Was the meltdown of the financial system predicted by events in the online virtual world Second Life more than a year ago?

Alan Greenspan, former head of the Federal Reserve, admitted last month that lending institutions could not always be trusted to regulate themselves. Really? Then maybe the 2007 collapse of Second Life’s virtual bank Ginko Financial can be instructive. In a post for MSNBC.com Jeremy Hsu writes,

Virtual economies in games such as Second Life and EVE Online may seem trivial, but they actually can provide real-life lessons on the patterns of free markets and unfettered capitalism. Researchers and self-described virtual economists have observed how virtual entrepreneurs establish themselves and compete, as well as how a lack of self-regulation can lead to dramatic banking failures, scams and even corporate espionage.

“I don’t view ‘Second Life’ as a game,” said Robert Bloomfield, an accounting researcher at Cornell University in Ithaca, New York. “I view it as a market space.”

Should we have seen it coming? Reuters reported on 2L’s unregulated banking in 2006 and Wired magazine reported a run on the virtual banks of Second Life was possible months before it happened. And a panel discussion a year ago about the virtual financial crisis and “take over” of Geko Financial in Second Life seems to be particularly prescient. In that incident, Lindon Labs effectively shut down Second Life’s unregulated in-world banking system with predictable consequences:

The end came when panicked investors began withdrawing their virtual money, known as Linden dollars in the game and exchangeable for U.S. dollars at a rate of roughly 250 Linden dollars to one U.S. dollar. Ginko did not have enough reserves to pay up. When the bank finally announced it was finished, an equivalent of $750,000 in real-world U.S. dollars went up in smoke. The collapse not only wiped out time spent earning Linden dollars in the game, but also hit the wallets of players who had legally paid U.S. dollars to buy Linden dollars. 

“The ‘Second Life’ financial markets have pretty much been unregulated,” Bloomfield told LiveScience. “There are accusations that people are doing everything from questionable behavior to outright fraud.” (Jeremy Hsu’s report for MSNBC continues here.)

Questionable behavior and outright fraud? I’m not an economist by a long shot but those words do ring true about now. And though virtual worlds are, well, virtual, by providing a portal to human behavior they can deliver real value in unexpected ways… if we pay attention.