No more Financial Crisis?

No more Financial Crisis?

A decade after the last financial crisis, finance professor Manuel Ammann and ethnologist Stefan Leins engage in a discussion about the value of forecasts, the meaningfulness of economic models, and the role of teaching.

The collapse of US investment bank Lehman Brothers is nearing its tenth anniversary. Today stock prices have recovered, banks have beefed up their equity capital, and they’ve refound their conception of themselves. Is the next financial crisis a long way off?

Manuel Ammann Market participants have done quite a lot in the intervening time. You mentioned banks’ equity capital, but I’m thinking also of other measures that market regulation has brought about, such as the institution of centralized counterparties for certain derivative transactions. I see greater transparency and greater stability on the whole today, also because banks have now redesigned their incentive structures with the long term in mind. But there still are some structural factors that make the financial system fragile. The financial crisis ten years ago was partly a debt crisis, and debt in general hasn’t diminished since then – quite the contrary, in fact. The growth in debt is not sustainable, and sooner or later it may lead to another crisis.

Stefan Leins As an ethnologist, I think from the perspective of people. And here, too, I can discern that something has changed. Public awareness of certain risks has certainly increased, though that in itself doesn’t avert them. What’s important to understand is that it’s ultimately people who constitute the market, and because of that, future crises cannot be ruled out.

Ammann Moreover, it would be illusory to believe that crisis-proof markets could even exist. Taking risks is not just part of human nature, but is also an essential component of the mechanism of the market.

Which market participants were to blame, then, for the last financial crisis? When the dot-com bubble burst, scapegoats were quickly found in financial analysts.

Leins The Financial Times in 2001 even ran an editorial titled “Shoot All the Analysts.” The year 2008 was different. The problem evidently was too complex to blame it on a single group of market participants. Yet it was this financial crisis that inspired me to undertake my field research. Over a period of two years, I worked in the financial analysis department of a large bank and conducted participatory observation fieldwork there. Among my colleagues at the bank, there were a few who found themselves at fault. The fact that they had issued recommendations to buy risky stocks or structured products made them guilty in their own eyes. But those financial analysts were the exception rather than the norm.

Ammann As an economist, I harbor near innate doubts about the predictability of markets. Was that a subject of your research?

Leins It was exactly. I asked myself why financial analysts exist in the first place when economic theory actually delegitimizes their forecasts. In this context, and tying in with the question of fault, it’s interesting that although an individual financial analyst cannot steer markets, the entire guild of analysts can indeed move individual stocks or sectors. That’s because there’s a frequently discernable consensus across banks. Take the BRICs, for example, the construct that lumps the individual states of economic development in Brazil, Russia, India, and China into one bucket. The propagation of the BRICs story and the corresponding investments made caused the formulated expectations to actually materialize in the market.

It would be illusory to believe that crisis-proof markets could exist.

Manuel Ammann


Financial analysts didn’t cause the crisis, but they didn’t see it coming either.

Ammann Just like the theoreticians didn’t. I do believe that the science of economics is capable of recognizing abnormal developments, but the notion that we can use scientific methods to predict the future is unrealistic. Asking a scientific discipline, or a profession in the case of financial analysts, to provide early warnings of crises in time to head them off is simply too high a demand.

Leins I can only concur with that. Nobody ever blames a political scientist for not having foretold a civil war. The idea of being able to predict such crises in the same way we do with avalanches implies that markets function in line with laws of nature. But in reality, they clearly don’t. As mentioned before, human beings play a central role. There are, of course, identifiable patterns. But there are also phenomena that defy all economic logic.

Did rigid belief in economic models thus perhaps even contribute to the crisis? Criticism to that effect was at least directed at the teaching of economic theory.

Ammann Could we at universities have done something differently? I repeatedly asked myself this question during and after the latest financial crisis. I ultimately arrived at the conviction that we taught and are still teaching the right theories. Those theories are the armamentarium. Economic models have stood the test of decades and help reduce complexity, but they have their limitations. If employed too aggressively, they can cause unexpected results.

Leins One indeed shouldn’t underestimate the impact of models. When applied in actual practice, models often take on a life of their own. When incentive systems that foster risky behavior are then thrown in on top of that, many a word of caution learned during one’s university days fades into the background. Moreover, something that I observed during my field research additionally happens: Senior financial analysts frequently urged rookies to forget what they learned in college for the time being and to develop a “feel for the market.”

Ammann I can illustrate that with an example. The metric “value at risk,” or VaR, expresses the risk exposure of a portfolio in a single number. But that number conceals within it a vast amount of assumptions. If, a while later, you stop paying attention to those assumptions, if you forget them or even intentionally sweep them under the table, sooner or later you are operating outside the bounds of theory. At the University of St. Gallen, we have always taught students to break away from a pure model perspective, to factor in the underlying assumptions and to even question those assumptions.

Leins We in the social sciences can play a part in emphasizing the human factor when analyzing markets. We have methods such as participatory observation that enable us to do that. During my time at the bank, I was able to watch what financial analysts do, how they behave within their group, and the resulting dynamics that develop over a lengthy period. If I had conducted a simple survey, I never would have discovered what really happens to models learned at university in actual practice.

Nobody ever blames a political scientist for not having foretold a civil war.

Stefan Leins


A broad-based curriculum and responsibly minded students. Is that the University of St. Gallen’s way of averting another financial crisis?

Ammann Our curriculum is, in fact, broadbased, the financial crisis from 2007 to 2008 has been thematically incorporated into it at multiple levels, and we have long operated an institute for business ethics. However, I do not believe that it’s the job of universities to prevent crises. But we do have to explain and critically examine their mechanics, and we occasionally have to draw attention to developments that are unsustainable. I mentioned the huge amount of debt at the start of our conversation. Without debt, there wouldn’t have been a financial crisis.

Leins I find that interesting. How can you entice banks to curb debt accumulation when debt is an intrinsic part of their business models? By persuading them of the long-term benefits?

Ammann An individual institution optimizes its business for itself and its shareholders. It will not forsake profits for the benefit of the overall system. That’s where regulators come into play. Policymakers must create market structures that permit only a certain magnitude of risk. Tax laws like those in Switzerland, which do more to encourage than inhibit debt accumulation, could be the subject of such a dialogue. But beware: A very strict regulatory regime aimed at preventing any and all crises would unduly inhibit market participants.

Leins After all, susceptibility to crises lies in the very nature of markets.

Book Tip: Stories of Capitalism

Dian Fossey, who was made famous by the film Gorillas in the Mist, had to travel to the jungle of central Africa to conduct her research. All Stefan Leins had to do was to hop a tram to the outskirts of Zurich. There, on the premises of a large Swiss bank, he studied the species known as financial analysts for his dissertation by joining the bank’s financial analysis department for two years as a part-time employee. His observations made there have now been laid out in a book. Stories of Capitalism describes after-hours initiation rites and financial analysts’ strict cultural segregation from asset managers and client advisors. But Leins primarily addresses the question of why financial analysts exist in the first place. After all, their forecasts are reputed to be not much more than reading tea leaves.

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