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March 07, 2008
Getting Back Alive from Subprime: Product Design, Creation Risk & Disaster Recovery Comments
Getting Back Alive from Subprime: Product Design, Creation Risk & Disaster Recovery Comments
"The board concluded "that the accident was not the result of a chance malfunction in a statistical sense, but rather from an unusual combination of mistakes, coupled with a somewhat deficient and unforgiving design." NASA, Report of Apollo 13 Review Board, p. 5-1.
"The total Apollo system of ground complexes, launch vehicle, and spacecraft constitutes the most ambitious and demanding engineering development ever undertaken by man. For these missions to succeed, both men and equipment must perform to near perfection. That this system has already resulted in two successful lunar surface explorations is a tribute to those men and women who conceived, designed, built, and flew it... Perfection is not only difficult to achieve, but difficult to maintain. The imperfection in Apollo 13 constituted a near disaster, averted only by outstanding performance on the part of the crew and the ground control team which supported them." Ibid., preface.
At the end of February 2008, it is pretty clear that many of the financial products generally associated with the "Subprime" crisis that fully erupted in August 2007, but had been trembling for many months previously, were designed by financial engineers and others in the industry in a 'somewhat deficient and unforgiving' manner.
Today, the world watches as a financial version of the recovery after the aborted lunar landing by Apollo 13 plays out. It is certain that the mission of increasing home ownership for lower income families through new (profitable) financial products has failed. Likewise other short and medium term instruments have failed to fulfill their missions.
It remains unclear whether Washington's fiscal and monetary reactions will produce the desired effect. The Main Street solutions don't really address some of Wall Street's biggest problems - the complete collapse of markets for some instruments. Yes, resolution of stress on monoline insurance companies is key. But where is the Odyssey for us to crawl into and return to earth? Paulson's Super-SIV wasn't it. If another exists and we're returning to Earth, why doesn't Main Street feel it? If such a product (suite) does not exist, how can it be designed and implemented in a manner that gives both Wall and Main Street confidence?
Indeed, if now is the time to lock the doors and bang (engineer's) heads together - why is there so much movement amongst Wall Street risk managers, with CROs coming and going at such a high rate and whole teams being shifted or shut?
A few notes for future reference:
(i.) Who can we get involved in product design?
(ii.) Where does design expertise and data on new products get housed? Who keeps responsibility for knowing what is inside (of a specific instrument)? Are today's themes of "I thought I had no exposure to subprime" and "I don't know what's inside" ones we seek repeated? What is the value to the enterprise of keeping the original product design team on staff to sort out eventual problems - how should this affect compensation?
(iii.) How are financial rewards / incentives examined to identify potential stress points? While subprime litigation is mostly focusing on sales tactics (worth remembering) and fraud, multiple tiers of participants - both vendors and employees - have each had a variety of incentives. Subprime had a complex group seeking reward off a small available % premium. What process would better ensure transparency of motivations - and flaws?
(iv.) Do we need to achieve and maintain perfection for this to work?
(v.) What is our escape route?
Posted by jtunkey at March 7, 2008 09:18 AM
Absolutely great - the analogy to Apollo 13. Unfortunately, this disaster cannot be averted.
Posted by: Brenda Childers at March 7, 2008 04:18 PM
We all must remember that perfection cannot be engineered into any mechanical, electrical, petro-chemical or financial process. Those who continue to be overly dependent on models will continue to form the detritus of the next catastrophe.
Posted by: Thomas O'Rourke at March 8, 2008 08:17 PM
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