The global regulatory consequences of an irrational crisis: examining 'animal spirits' and 'excessive exuberances'

What does it mean to describe the financial system as 'irrational'? And what would be the global regulatory implications and consequences for the financial system if it were thoroughly 'irrational'? These are the issues pursued in this article. The article sets out to explore the nature of both the financial system and the economic models deployed to price the main products that are traded in the system, like options, derivatives and collateralized debt obligations (CDOs). The underlying assumptions associated with these economic models are examined and the failure of the markets to track risks assessed. The article moves on to review several alternative and radical theoretical approaches that draw attention to the nature of the potential irrationality of markets and decision making in the financial sphere, like 'excessive exuberances' and 'animal spirits'. Finally, the article assesses the consequences of this kind of analysis for regulation. A key claim is that the financial system might be more profitably considered as one that works in a similar way as do natural disasters like earthquakes, tsunamis, or volcanoes. Natural disaster planning is thus an intellectual resource that needs to be brought into play to manage and regulate the financial system. This is linked directly to the issue of 'irrationality' considered in its existential forms as highlighted by the radical philosophical literature reviewed earlier. Thus a completely new and different framework for considering financial regulation is suggested in contrast to the current emphasis on rational top down initiatives emanating from a global calculating centre like the BIS, the IMF's Financial Stability Forum or the G-20