catastrophic collapse between late 2007 and end of 2008 (Wray 2009, 2010). Bank share prices collapsed across the US and EU and the direct and collateral impacts were felt globally. The impacts of the crisis rapidly spread into the real economy and a deep recession began (Wray 2009, 2010). In the years prior to the Financial Crisis various complex products and risk management processes had been developed resulting in both a misplaced sense of confidence in the stability of the industry, and the development and incubation of a number of dangerous weaknesses at its core. As conditions changed these risks began to crystalise and rapidly move through gaps in defences of various institutions. The impacts were both swift and dramatic. How had an industry which had experienced numerous systemic events in the past allowed another crisis to develop unseen, and how were so many stakeholders unable to respond to the rapid change in their industry? Utilizing Kaufmann’s (1996) Fitness Landscape Theory to frame the financial industry as a complex adaptive system, this research assesses the evolution of the industry in the years prior to the Financial Crisis and how risk was able to build up unseen within the industry, examines the responses of 3 financial institutions during the Financial Crisis for evidence of their ability to adapt to changed environmental conditions. This research identifies the weaknesses and strengths within the three case studies and identifies structures and communication processes which could limit exposures to future phase transitions and improve decision making under strained conditions