Scary financial stuff

demon of our own design is an interesting look at the world of financial risk.

The Author is a practitioner and academic who provides a welcome perspective on the area of contemporary finance and the environment of financial risk. 
The book is a bit heavy going for the lay person who may not be comfortable with options and and basis points, but for the market practitioner it is a must read.

The author put forth a very reasonable account of the foibles and mistakes that have been made in recent areas of finance.  He articulates the theory of Normal Accidents and how they relate to finance in a great way.  Normal accidents, are a phenomenon of design whereby a complex system, be it a nuclear reactors, airplane safety procedures or any complex system is designed to fail.  This design for failure of course isn't intentional but unfortunately due to complexity of interaction the system fails in an un-intended but wholly preventable way, 3 mile island, Chernobyl and about any financial accident you can think of falls within this group.

The author does a good job of explaining why there really is no such thing as a hedge fund and also posits a few interesting questions about the half life of a trading strategy and the usefulness of ever more esoteric instruments.  As he states, just because you can swap out a cash flow based on a state variable doesn't mean you should.

The clarity, candor and perspective in this book are refreshing.  My own personal concerns in terms of financial risk were only re-enforced.  The current credit crunch articulated in this blog will grow in size significantly but most likely not pose any systemic threat on a global basis. 

The current credit issue will be acute not chronic a $2-4 trillion mess at most.  Looming in 3-5 years will be a crisis which will ultimately be attributed to the Basel II capital accords.  This will be chronic and most likely caused by the safety mechanism of the Capital accords which are being put into place to mitigate risk. 
My sincere hope is that more people read this book and think about the dangers inherent in layering on ever more esoteric risk management systems with finer models thus allowing ever greater financial "innovation".  Gamma risk will look like nothing compared to Basel II model risk when it is fully realized.  Innovation is rarely a good thing in finance and banking especially when it involves ever more esoteric ways of "deriving" value by seperating an asset from the fundamental information or sources of it value creation.