I was always taught that you didn’t discuss politics in polite society since it was sure to result in some heated discussions and potentially ruined relationships. Speaking on behalf of the engineering community though it seems we could use a little more critical thinking and a lot less politicking when it comes to governance of the financial markets.
Let’s take a look at the recent financial meltdown that started in the U.S. and take it down to its simplest elements. Easy money (low interest rates and relaxed lending practices) led to banks lending money to people who were a really poor credit risk. High risk ventures are by their very nature volatile since they are highly leveraged. At some point the risk gets so great and the substance behind the risk is so tenuous that the whole financial system that has been built around they flimsy assumptions collapses. Just like a bubble – hence the name.
This is not a brand new phenomenon. Dutch flower bulb traders in the 1500’s were a prime example, but there are even more recent ones to look at: Enron energy market trading and the dot-com implosion come to mind. Any control engineer that has a lick of sense can tell you that when a system runs open loop (is unregulated or loosely regulated like the lending markets were) and a high gain (lots of money pouring in) it can easily get out of control. What we need is an engineered solution to these kinds of problems since they are really system level problems. Throwing politicians at the problem is sort of like hiring Martha Stewart to design a car. It may look good, but it won’t run worth a darn.
It’s time to “engineer” a solution to prevent future bubbles. I would like to propose that a simple PID control should do the trick. Let’s take the difference between the money being poured into a market and the market value as determined by sales as the “market error”. Apply a proportional control so the bigger the error, the stronger the feedback to reduce the investment. Now we also need an integral control to force the investment to drive toward a specific market value. Since integral control drives the error to zero over time, we can use time as a variable and further tighten the lending restrictions the longer the condition exists. Lastly, the differential control portion minimizes the overshoot of the control and helps it settle down more quickly based on the rate of change so we can look at the rate of increase of investment as another element to dampen the enthusiasm for continued investment by limiting the amount of “speculative” investment (for the housing bubble example, we could require an owner to actually hold the house or live in it for a period of time in order to realize a gain from the sale or pay a huge tax penalty for example.
There you have it. People respond to financial incentives, let’s just start tying the financial incentives in a logical way to the desired result and keep the politicking where it belongs – wherever that is. I welcome your thoughts on the workability of this proposal. Let’s put some logic and control into the political system.