September 20, 2008
What's tech got to do with it?
This has been an interesting week to say the least - two of the largest investment banks in the world felled by events by seemingly unforeseen circumstances, with a third being brought to the brink; the world's largest insurance company being felled with the same chilling efficiency by the markets. If you're like me, your head must be spinning with the questions.
Why did it happen? How did this come to pass? And most humanly - who was responsible? Predictably uninformed, political types jumped on the economy bandwagon calling for fixing the "greed" in the "casino on Wall Street".
In the midst of all this, a risk techie like myself was asking (with apologies to the fabulous Ms. Turner) - "what's tech got to do with it (if anything)?". Does risk technology matter? Did any deficiency in risk technology have a role to play in the current crisis? Could better technology have helped?
With all the talk of transparency, corporate governance and control, one could be forgiven for assuming that this was all the fault of a few men sitting in smoky, oak-paneled rooms cutting deals that left the rest of the economy in shambles. The uninformed might reasonably assume that if only the people in the places of power had demanded better control, or had been more ethical, or had put in place better governance policies, we would not be in this sorry shape.
My submission is that the reality could not be more different. There's no denying that these factors played an important role. However even the best intentions can have an effect only when they are implemented. This week's hand-wringing about the need for increased corporate transparency seems to suggest that the titans of the financial industry were actively trying to hide their financials. While doubtless there are (and will always be) a few bad apples, let's take an example:
- Merrill Lynch announced on Oct 5, 2007 that it would take write-downs of $4.5 billion due to mortgage exposures (I know - this seems like small potatoes now, but believe me, back in the old days this was a shocker).
- Barely three weeks later, Merrill announced that no, it was so sorry; the real number was $7.9 billion.
Ok, if we are now so numb to the size of these numbers, perhaps it'll help to talk in percentages - the new disclosures, coming just 3 weeks after the old one, was seventy-five percent higher (for full details, see Merrill's $3.4 billion balance sheet bomb). It seems hard to believe that it was in erstwhile CEO Stan O'Neill's best interest to shield the truth (a week later he paid the price by being forced to resign) or even less plausibly, that the mortgage market soured so badly in three weeks as to warrant such an increase in write-downs. It seems clear that he did not know the size of the disclosures. Making the logical assumption that everyone under the CEO had the same self-interest in ensuring full disclosure, the only logical conclusion is that no one knew the size of the exposures. Following this episode, many other storied financial institutions came out with their own write-downs in the same haphazard manner.
The real secret is that financial markets have become so complex and interconnected that it's impossible to perform "back-of-the-envelope" calculations of risk exposure. My conclusion is that not only is technology relevant to the present financial crisis - rather, better technology is essential to solving the problems facing the US and world economy today. Given the size, scope, interconnectedness and complexity involved, every aspect of risk management - measurement, monitoring, transparency and controls - depends on technology more than ever. In the near future it will even more critical that we not rely on a band-aid ridden risk infrastructure to drive the world-economy forward. Rather it's critical that adequate attention be paid to this important aspect of risk management.
Posted by dkrishna at 12:18 PM
| Comments (1)
