A crisis is often triggered by some formerly unquestioned assumption abruptly breaking down. The 2008 financial crisis for example, sprang from the belief that the US would never suffer a nationwide decline in housing prices.
But the real problem isn’t the initial mistake.
EVERYTHING HAS CHANGED
It’s the ripple effect – what happens when that first false assumption starts to undermine more and more of our bedrock beliefs.
This is why, in a crisis, normally unrelated assets start to all drop together. In 2008, the crucial cascade failure came when Lehman Brothers’ collapse caused a money market fund called Reserve Primary to lose US$785 million. That shock led investors, who had assumed that money market funds were essentially riskless, to stampede away from them, shrinking banks’ access to credit by roughly US$1 trillion and making the situation infinitely more dangerous.
Crises reveal and create new linkages between events, breaking the causal chains that had previously guided our actions. Before 2008, no one would have thought there was a relationship between money market funds and real estate prices.
