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Wildfires, Financial Crises, and Type Conversions in Markets

by: Paul Kedrosky September 04, 2008    
Paul Kedrosky

Paul Kedrosky

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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 human 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.

What is the cumulative impact of all these 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

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This article has 4 comments:

  •  
    Sep 04 03:29 PM
    Fantastic analogy - good post!
    Reply
  •  
    Sep 04 05:59 PM
    The analogy is fine enough, but I hope the implication isn't that we should continue to unnaturally suppress the healthy fire/clearing process. In fact, it would be easy to extend the analogy and contend that the federal government has had a "no burn" policy in the markets for way too long, fostering rampant moral hazard that has only brought us to the natural conclusion that a big fire is coming. If you doubt this, find the youtube video on the vice president of the Federal reserve claiming that the fed "is in the business of creating moral hazard"...as if this is a good thing! All the meddling and preventing of small fires has only brought us to the Yellowstone moment in the markets..... Folks might not immediately recognize how good the burn will be when it's happening, but rest assured that the sun will come up again, the market will renew, and savers and responsible people will be able to afford assets at much more reasonable prices. Those who lived by debt and moral hazard will learn the life lesson they need, and let's all hope that more than a few fraudsters will be discovered and put in jail for the messes they created. The sooner the better...let's get on with it.
    Reply
  •  
    Sep 04 06:39 PM
    Continuing the analogy, natural fire cycle interference by - surprise, surprise - government agencies, ultimately results in the damaging big burns that begin the cycle of ecological succession you are referring to as type conversion. Type conversion principally occurs because of invasive species replacement of native plant communities.

    The current "type conversion" in the markets may also be caused in part by government interference (read - printing money) and reflect the presence of "invasive species" in the form of foreign capital and "creative" investment processes like derivative funds.
    Reply
  •  
    Sep 08 08:03 AM
    doughni - I agree with your point - that's the inference I drew from the author. conflagration anyone?
    Reply
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