I am trying not to spend too much time following the crisis on Wall Street and the world’s financial markets. It’s not so much the precipitous drops in the market indices that I find hard to take, it’s the contact sport of pointing fingers. While seemingly 3% of the interested parties are trying to find a solution to the mess, the other 97% are assigning blame. The reality of the situation is that the blame can be distributed far and wide, from politicians and regulators that sought to ease credit restrictions, to corporate management who sought to profit from it, to the speculators and consumers who got in over their heads trying to benefit from it. Your politicians and mine, all are culpable for either being involved from the beginning or failing to heed the warning signs.
What I want to know is, why did our controls fail us? Wasn’t Sarbanes-Oxley intended to institutionalize the type of corporate governance that would allow us to steer clear of these lemming leaps into irresponsibility? What about the GRC framework, that seeks to align Governance, Risk Management and Compliance objectives in a way that maximizes profits, but only a responsible way? The ability for publicly traded financial institutions to accurately manage risks will properly be scrutinized for their role in this mess. Why did risk management fail? Risk management is not easy, but it should have been possible to do much better. However, enterprise risk management breaks down when it is not comprehensive. And it cannot be comprehensive if we do not have alignment between the risk to a financial institution and that financial institution’s officers. That is a section I would like to see in every 10-K filing: what is the personal risk to the corporation’s directors and officers for a failure in their business? If they have none, that should worry us all. If we cannot account for the risk to our corporate leaders pursuing dubious quarterly targets, what will we really have learned from this mess?
3 Responses to “The Credit Meltdown and the failure of Risk Management”
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Matt Barney Says:
October 7th, 2008 at 5:21 pmI appreciate your broad view of the problem. For certain, current risk management methods are still inadequate. One area in particular, appears to be it’s lack of explicit support for Evidence-based Management, using stochastic risk management methods on selecting senior executives, for example. Psychometric methods from Industrial/Organizational psychology aren’t perfect, but they increase the probability of finding, growing and improving the performance of employees, leaders, and boards. This includes the culture of transparency, decision making effectiveness, humility, and conscientiousness.
Is there any doubt that we can improve our odds in these areas, traditionally outside the scope of Audit and Financial Engineers?
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Kurt Seifried Says:
October 8th, 2008 at 3:54 amNone of this really matters if the risk/reward relationship is decoupled. Witness all the CEOs, board members, executives, traders, etc. still collecting bonuses on their way out the door. Or to put it another way I was watching a video of Lehman brothers closing up shop, people were leaving the building with a box or two of their stuff (normal) to be picked up by chauffeur driven cars (I suspect most people that lose their job might opt to save a few bucks and take a taxi). Realistically no amount of corporate governance is going to matter if the people making the decisions are not held accountable and censured in some way for bad decisions or decisions that violate the rules.
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October 8th, 2008 at 10:19 amKurt, your points are well taken. It begs the question - what person or group of people are accountable for ensuring risk and reward/consequences are tightly integrated? It’s one thing to have policies written and communication ’spin’ about pay for performance. It’s entirely different to systematically implement these methods in real organizations, given a culture and climate that is less than fully transparent or consequence oriented Similarly, too often senior executives lack humility and respect for uncertainty and risk in management issues.
