Fire Regimes, Financial Crises, and Type Conversion in Markets

When wildfires burn a landscape, it’s not all bad. It cleans out underbrush, helping the next generation of plants and trees emerge. Wildfire is also required by some plants to propagate, like various species of chaparral, whose seed pods only open under the kinds of heat created by wildfires. Those species are, in a sense, fire-adapted.

Saying the preceding, however, is not the same thing as saying that all wildfires are good. Highly infrequent wildfires — usually caused by over-aggressive fire suppression policies — tend to be much more severe, with larger areas burned, and more plants burned right down into the roots, increasing the cycle time for landscape recovery. We had that happen in southern California in 2003 with the Cedar wildfires, but the Yellowstone fires of 1988 are good examples too.

555_Viejas_Cedar_Burn_w_Jon_II_f On the other hand, overly frequent wildfires — usually caused by the introduction of an ignition source (read: humans) into a wild landscape — come with other problems. In California, for example, the dominant coastal brush, chaparral, requires at least a few years to germinate and grow. Wildfires that happen in the same area in less time than it takes for new chaparral to re-establish itself can destroy the ecosystem. The fires suppress natural regrowth, while allowing fast-growing (and often foreign) plants to take hold, which in turn prevent chaparral from ever emerging. These new plants tend to be forms of wild grass, which give a landscape the superficial appearance of recovery, but are almost always even more fire-prone than the fire-adapted ecosystem they have supplanted.

In short, infrequent wildfires tend to be catastrophic, but overly frequent wildfires cause what fire ecologists call "type conversion": the original plants are replaced by new species, and the new plants tends to be more prone to frequent fires. In other words, frequent fires make an already fire-prone landscape even more dangerous.

I got to thinking about this in a capital markets context recently. We have gone through a series of capital market conflagrations in recent years, with each coming increasingly speedily on the heels of the one before it. There is the current banking/mortgage crisis, the dot-com crisis before it, the Southeast Asia troubles, the LTCM meltdown, the S&L Crisis, etc. It has been one thing after another, each coming more quickly.

It helps to look at historical patterns. We had financial crises in 1873, 1884, 1890, 1893 and 1907. That series culminated in WW I and the Great Depression, after which we had no financial crises from 1941 to 1971. Since then, however, we have had crises in 1972, 1978, 1988, 1998, 2000, and 2007/8, each of which has gotten more dire as measured in total losses, as well as more global, in terms of markets affected.

What is the cumulative impact of all these modern financial crises? Far from making markets more resilient, I argue that they are making markets more, not less, prone to crises. It is happening because market participants are changing, as are the methods and styles by which they trade. Think about it. If you fail to thrive — i.e., don’t make money — you either get eliminated or find something else to do. You are, in a markets sense, as readily replaced as any plant overrun by invasive species after frequent wildfires. The result, however, is a market more — not less — prone to wildfires.

Sound familiar? It should: I think we have type conversion underway in capital markets. Markets will always be prone to wildfires and crises — that is part of their essence — but over-frequent conflagrations are causing native species to be replaced, newly making markets even more crisis prone than most people understand.

More reading:

  • Effects of invasive alien plants on fire regimes. Brooks, M.L., et al. 2004. Bioscience 54:677-688.
  • Fire in America, by Stephen Pyne