Didier Sornette: How we can predict the next financial crisis

Translator: Joseph Geni
Reviewer: Morton Bast Once upon a time we lived in an economy of financial growth and prosperity. This was called the Great Moderation, the misguided belief by most economists, policymakers and central banks that we have transformed into a new world of never-ending growth and prosperity. This was seen by robust and steady GDP growth, by low and controlled inflation, by low unemployment, and controlled and low financial volatility. But the Great Recession in 2007 and 2008, the great crash, broke this illusion. A few hundred billion dollars of losses in the financial sector cascaded into five trillion dollars of losses in world GDP and almost $30 trillion losses in the global stock market. So the understanding of this Great Recession was that this was completely surprising, this came out of the blue, this was like the wrath of the gods. There was no responsibility. So, as a reflection of this, we started the Financial Crisis Observatory. We had the goal to diagnose in real time financial bubbles and identify in advance their critical time. What is the underpinning, scientifically, of this financial observatory? We developed a theory called “dragon-kings.” Dragon-kings represent extreme events which are of a class of their own. They are special. They are outliers. They are generated by specific mechanisms that may make them predictable, perhaps controllable. Consider the financial price time series, a given stock, your perfect stock, or a global index. You have these up-and-downs. A very good measure of the risk of this financial market is the peaks-to-valleys that represent a worst case scenario when you bought at the top and sold at the bottom. You can look at the statistics, the frequency of the occurrence of peak-to-valleys of different sizes, which is represented in this graph. Now, interestingly, 99 percent of the peak-to-valleys of different amplitudes can be represented by a universal power law represented by this red line here. More interestingly, there are outliers, there are exceptions which are above this red line, occur 100 times more frequently, at least, than the extrapolation would predict them to occur based on the calibration of the 99 percent remaining peak-to-valleys. They are due to trenchant dependancies such that a loss is followed by a loss which is followed by a loss which is followed by a loss. These kinds of dependencies are largely missed by standard risk management tools, which ignore them and see lizards when they should see dragon-kings. The root mechanism of a dragon-king is a slow maturation towards instability, which is the bubble, and the climax of the bubble is often the crash. This is similar to the slow heating of water in this test tube reaching the boiling point, where the instability of the water occurs and you have the phase transition to vapor. And this process, which is absolutely non-linear — cannot be predicted by standard techniques — is the reflection of a collective emergent behavior which is fundamentally endogenous. So the cause of the crash, the cause of the crisis has to be found in an inner instability of the system, and any tiny perturbation will make this instability occur. Now, some of you may have come to the mind that is this not related to the black swan concept you have heard about frequently? Remember, black swan is this rare bird that you see once and suddenly shattered your belief that all swans should be white, so it has captured the idea of unpredictability, unknowability, that the extreme events are fundamentally unknowable. Nothing can be further from the dragon-king concept I propose, which is exactly the opposite, that most extreme events are actually knowable and predictable. So we can be empowered and take responsibility and make predictions about them. So let’s have my dragon-king burn this black swan concept. (Laughter) There are many early warning signals that are predicted by this theory. Let me just focus on one of them: the super-exponential growth with positive feedback. What does it mean? Imagine you have an investment that returns the first year five percent, the second year 10 percent, the third year 20 percent, the next year 40 percent. Is that not marvelous? This is a super-exponential growth. A standard exponential growth corresponds to a constant growth rate, let’s say, of 10 percent The point is that, many times during bubbles, there are positive feedbacks which can be of many times, such that previous growths enhance, push forward, increase the next growth through this kind of super-exponential growth, which is very trenchant, not sustainable. And the key idea is that the mathematical solution of this class of models exhibit finite-time singularities, which means that there is a critical time where the system will break, will change regime. It may be a crash. It may be just a plateau, something else. And the key idea is that the critical time, the information about the critical time is contained in the early development of this super-exponential growth. We have applied this theory early on, that was our first success, to the diagnostic of the rupture of key elements on the iron rocket. Using acoustic emission, you know, this little noise that you hear a structure emit, sing to you when they are stressed, and reveal the damage going on, there’s a collective phenomenon of positive feedback, the more damage gives the more damage, so you can actually predict, within, of course, a probability band, when the rupture will occur. So this is now so successful that it is used in the initial phase of [unclear] the flight. Perhaps more surprisingly, the same type of theory applies to biology and medicine, parturition, the act of giving birth, epileptic seizures. From seven months of pregnancy, a mother starts to feel episodic precursory contractions of the uterus that are the sign of these maturations toward the instability, giving birth to the baby, the dragon-king. So if you measure the precursor signal, you can actually identify pre- and post-maturity problems in advance. Epileptic seizures also come in a large variety of size, and when the brain goes to a super-critical state, you have dragon-kings which have a degree of predictability and this can help the patient to deal with this illness. We have applied this theory to many systems, landslides, glacier collapse, even to the dynamics of prediction of success: blockbusters, YouTube videos, movies, and so on. But perhaps the most important application is for finance, and this theory illuminates, I believe, the deep reason for the financial crisis that we have gone through. This is rooted in 30 years of history of bubbles, starting in 1980, with the global bubble crashing in 1987, followed by many other bubbles. The biggest one was the “new economy” Internet bubble in 2000, crashing in 2000, the real estate bubbles in many countries, financial derivative bubbles everywhere, stock market bubbles also everywhere, commodity and all bubbles, debt and credit bubbles — bubbles, bubbles, bubbles. We had a global bubble. This is a measure of global overvaluation of all markets, expressing what I call an illusion of a perpetual money machine that suddenly broke in 2007. The problem is that we see the same process, in particular through quantitative easing, of a thinking of a perpetual money machine nowadays to tackle the crisis since 2008 in the U.S., in Europe, in Japan. This has very important implications to understand the failure of quantitative easing as well as austerity measures as long as we don’t attack the core, the structural cause of this perpetual money machine thinking. Now, these are big claims. Why would you believe me? Well, perhaps because, in the last 15 years we have come out of our ivory tower, and started to publish ex ante — and I stress the term ex ante, it means “in advance” — before the crash confirmed the existence of the bubble or the financial excesses. These are a few of the major bubbles that we have lived through in recent history. Again, many interesting stories for each of them. Let me tell you just one or two stories that deal with massive bubbles. We all know the Chinese miracle. This is the expression of the stock market of a massive bubble, a factor of three, 300 percent in just a few years. In September 2007, I was invited as a keynote speaker of a macro hedge fund management conference, and I showed to the conference a prediction that by the end of 2007, this bubble would change regime. There might be a crash. Certainly not sustainable. Now, how do you believe the very smart, very motivated, very informed macro hedge fund managers reacted to this prediction? You know, they had made billions just surfing this bubble until now. They told me, “Didier, yeah, the market might be overvalued, but you forget something. There is the Beijing Olympic Games coming in August 2008, and it’s very clear that the Chinese government is controlling the economy and doing what it takes to also avoid any wave and control the stock market.” Three weeks after my presentation, the markets lost 20 percent and went through a phase of volatility, upheaval, and a total market loss of 70 percent until the end of the year. So how can we be so collectively wrong by misreading or ignoring the science of the fact that when an instability has developed, and the system is ripe, any perturbation makes it essentially impossible to control? The Chinese market collapsed, but it rebounded. In 2009, we also identified that this new bubble, a smaller one, was unsustainable, so we published again a prediction, in advance, stating that by August 2009, the market will correct, will not continue on this track. Our critics, reading the prediction, said, “No, it’s not possible. The Chinese government is there. They have learned their lesson. They will control. They want to benefit from the growth.” Perhaps these critics have not learned their lesson previously. So the crisis did occur. The market corrected. The same critics then said, “Ah, yes, but you published your prediction. You influenced the market. It was not a prediction.” Maybe I am very powerful then. Now, this is interesting. It shows that it’s essentially impossible until now to develop a science of economics because we are sentient beings who anticipate and there is a problem of self-fulfilling prophesies. So we invented a new way of doing science. We created the Financial Bubble Experiment. The idea is the following. We monitor the markets. We identify excesses, bubbles. We do our work. We write a report in which we put our prediction of the critical time. We don’t release the report. It’s kept secret. But with modern encrypting techniques, we have a hash, we publish a public key, and six months later, we release the report, and there is authentication. And all this is done on an international archive so that we cannot be accused of just releasing the successes. Let me tease you with a very recent analysis. 17th of May, 2013, just two weeks ago, we identified that the U.S. stock market was on an unsustainable path and we released this on our website on the 21st of May that there will be a change of regime. The next day, the market started to change regime, course. This is not a crash. This is just the third or fourth act of a massive bubble in the making. Scaling up the discussion at the size of the planet, we see the same thing. Wherever we look, it’s observable: in the biosphere, in the atmosphere, in the ocean, showing these super-exponential trajectories characterizing an unsustainable path and announcing a phase transition. This diagram on the right shows a very beautiful compilation of studies suggesting indeed that there is a nonlinear — possibility for a nonlinear transition just in the next few decades. So there are bubbles everywhere. From one side, this is exciting for me, as a professor who chases bubbles and slays dragons, as the media has sometimes called me. But can we really slay the dragons? Very recently, with collaborators, we studied a dynamical system where you see the dragon-king as these big loops and we were able to apply tiny perturbations at the right times that removed, when control is on, these dragons. “Gouverner, c’est prévoir.” Governing is the art of planning and predicting. But is it not the case that this is probably one of the biggest gaps of mankind, which has the responsibility to steer our societies and our planet toward sustainability in the face of growing challenges and crises? But the dragon-king theory gives hope. We learn that most systems have pockets of predictability. It is possible to develop advance diagnostics of crises so that we can be prepared, we can take measures, we can take responsibility, and so that never again will extremes and crises like the Great Recession or the European crisis take us by surprise. Thank you. (Applause)

100 thoughts on “Didier Sornette: How we can predict the next financial crisis

  1. he gave you tons of real examples, were you blind? Real info is that nothing can grow forever, and if it's growing extremely fast—there's gonna be extreme crash

  2. I hope not only me has came to quite different conclusion: he put it very simply, mb even too much

  3. Thanks for replying.
    Iran and Syria are a few of the remaining countries outside of the grip of the banks.
    It's why Libya, with previously the worlds second highest standard of living, was taken out.
    The human race is being farmed en masse under the guise of democracy and commercialism, stirred with religion.
    The 1st step towards freeing ourselves is to alert people to what is really happening.
    Luckily, the people ARE the power and our awareness and non-compliance is all that is needed.

  4. There was responsibility. The governement eliminated regulations, and the banking industry took advantage and proceeded to gouge and ruin individuals. There were indicators for those who were willing to look.

    Also, they are working to do it again!

  5. Heu guys, did you know the "Sornette" is a polite way of saying bullshit in french? I think it explains this video.

  6. You can stop financial crisis if you:
    1. Meet all the bankers in the world.
    2. As soon as they start laughing, kill them all.
    3. Meat all the bankers in the world.
    Don't forget to make them suffer.

  7. There was nothing surprising about the crash of 2008. When you see kids straight out of high school qualifying for mortgages on homes upwards of 250k with no real assets, something is dreadfully wrong, no guesswork involved.

  8. Click the 'Automatic English captions' button below this video if you're having trouble listening to his accent…ALL WILL BE CLEAR

  9. Bubbles are hard to predict, very hard actually. If you believe you can see a bubble before the market, just go short a bunch of stocks whenever you see one and make millions.

    If bubbles were easy to see they would not exist.

  10. They do work to lend money, they don't do it because of how humanitarian they are. I know, everyone works for money, but if your job is to make people in debt, you're not nice at all.

  11. Their job is not to make or force people into debt. It is to give people the option to borrow money, clearly if people are of sound judgement they will only do so when they expect it to better their lives. For exampl i might go into debt to fund my education, without a bank acting as a mediator between those who wish to lend and those who wish to borrow we would be much worse off individually and as a society.

  12. Doesn't anyone notice the timeframe(2030-2060) for the massive change for humanity. The year he gives is 2045, which is the same year for Ray Kurzweil's singularity. There are no coincidences.

  13. but wouldnt we pop the bubble by detecting and measuring it? if someone had did this in 2005-2006 and announced that real estate market is over valued and had proven this then the crisis would have begun 1-2 earlier that it did.

  14. How will economists predict the next financial crisis? I assume, in the same way as they predicted the last one. They will cluelessly wait until it happens and than they will explain that such and such lead to this and that and how it all was inevitable and had to happen the way it happened.

  15. Robert Kiyosaki (rich dad poor dad) predicted this crash almost a decade ago in the book: Rich Dad Prophecy.

  16. This is nothing new. This is the old proverb "nothing good can last forever" applied to economics. Obviously exponential growth isn't indefinitely sustainable.

  17. If that model is so great, why doesn't he put some money on it and became millionaire, instead of release those useless "reports"? Oh! I see… he is a "professor", an academic, more interested in the benefit of the humanity than in his own benefice.

  18. Most of the people unfortunately have not clue what he is talking about. It's finally all statistics. That's why he doesn't make money with it, it's just a probability. No one will ever be able to predict a complex system with certainty. Most of you folks have never ever actually worked with stocks have you. It's not especially hard to get the basic trends, it's hard to know EXACTLY when to buy/ sell and probabilities are uncertainties and therefore only of little help in this case.

  19. While I agree almost anyone can spot bubbles. Knowing when they are going to pop is very important.

    I know someone who saw a major bubble in our economy, knowing when it popped Gold prices would shoot up he heavily invested in gold. After many years he finally sold the gold for a loss. About two years later bubble popped gold went through the roof.

    Knowing the pace of the bubble, knowing exactly how unstable it is. Is very important.

  20. it always seemed to me like a lot of people saw the crisis coming and did nothing about it… and the daft governments of europe continued to spend a lot when it was very obvious that economic activity was going way down

  21. I think he should use it to predict earthquake. If this is truly working, I rather to see it saving people lives from natural disaster than man made financial bubble created by greed.

  22. I'd distill this talk down to extolling the virtues of the Scientific Method as applied to economics & other studies. Mathematics is at its core; research & data acquisition is its fuel. The main benefit here is predictability that allows us, as individuals & societies, to plan for success. Economic theory has certainly missed the mark for most of us because of its ideological basis that obviously needs a make-over to bring it more into the realm of science.

  23. If you are having a hard time with his accent there is an option to turn on closed captioning at the bottom of the video.

  24. To think that the markets follow some rule of nature couldn't be farther from the truth. The financial markets are rigged so it is not free market capitalism at work. Some people knew absolutely the 2008 crash was coming because of all the fraud that was being committed. This theory does not take into account the fraud that leads to bad investment and prices that don't reflect true value.

  25. Schrodingers's cat will argue otherwise.

    By observing and 'predicting', you change the outcome thus ensuring unpredictability.

    Central planners have been trying this for decades and all they've done is manage to incite ever increasing amplitudes of volatility. The derivative of what they're doing is eventually going to hit a parabolic infinity. That's when the cat is both dead and alive.

    Predicting humans is pure fantasy, even when they're controlled.

    The French should know this intimately

  26. This guy actually advocates that "Quantitative Easing" and Austerity do not work and do not address the systemic central problem.

  27. "To think that the markets follow some rule of nature couldn't be farther from the truth. The financial markets are rigged…"
    Indeed, they are rigged.
    But…the rigging is surely a "rule of nature."
    I mean…to say that ANYTHING that exists within nature somehow doesn't follow the rules of nature…is kind of absurd.
    Everything that is(you sitting at your computer, the birds outside, the Rolling Stones, financial markets, rivers, galaxies, red blood cells) is nature.
    Everything is natural.

  28. The word SUSTAINABILITY is of significance.
    When a system can no longer sustain the growth…then we have a crash..
    A good analogy is the balloon…Keep inflating it and it reaches a breaking point where the growth of the balloon is not sustainable because of the physical limitation…and it bursts.!!

    Exponential growth is not sustainable when there is a limit to that growth.

    The exponential population growth we witness is not sustainable.


  29. Is this a joke? I'm only 30 seconds in…who the hell was calling '86 to '07 stable?? You can even see in the employment chart the fallout from Black Monday and the other major crashes around the Gulf war. I thought it was common knowledge that major financial markets crash on an average 7 – 11 year cycle anyway?

  30. He said that the dragon king should eat the black swan, but the definition is of a black swan is that it is unpredictable, unlike the dragon king. How can one predict the fact that the Greece played around with the numbers?

  31. Slow down Pepe Le Pew… its all scare tactics. Nothing is going happen. It amazes me that all this talk about crap but CRAP never changes. Same thing day after day…. no changes other than the amount of money they will slowly drain for the world population until we are all taxed 100% and giving only what the world governments think we need to live. Oh, and don't forget they will do everything to divide us all and keep CRAP going. Its a promise.

  32. at time 9:29 no index (readable) of left side of graph….what…trillions of USD? also I came here to see a circuit diagram of the hardware he uses…..where is that?

  33. 13:38 – Why does the graph of the Chinese bubble stop at 2009? This talk was in 2013 and data is pretty easy to get. That makes me suspicious that this is a bit of a curve-fitting exercise. Though he does say this is 'just the third or fourth act' so maybe the financial bubble indeed goes in pockets of predictability. These so-called non-linear transitions are interesting.
    I still have Sornette's book on stock market crashes and power laws, it motivated me to take up finance in the first place.

  34. It has been a year since this guy bragged about his predictions. He said the Nasdaq was in a bubble in May of 2013. It was around 3530 at that point. It is currently at 4300. 

  35. This is another out-of-touch academic selling us theories that do not have solid real life experiment. Myself as a scientist/engineer always rely on tests to confirm any analysis even though past analytical results were confirmed by experiment. The problem with these predictions are many parameters interact nonlinearly and you never know when and how a crash would occur.  for example Hurricane prediction and modeling is based on allot of measurements, past history and nonlinear dynamics. You can see it is coming but not accurately know where it is going to hit and what time it will hit. The financial market is random event which is heavily influenced by consumer psychology, government policies and a host of other unpredictable factors. I guess Professor Didier should invest all his assets in the financial market since he can predict the outcome. He will be extremely rich !!!

  36. Trying to analyze the 07 08 crisis by looking at stocks is incoherent. It was in extremely complicated derivatives and the perverse incentives surrounding the speculative frenzy in those illiquid markets.

  37. Didier Sornette is a professor from ETH Zurich, one of the best universities in Europe.
    All those dislikes because the cowards/sheeple can't handle the truth xD

  38. Sustained growth. How? First of all, without democracy a few tend to take it all. With corporate capitalism, the ultimate goal is to take more than is given. That's called profit. With the increased efficiency of profit maximization, those in control make the decision when to water the garden, how much to water the garden and if to apply fertilizer, how often or when? With greed and no checks and balances, those in control of the economic garden, kill it. To this day in spite of his back peddling rambles soon after the economic downturn, Alan Greenspan has not learned one damn thing. There are too many more just like him.

  39. Another one is coming if few years & the biggest will be after the electronic money that will shake up down the world societies, wars & planed terror attack will be among those years !! Enjoy the Joy muy soy heheho

  40. It's ridiculous how many ignorant people come here not to dialogue with knowledge but to nitpick a respectable academic of his accent, which is not even that strong.

  41. Wow, so how was that big bubble burst of 2013, Prof Sornette? Another self-important quack claiming to predict the markets.

  42. The PRIVATE central bank called "Federal" Reseve knows exactlt when it will happen, but the are a criminal enterprise based on theft and usuary. And rich people like this guy are privy to this information

  43. Explain where the losses went. Was it cash or simply paper? Why does it trickle down? Is the bettor using money that if lost, effects others? Should that be legal then…as it wouldn't be his money?

  44. With the end of an era, and a 90 million dollar funeral….
    I have made a detailed explanation on the financial crisis.
    I hope this video is good.

  45. Very thought-provoking…..would love to see what he suggests for the emergent increase of general interest rates in the world's largest mrkets.

  46. Can you predict randomness? Are we god yet? Can we predict herd behavior? Can we predict the weather? Answer is no. It's wishfull thinking, and this ted title is the kind of talks you look at when your bored af and seek "dumbening" entertainment. Btw, the best you can do is statistical prediction. Good luck with that – James Simons bought up all geniuses in science areas.

  47. Cutting a 17 min TED talk about bubbles short: Bubble Genisis = Low Interest rates. Bubble maturity/ pop = Interest Rates rise. 17 min of tedious research compacted. Thank me later.

  48. The factors that determine a crash are 2 things. Supply & demand.
    2008 mortgage brokers giving record number of "NINJA" loans.
    Interest only loans… reaching over 51% of all mortgages will be the tipping point. At this rate it will be 2020! People buying houses they cannot afford…..SIMPLE. impressing other people will cost you dearly!

  49. https://www.youtube.com/watch?v=vuvbghZuM8U&t=2314s
    This video is a bit hard to follow due to the accents, sound quality, and the level of sophistication of the conversation. It is worth checking out, however. Nassim Taleb (Black Swan) and Didier Sornette (the speaker of the video above) debating these rare events and their predictability.

  50. Take us-you-by surprise. Without the complexities it is possible to predict from obvious data. And yet, who will listen? If I am not taken by surprise, still others are. Complexity has many threads and who follows them all? We are due for a terrible collapse of fiat funny money. Zero interest and excessive debt coupled with massive shortages in pensions and other promised returns, will soon collapse the system. This is July 2018. Soon we stumble and then the fall. I won't be surprised but many will-sad.

  51. You can tell a bubble is a bubble by the composition and psychology of the participating investors. When an investment becomes viewed as a popular and easy way to make money, and a broad portion of the investment community is throwing money at it, you have a good idea that a bubble is brewing. I invite anybody interested in investment, economics, philosophy, books or movies to subscribe to my channel. Leave some questions or comments about topics you would like to hear about, if you want.

  52. 1) I am sorry to say, but the good professor is clueless. He uses flawed economic theories, build on flawed ideas, due to entrenched flawed ideologies.
    2) It wasn't a marginal risk call (black swan), it was a debt/fraud/lagging oversight bomb.
    He draws all the wrong conclusions. It is heartbreaking to watch -.-

  53. he tells us nothing. I would advise Didier Sornette in the video to read the works of Dr. Steve Keen concerning the build up of excessive private debt and excessive growth rates in this in relation to speculation and bubbles. And read New World Disorder at https://www.amazon.com/New-World-Disorder-Terrorism-Democracy-ebook/dp/B076Z7HLR9 to educate himself about bubbles and crashes.

  54. I've been familiar with Prof Sornette's work for many years. He is one of few geniuses working in academia today. What a pleasure it was hearing him speak.

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