In This Review

The Illusion of Control: Why Financial Crises Happen, and What We Can (and Can’t) Do About It
The Illusion of Control: Why Financial Crises Happen, and What We Can (and Can’t) Do About It
By Jon Danielsson
Yale University Press, 2022, 288 pp

“Not another book about financial crises!” one is tempted to exclaim. Fortunately, this is an exceptionally provocative and original addition to an ample literature. Drawing on the historical record, Danielsson explains why regulators have not been more successful at limiting financial instability. They tend to focus excessively on exogenous risks (shocks coming from outside the financial system) while neglecting endogenous risks—the destabilizing responses of the participants in financial markets to those same exogenous shocks and, no less, to regulatory action. Having been encouraged in the wake of past crises to develop numerical measures of financial risks, regulators tend to place excessive confidence in the accuracy of those numbers, which are better at predicting the last crisis than the next one, given the ever-changing nature of the financial system. Regulators think of financial institutions and their activities as falling into various separate silos, and each regulator tends to care deeply about his or her particular silo, without considering the interconnectedness of the larger system. The author concludes that a more diverse financial system is likely to be more stable, for the same reasons that greater biodiversity in ecosystems, species, and individuals leads to greater systemic stability.