This shows the results of a simulation of a hypothetical financial network of firms. These have differing levels of financial strength, measured on the x-axis. Think of this as a country’s level of official reserves or a bank’s level of liquid assets. On the z-axis is a measure of network interconnectivity – the scale of cross-border assets or interbank exposures. Finally, on the y-axis is a measure of systemic risk – the incidence of default across the network, whether of countries or banks. As the network becomes better integrated, for a given degree of financial strength, systemic risk remains low. We operate in a zone of systemic stability. That is because the network is operating as a shock-absorber, a network insurance device scattering risk to the four corners. So it was pre-crisis. But for a large-enough shock to financial strength, the system fundamentally changes shape. The network flips to a zone of systemic instability. That is because it is now operating as a shock-transmitter, a network incendiary device – and the greater the degree of integration, the sharper this knife-edge. So it was during the crisis. This is the robust-yet-fragile property of connected webs. The global financial crisis provided no better example. The flat earth that was the Great Moderation gave way to the fragile planet that was the Great Recession. Risk-sharing gave way to risk spreading, risk distribution to risk contagion. This was by no means an isolated incident.

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