In the days before banks with national scope, e.g., late 1920s in the United States, a single bank failure would destroy the economy of an entire community. Spreading risk across the entire country since the 1930s and around the world in the 21st Century protects locals from the bad decisions of other locals. As with other attempts at risk management, the model has to account for “common cause”, which has not been dealt with comprehensively yet (see the economic crisis of late summer 2008 and subsequent legislation). When only a few people can quantitatively calculate financial risk, they tend to make the same assumptions and thus introduce systemic risk where the intention is to disburse risk.
Very interesting post. Thank you.