Designing New Financial Instruments

Our current financial system, with its high dynamic and detail complexity is sensitive to manipulation and prone to herd-behavior. The outcome is often creative destruction, leading to the poorly tolerated periodic bubbles and bursts.
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Cowritten by Mads Palsvig

Our current financial system, with its high dynamic and detail complexity is sensitive to manipulation and prone to herd-behavior. The outcome is often creative destruction, leading to the poorly tolerated periodic bubbles and bursts. Increased understanding of behavioral economics, the study of the irrational context dependent decisions we all make daily, has taught us that the rational human self-interest model is wrong. For over two hundred years, we have increasingly used this flawed and dangerous model to plan our societies. Now that pure Capitalism or Socialism has been shown to fail miserably, could a blend of these as exemplified by the Scandinavian Model, which allows for balancing growth with sharing, be our best chance of sustainable progress? If so, how could the flow of our transactions become as reliable as the air on which we all depend? How do we transform our current perverse opportunistic accounting into a truly creative opportunity for all living beings?

You might be surprised to learn that the current financial packages securing our daily lives, our children's futures and our well-deserved retirements are not subjected to the same rigorous product development process, as are automobiles, spaceships and LEGO bricks. Financial services are either incremental developments of existing offerings or the result of computer model generated business schemes, using models based on faulty assumptions of human behavior. To provide useful, life enhancing offerings, financial institutions would have to understand and design for the fundamentals of human behavior.

All human behavior and interaction is based on trust and humans are designed and optimized to function in tribes, not in societies that consist of millions of individuals. When groups grow beyond 50,000 individuals, it becomes too large to know and reliably judge the trustworthiness of everyone else. It is at this point, that it becomes necessary to enact democratic government institutions with effective financial systems and enforceable agreements.

Often, the originally designed solutions are the root cause of future problems. For example, institutions have an inherent tendency to grow beyond their effectiveness while centralizing decision-making in an attempt to stay in control. Organizations are not human and they do not have any emotions with regards to human beings. The system will simply continue to expend capital without thought of human misery, eventually collapsing under its own weight and this disregard of human nature is the root cause of our society's inherent and continued financial disasters.

To address these inherent human limitations, organizations might be required to remain smaller in ways that respect people's ability to understand, relate and reliably manage trust, creating dynamic legal definitions of organizations to avoid conflict of interests and perverse incentives. To prevent systemic instability, no one group of organizations can be allowed to monopolize a business to the extent that they distort competition and then simply become "too big to fail."

An example might be separating out all retail or private investments, so as to protect them from anyone powerful enough to lobby and to receive loans for speculative purposes.

Human tribal nature has a natural built-in tendency to seek control and approval. Unaware of our cognitive limitations to analyze and make decisions, society's leaders believe more centralized control makes us safer and this may have worked when the world's population was smaller and resources more plentiful. However, for the past five hundred years, every generation has started its own war and the definition of insanity is continuing to repeat the same thing over and over and to expect a different result. By utilizing cooperative, creative thinking we have a chance to finally change the game plan.

Special thanks to Mads Palsvig for researching and co-writing this article.

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