“Synchronous Lateral Excitation” … risky, but not what you’re thinking.

TakeAway: In finance, actions can be both individually prudent and collectively disastrous. It’s called “synchronous lateral excitation”, and it explains the credit crunch of 2008 – 2009.

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Excerpted from New Yorker: Rational Irrationality – The real reason that capitalism is so crash-prone, John Cassidy, October 5, 2009

On June 10, 2000, Queen Elizabeth II opened the high-tech Millennium Bridge, which traverses the River Thames from the Tate Modern to St. Paul’s Cathedral.

Thousands of people lined up to walk across the new structure, which consisted of a narrow aluminum footbridge surrounded by steel balustrades projecting out at obtuse angles. Within minutes of the official opening, the footway started to tilt and sway alarmingly, forcing some of the pedestrians to cling to the side rails. Some reported feeling seasick.

The authorities shut the bridge, claiming that too many people were using it. The next day, the bridge reopened with strict limits on the number of pedestrians, but it began to shake again. Two days after it had opened, with the source of the wobble still a mystery, the bridge was closed for an indefinite period.

Some commentators suspected the bridge’s foundations, others an unusual air pattern.

The real problem was that the designers of the bridge, who included the architect Sir Norman Foster and the engineering firm Ove Arup, had not taken into account how the footway would react to all the pedestrians walking on it. When a person walks, lifting and dropping each foot in turn, he or she produces a slight sideways force.

If hundreds of people are walking in a confined space, and some happen to walk in step, they can generate enough lateral momentum to move a footbridge—just a little. Once the footway starts swaying, however subtly, more and more pedestrians adjust their gait to get comfortable, stepping to and fro in synch. As a positive-feedback loop develops between the bridge’s swing and the pedestrians’ stride, the sideways forces can increase dramatically and the bridge can lurch violently.

The investigating engineers termed this process “synchronous lateral excitation,” and came up with a mathematical formula to describe it.

What does all this have to do with financial markets? Quite a lot.

Most of the time, financial markets are pretty calm, trading is orderly, and participants can buy and sell in large quantities.

Whenever a crisis hits, however, the biggest players—banks, investment banks, hedge funds—rush to reduce their exposure, buyers disappear, and liquidity dries up.

Where previously there were diverse views, now there is unanimity: everybody’s moving in lockstep.

“The pedestrians on the bridge are like banks adjusting their stance and the movements of the bridge itself are like price changes,” Shin wrote. And the process is self-reinforcing: once liquidity falls below a certain threshold, “all the elements that formed a virtuous circle to promote stability now will conspire to undermine it.” The financial markets can become highly unstable.

This is essentially what happened in the lead-up to the Great Crunch of 2008.

http://www.newyorker.com/reporting/2009/10/05/091005fa_fact_cassidy?printable=true

2 Responses to ““Synchronous Lateral Excitation” … risky, but not what you’re thinking.”

  1. Chris Says:

    This is more commonly known – and more easily understood – as “all correlations go to 1 in a crisis.”

  2. Laj Says:

    Sounds to me like a high falluting name for the tragedy of the commons.

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