Paul Kedrosky: Y2K, the Credit Crisis, and the Rosencrantz Fallacy

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February 28, 2009

Y2K, the Credit Crisis, and the Rosencrantz Fallacy

Back in the late 1990s I was a public equity skeptic -- I wrote a widely-cited piece in the Wall Street Journal calling the Internet bubble a bubble. I was also a Y2K skeptic, writing that it was unlikely to be anywhere near as dire as the doomsters thought it would be. (I even offered to spend New Year's Eve flying 'round and 'round North America on a commercial airline of people's choice as a test of the air grid. No takers, sadly.)

Which position do you think drew more flack, Y2K skeptic or net skeptic? Surprisingly, at least to me, the Y2K thing drew far more pillorying and noisy nuisances than did calling the equity bubble a bubble. I was regularly savaged, called stupid, and told that when the world came down around my ears … would I ever regret it. That sort of thing.

Unlike most bubble-chasing stock traders back then, the people most worried about Y2K were smart, technically astute, and mostly fairly rational, and they couldn't understand why people didn't see how this would be impossible to fix in time. If you asked management, the answer wasn't that much more reassuring. They would say, "We think we have it figured out, but there are a bunch of people we talk to who don't have their act together". So even the people who were cleaning up their mess weren't convinced that the end wasn't nigh.

But then it didn't happen. January 1st 2000 went by, and pretty much nothing happened. While some people then pronounced that the whole Y2K thing had been a fraud, the truth was much more interesting and important. It hadn't been a fraud; there had been real and consequential risks in important and complex systems. If those problems hadn't have been addressed, many of the consequences imagined by the apocalypticists might well have happened. We could, in the limit, have been facing real breakdowns in societal fabric.

So, why didn't the worst happen? In part what happened is this: People acted. While they were late, slow, stupid, and error-prone, they did what people do when a big enough alarm bell is rung loudly and long enough: They tried to figure out what they could do in the time they had to reduce their risk, and they did those things. They didn't think other people would get there, but they knew they would.

And it turned out to be enough. Too many models projected people as actors caught in a play, a sort of Rosencrantz and Guildenstern with nothing to do but be swept along by the plot. They weren't, and in improvising instead of following the script they surprised people and helped things escape unscathed.

I find myself thinking about this again these days. I hear too many naive projections, too many scenarios constructed via extrapolating early failures forward and assuming the same thing can happen in the same way, so systemic collapse is ahead. While that is possible, and this time is different (tm), it's at least worth wondering what if the Y2K lesson matters more than we might have thought. Government aside, independent and fiercely survival-minded actors are doing what they can throughout the economy and the financial system to mitigate the risks they face from the current depression. Credit default swaps are being netted and torn up; banks are trying to unwind swaps and other derivatives. Some financial institutions are accidentally healing, at least a little, under the flood of savings pouring into them from petrified and security-seeking citizens. There are myriad other examples, but the point is that the bell has been rung, people are acting, and communication networks are afire -- and history says these are circumstances in which people can, by protecting themselves, surprise us all with the outcome.

None of this, of course, means the current downturn isn't awful, and that it won't be long and painful. That seems, at least to me, more or less a given. I'm speaking more to the broader issue of how we could surprise ourselves by successfully dodging many bullets, large and small, along the way.

This is hastily sketched, so apologies for any/all incoherency, but I'm curious about people's thoughts.

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