Could the 2008 US Financial Crisis Be Avoided with Network Governance?

Abstract

Banks failed in 2008 because individuals with knowledge of risks were not connected to individuals who had the incentive and power to take corrective action. Evidence of this problem is provided by reports from the Lehman liquidator and The US Government Financial Crisis Inquiry Commission. However, researchers have reported that financial firms more closely complied with what is considered “good governance” than industrial firms. This indicates that the current system of centralised control represents a systemic problem consistent with the insights of cybernetics. Cybernetics is defined as “the science of control and communication in the animal and the machine”. Cybernetic laws explain why the integrity of control and communications channels in complex systems is dependent upon “supplementation” with a requisite variety of co-regulators. Adoption of this insight would introduce “network governance” with cross checking channels within and between banks, their regulators, and stakeholders. Lawmakers and/or regulators can introduce network governance by requiring bank shareholders to amend their corporate constitution to introduce a division of power with checks and balances from stakeholders who can take on the role of supplementary and/or co-regulators. Such decentralized regulatory architecture is how simple creatures sustain their existence in complex, dynamic and unpredictable environments without suffering communication errors and/or data overload. The human brain illustrates network governance, as there is no chief executive neuron. A contribution of this paper is grounding the theory and practice of regulation and control in the science of governance. Cybernetic laws explain why regulators and large firms fail to reliably manage, regulate or govern complexity. Examples of large network governed firms provide evidence that no changes in existing laws are required to introduce network governance in the US, UK or Europe. The examples also provide evidence that network governance provides sustainable operating advantages over business cycles. This indicates how natural systems provide design criteria to enhance the efficacy and resilience of business operations, governance and regulation.