Systemic Risk, Part 1: What It Is, and How Often It Really Happens

Part 1 — What It Is, and How Often It Really Happens

Educational only. Not investment advice, and not a recommendation to buy or sell any security or asset. Nothing here is tailored to any individual situation. Past performance does not guarantee future results.

Key takeaway: Systemic risk is the risk that the financial system itself stops working: payments, lending markets, the currency, or legal claims on assets. Diversification alone doesn't address it, because every holding depends on the same system. Serious disruptions are rare but have occurred several times in the last century.

What is systemic risk?

Most of the risk we talk about in planning happens to one thing at a time. A company has a bad quarter. An industry falls out of favor. A borrower fails to pay. Owning many different investments is designed to handle that, because when one holding stumbles, the others can carry the portfolio.

Systemic risk is different. It is the risk that the plumbing stops working: the systems that move money, the markets that lend it, the currency itself, or the legal claim you hold on your property. Diversifying inside a system does not protect you from the system. Spread money across twenty holdings and all twenty still sit behind the same custodian, the same clearing system, and the same rule-setter. When the rules change, they change for all twenty at once.

Systemic vs. systematic risk: what's the difference?

The two terms sound alike but describe different things:

• Systematic risk is ordinary market-wide risk: recessions, interest-rate moves, broad selloffs. Diversification can't remove it, but markets keep working while it plays out.

• Systemic risk is the risk that the system itself fails or is changed: markets close, a currency collapses, or the rules on what you own are rewritten.

Put simply, systematic risk moves the price of what you own. Systemic risk can affect whether you can sell it, what it's paid out in, or what the rules say it is.

Has the financial system broken down before? Examples from history

Yes, several times. In most of these episodes, the disruption was not widely expected beforehand.

1914: The NYSE closes for four months. On July 31, 1914, as war broke out in Europe, the New York Stock Exchange closed. It reopened for limited bond trading on November 28 and for stocks on December 12, the longest shutdown in its history. During that time, investors could not sell listed securities on the exchange, and no reopening date was announced in advance. Some brokers traded for cash on the street outside the exchange, and were allowed to continue only if their prices stayed out of the newspapers. (Saturday Evening Post; History.com)

1921–1923: Hyperinflation in Germany. The currency lost nearly all of its value. The hardest-hit households were often the conservative ones: those holding cash and government bonds saw both become close to worthless, while owners of land and buildings kept real assets.

1933–1934: The U.S. gold order and revaluation. In April 1933, Executive Order 6102 required Americans to turn in most of their gold at the official price of $20.67 an ounce, with penalties of up to a $10,000 fine and ten years in prison. The following January, the Gold Reserve Act led to a new official price of $35 an ounce, which cut the gold value of a dollar to about 59 cents of what it had been. Those who complied received dollars that were soon worth less in gold terms. (Federal Reserve History: Roosevelt's Gold Program; Gold Reserve Act of 1934)

1971: The end of dollar-gold convertibility. The United States stopped exchanging dollars for gold for foreign governments, ending the Bretton Woods system. (Federal Reserve History)

2008, 2020 and 2023: Emergency guarantees. In each crisis, officials stepped in with guarantees that had not existed the week before.

You will sometimes hear this pattern called a Fourth Turning, from a theory that societies move through roughly eighty-year cycles that end in crisis and renewal. It is a useful reminder that no financial arrangement lasts forever. It is a poor prediction tool, because a pattern that is clear only in hindsight is hard to act on beforehand.

How likely is a systemic financial collapse?

Low. Not zero.

That difference deserves more respect than it usually gets. People tend to land in one of two camps. Either the system is fine and the question is silly, or collapse is coming and everything else is denial. Both camps make the same mistake. An event that is unlikely but severe calls for preparation, not prediction.

In nearly every episode above, the system did not fail. It was rescued. How these rescues work, and who bears the cost, is the subject of Part 2.

Frequently asked questions

What is systemic risk in simple terms? Systemic risk is the risk that the financial system as a whole stops working normally: markets close, payments freeze, a currency loses its value, or the rules governing ownership change. It is rare but has happened several times in the past century.

Can diversification protect against systemic risk? Not by itself. Diversification spreads risk across holdings, but those holdings usually share the same custodians, clearing systems, currency and legal framework. How to plan for this depends on individual circumstances and is worth discussing with a financial professional.

What's the difference between systemic and systematic risk? Systematic risk is market-wide price risk, such as a recession-driven selloff. Systemic risk is the risk that the financial system itself breaks down or is restructured.

What are examples of systemic risk events? Historical examples include the NYSE's four-month closure in 1914, German hyperinflation in 1921–1923, the U.S. gold order and dollar revaluation in 1933–1934, the end of dollar-gold convertibility in 1971, and the emergency interventions of 2008, 2020 and 2023.

How often do financial systems break down? Serious disruptions have happened several times in the past century, but outright failure is rare. In most episodes, governments and central banks intervened and the system continued operating.

Is the Fourth Turning a reliable way to predict a crisis? No. It's a reminder that financial arrangements change over time, but its cycles are clear mainly in hindsight, which makes them hard to act on.