One of the carefully nurtured ideas that sits at the heart of most modern finance is the idea that there's a risk-free asset that we can retreat to when we lose our nerve. This is the financial equivalent of the philosopher's stone, capable of saving us when nothing else is. Almost by definition the lender of last resort is the government and the risk-free asset usually ends up being government backed debt.
The only slight fly in this magic ointment is that not only is government debt not risk-free but neither are governments themselves: it turns out they have a nasty habit of not being there exactly when you need them most.
Correlated Chaos
One of the things that became starkly visible in the economic crisis that erupted during 2008 was exactly how much of modern financial theory was built on a single, bad premise. The idea was that by mixing and matching different sorts of financial assets to ensure that they were "de-linked" such that if one sort of asset fell in value another sort would rise, or at least not fall as much, it was possible to manage risk. Ensuring that this so-called correlation was carefully managed would, it was theorised, ensure that impacts on one part of a portfolio would have limited effects on others.
Unfortunately, when the black swan hits the fan, this isn't true. There are times when everything falls together and this has happened many, many times in the past. In This Time It's Different: A Panoramic View of Eight Centuries of Financial Crisis the authors, Carmen Reinhart and Kenneth Rogoff, carefully draw out the lessons to be learned if you're prepared to look beyond the tiny bubble of time in which each of us spends our existence.
Frequent Failure
What they find isn't encouraging. As they show (have a look at Appendix A.3) banking crises happen with alarming regularity – around 120 of them in the last 210 years. Indeed, years without bankers blowing up some economy somewhere in the world are rarer than those with one. Furthermore they suggest is that these problems seem to happen more frequently when it's easier to move capital around the world: essentially the easier banks find it to invest their funds offshore the more likely something is to go wrong.
The net result of all this global…
