Financial System Engineering

Financial systems are shaped by conscious design and market forces. The Dodd-Frank Act is, at least in part, a collection of mechanisms to supplement and better channel market incentives. It expands the scope of financial regulation and requires regulators to engage in a full-scale re-engineering of financial rules and of financial systems more generally. After the financial collapse that began in 2007, commentators and legislators were in broad agreement as to some of its main causes: institutions, securities, and markets that were too complex and lacked transparency, and the paucity of timely monitoring by regulators and investors. However, we still do not have a good understanding of the relationship between complexity, transparency, and real-time governance (monitoring followed by accountability). This article develops a theory of complexity and real-time transparency in financial systems. It divides the concept of complexity into four sub-types: intertemporal, coordination, strategic, and governance complexity. It also considers techniques developed by engineers to manage complexity and shows how to extend these to the financial systems. The article gives special attention to a set of engineering techniques used to design, test, and monitor real-time, safety-critical systems. The complexity and real-time constraints in financial systems resemble those in nuclear power plants, air traffic control systems, hospital monitoring equipment, and a variety of similar systems in which it is necessary to collect information on an ongoing basis, identify problems, pierce through the complexity, and design and implement solutions in a timely fashion. The more general normative claim of this article is that, in designing financial systems, regulators should make full use of the specification, design, and testing techniques developed by engineers