Sustainable Developments: Blackouts and Cascading Failures; January 2009; Scientific American Magazine; by Jeffrey D. Sachs; 1 Page(s)

The global economic crisis is akin to a power black-out. A single downed power line or transient overload causes power to be shunted to another part of the grid, which in turn leads to new overloads, more shunting and ultimately to a cascade of failures that pushes a region into darkness. Similarly, a U.S. banking emergency caused by worsening national market conditions has sent shock waves through the world¿s financial system, causing a global banking crisis that now threatens to become a severe global economic downturn. Cascading failures are emergent phenomena of a network, rather than independent and coincidental failures of its individual components. Although many banks in the U.S. and Europe simultaneously overinvested in mortgage-backed securities (MBSs) to their peril, positive feedbacks in the global economic system amplified those errors. Bank regulators and macroeconomic policymakers have not yet given those feedbacks proper regard.

The first key feedback is the ¿debt-deflation spiral.¿ When default rates on mortgages started to rise in 2007, the banks suffered capital losses on their holdings of MBSs. To repay their creditors (such as the money-market funds that had lent them short-term money), the banks sold their MBSs en masse, driving the market prices of those securities even lower and amplifying the banking sector¿s losses.