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Risk Manager-In-Chief
One way to view the current economic crisis is as a pervasive failure to manage risk. In fact, bad risk management actually explains a lot of what's gone wrong in recent years. And that realization is one we'd be well advised to bring with us into the voting booth in a few weeks.
One of the main reasons the financial system is seizing up is that too many institutions borrowed beyond their capacity and used the money to make risky bets. Some of those bets took the form of subprime mortgages--loans to people who were credit risks, but would be able to service the debt as long as their new home continued to appreciate at double digit rates. Other bets were in the form of derivatives--many of which also ultimately depended on home prices endlessly defying gravity.
The bubble burst, home prices began to slide, mortgage defaults accelerated, and the extent of overleveraging--borrowing beyond your means--in the financial sector was exposed. The Treasury and the Fed are throwing everything they've got, including a bunch of stuff no one ever knew they had, at the problem, but little is really sticking yet.
What does any of this have to do with risk management? A lot.
When lenders make a loan, they face a risk of not getting paid back. If that risk is kind of high, they're likely to insist on a hefty down payment and set the interest rate on the loan higher than they would otherwise. Remember, that rate is the cost to the borrower of the loan, and if the market is working right, risky borrowers should face higher rates, both to discourage them from getting in over their heads, and to pay the lender a risk premium--a little protection money--for taking a chance.
If the risk is really high, a reasonably savvy lender won't make the loan at all.
But what if both lender and borrower fail to recognize the risks they're taking on? What if the banks think a debt, whether it's a mortgage or a complex derivative, is perfectly likely to be repaid with interest, right on time, when the reality is that it probably won't be. What if borrowers believe they'll be able to finance a loan when in reality, they won't even come close?
And what if a president and defense secretary think they'll be greeted as liberators in a country they've decided to occupy?
The failure to accurately assess risk has been truly epidemic in this country, and the costs have ranged from expensive (and I'm talking trillions here) to fatal.
The key questions are why did these failures occur and which presidential ticket would be best chosen in that regard (okay, question two is a terribly transparent set up, but please read on anyway).
The failure to assess risk in financial markets stems less from greed--that's always been there--than from a combination of "innovative" transactions and lax oversight. The Greenspan Fed not only watched the real estate bubble inflate, they blew into the balloon, touting the wonders of adjustable rate mortgages. Though the Fed is supposed to monitor the subprime market, they ignored internal warnings that large imbalances were forming. As Peter Goodman points out in this must-read article, Greenspan and other top officials blocked initiatives to regulate derivatives, despite the fact that the growing magnitude and interconnectedness of this market meant that their failure threatened the system.
Economists and bankers failed to manage the credit risk that occurs when cheap money and large external (i.e., from other countries) flows of capital finance a spending spree that's not supported by real income growth. In fact, the ability to package and sell that NINJA (no income, no job, no assets) loan you just made to some other dealer, meant that loan originators didn't need to worry about those pesky, old-school underwriting standards.
How did it come to this? The answer has a lot to do with economic ideology. Mainstream economists convinced policy makers that markets were self-disciplining. Oversight, borrowing constraints, the enforcement of lending standards...these would only cuff the invisible hand. Instead, the market would punish those who underpriced risk. Even when key markets were showing clear signs of flying off the hinges, the nation's top economists were reassuring us that these "temporary disequilibriums" were of little concern.
You see how well that has worked out. We very desperately need a new economics that sees market failures--and accurately prices risk--much sooner than the current brand.
But while bad risk management in financial markets is capturing our attention right now, the problem goes much deeper. Faulty intelligence overestimated the risk from WMD's in Iraq, and underestimated the challenges our military would face from the insurgents. In fact, when it comes to risk assessment, economic or otherwise, it is now quite impossible to trust the judgments of our leaders.
Which brings us to leadership. As noted, the economic failures to manage risk were caused by ideological blinders. The foreign policy failures were caused by the inability of our imperiousness leaders to entertain evidence that didn't fit their views. You can't assess risk if your mind is closed. Ideologues, who are by definition impervious to evidence, need not apply.
Now how does this all map onto Obama/Biden versus McCain/Palin?
Obama will be good at this. He has a balanced, evidenced-based approach to risk assessment. To the consternation of many in the base, he is not particularly ideological. He's also naturally cautious, deliberative, if not plodding. In fact, these very qualities were often (rightly) criticized during the campaign, as he failed to catch fire and communicate a simple, compelling narrative.
But at this point, many voters are looking for precisely the kind of leadership I believe he offers in this regard. It's not indecisive. It's gather the evidence, assess the risk factors, and make the call with the greatest objective, not subjective, chance of achieving the goal. It doesn't mean you check your gut at the door. It just means you let your brain into the room too.
With McCain, I fear that when it comes to making the big decisions, we'd get the subjective, shoot from the hip we've seen far too much of in recent weeks. That's certainly the message from the erratic turn the campaign has taken, as they lurch from one surprise to another. The old McCain was not particularly ideological, an advantage in judging risk; the new one is worse than Bush on this score.
McCain's economic policy is a good example. At this point, it's simply impossible to objectively look at the Bush economic record, and conclude it worked, yet McCain doubles down on it. He's also moved to right of Bush on the war, opposing timetables that Bush and even the Iraqi's themselves are brigning to the table.
But the worst sign regarding McCain as risk manager was the choice of Palin for his VP. That move, made for purely short-term political gain, with no regard for the risks it posed to the country, has turned even a number of staunch Republicans off their ticket. It's not just that she's inexperienced. It's that she doesn't seem to know what she doesn't know, and it's easy to imagine her, if she got the chance, making choices from inside the same sort of insulated Bush/Cheney bubbles that got us where we are today.
Finally, and I recognize I wade into choppy waters here, there's a relationship between a candidate's religious views and his or her ability to effectively assess risk. Of course, presidents have and will always be profoundly informed by the ethical tenets of their religion, and I see nothing wrong, and much right, with that (though how Bush's condoning of torture fits in here, I'm not sure).
But then there's these types of comments from Palin, who called the Iraqi war "a task from God," asserting that "there is a plan and that plan is God's plan" (sorry, but I think God's plan would have been infinitely better than the one in play). She made a similar point re God's will in getting their gas pipeline built up there.
With respect, that's mixing religion and policy analysis in a way that I fear leads to inadequate risk assessment. Bush never made such revealing statements, but it may be the case that evangelicals don't always make the best risk assessors.
I suggest we tout this role of risk manager-in-chief over the next few weeks. Given the challenges facing our country, it's a critically important distinction between the two tickets. And given the direction in which the polls are finally trending, it would appear that the majority of voters are ready to place a reality-based risk assessor in the oval office. To not do so would just be too...what's the word? Risky.
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Few worry that our military is the world's most expensive while, in economic terms, all military spending is waste. Our Iraqi experience makes two points: 1) A country with insufficient military can be costly to invade; and 2) A country with insufficient military is likely to be invaded.
Since we spend about 10x the amount of the next most expensive military, we should be able to get by with about 1/11th of what we spend. This would leave us too expensive to oppose in war while freeing funds to increase our domestic economy and to wage "soft" diplomacy. Actually, i have much respect for the professionalism in the military, and I have been surprised at times by their commitment to decency and constitutional government. While we have crazy people like McCain who obsess on "victory," having little concern for practical objectives beyond pounding all opposition, outstanding military leaders ever since George Washington have supported civilian government.,
If reasoning and logical connections were all that's needed, Jared, your article would be game, set, and match!
But it may take a lot more of watchfulness than of reasonableness to get the far better risk assessors into the White House.
From where I'm sitting your country have not been abysmal risk managers just for the duration of the failed Bush administration but pretty much my entire adult life. I still remember listening to "Life's Rich Pageant" (a phrase taken from Inspector Closeau to describe every event he stuffs up) by REM in college in the 1980s and thinking to myself - how could this be happening? Who could possibly support the sale of weapons to Iran to fund the contras? Yet one of the signatories to the minority report on this scandal (Cheney) has never shown any remorse to the death and destruction the events of the 1980s have cast on the world. Even worse it seems your average American doesn't care, allowing this extreme right-wing idealogue to implement their disastrous financial, economic and military policies. Has anyone even asked how your country will repay the trillions of dollars spent, wasted and foregone over the last 28 years? All I hear on the news are complaints that taxes will have to be raised. It is time for America to wake up and smell the roses.
Your right! We should close all our borders and Nationalize our economy and to heck with the rest of the world.
Yes, yes, yes, it can be observed in the Bush administration and continuing in the McCain campaign, a strange theology in itself more than ideology: clinging to a Rockwell(ien) mythology of the past, a refusal to view cause and effect in making crucial decisions in the present and a "magical manifestation" hope for the future. The trickle down effect of this type of almost child-like thinking has been astonishing and the damage has been very real. I have appreciated Senator Obama's recent statements that adhere to present realities and that we cannot go on living as though there is no consequence for tomorrow.
I am amazed that McCain/Palin, with their almost surreal, anti-intellectual rhetoric, has reached over Bush's 23% approval rating.
As others have noted, cancer is a very successful "growth" strategy. Unfortunately, Wall Street investment "bankers" (wankers is more like it) used cancerous techniques to game the system and guess what... the cancer metastasized! Imagine our surprise! Who could have predicted!?! Well, for one, a 12-year old with a paper route who saves his money and doesn't buy stuff until he has enough money. That's one person who could have predicted that when you buy stuff you don't need and can't afford, bad things will happen.
"Wankers,'' not bankers, and cancer as a "very successful 'growth' strategy". . . You've got it working, Fez!!
One thing and it is simple, we must not go backwards, we must still conserve oil, use public transportation, use less, require less, stop using credit, return to cash, I did and I buy much less, live more simple fullfilled lives, spend time with your kids, get involved in volunteer work, help your fellow man, get going on community organic gardens, get involved in life and not video games, computers and TV,go save a child, an animal, get involved in bartering, join a credit union, buy green, buy Made in America, don't buy anything from China ever.
Not a good idea to "tout" - way too complicated for the current environment.
It is good today to hear Obama's support of taking the penalty away from early withdrawals from
401(k)s, something that I have been advocating for some time. I do hope that people also recognize that this will slow growth, something that I support. The losses in 401(k)s that people have already endured cannot be recovered. What is needed is to find more localized forms for investment that are more stable in the long run.
steve, false accusations will get you no where,
all i will say is Keating 5 cause yes Mccain did use his public office to try to influence
regulators to leave his friend, buddy, whom he traveled with on vacations, to leave him alone or go easy on him.
that is fact, not some loosely tied shoe strings
dang you guys are real good at stringing together your accusations by name dropping.
reminds me of my ex-wife who always came to an agruement with a list written out.
I had to start keeping a mental list of my own.
America We Need a Divorce from teh Republican party, they sound just like my Ex Wife
There's no doubt that Saddam is as brutal of a dictator as the Presidents of Syria, Egypt, Saudi and all the middle east (except Israel) but what's sad that we lose the credibility context with him just because of the mafia in charge of the country
Even the charge of using WMD's against his own people they couldn't use it to try him for. They used the incident where he excecuted 130 people who tried to assasinate him when they fired at his convoy, because they thought it was the strongest case (as weak as it was, I wonder what the sentence would be for somebody who would try to fire at Bush's convoy)
The only thing in the public record that Saddam said in an interview before the war is that he didn't gas the Kurds. He said there was an independent group that determined that the material collected at the scene was used by the Iranians for Chemical weapons and the gasing took place in the last year of the Iraq-Iran war (1988) which was the nastiest (both fired missles with chemical warheads at each others). I don't know how true that it is but he seemed that in every issue about Iraq he was more credible than the neocons. They lied and apparently nothing in the public record show that Saddam lied (from the lies of his link to Al-Qaeda to WMD) And we could have found out the truth if we had a real investigastion instead of the circus trial they rushed into to get it over with before the american people start asking questions.
McCain said yesterday "and all that entails with his commitment which when after he was captured, he stated categorically that he would acquire weapons of mass destruction, and he would use them wherever he could." speaking of Saddam Where did he pull his information from? right out of his butt ? Saddam never said that. Plus these neocons keep telling us that Saddam said this and that, but while they had him in custody for 3 years they couldnt' tape any of his comments or make an interview with him to prove any claim they make about him or how evil he is. It's sad that in the context of truth vs. lies between a dictator like Saddam and the US, Saddam won because of the neocon mafia who took command of the nation's security. And a nut like McCain who's still in a state of denial still keeps lying about Iraq. Show me a tape of Saddam saying that, you LIAR. What kept you from taping the conversation? Saddam refused to be taped? hmmm.. I know that your base don't have critical thinking to challenge your lies but "Saddam refused to be taped" sells with them
It is almost 2000 days since Bush Landed on an Aircraft Carrier in Iraq and DECLARED VICTORY!
In the meantime we have spent over $700 Billion in Direct Costs.
Harvard Magizine calculated the Iraq War cost in 2006 at $2 Trillion including indirect costs and in 2008 that number is closer to $3 Trillion!
It's that Military Industrial Complex that Dwight D Eisenhower warned this country about. He told us to be aware and who would know better than an Army General and President of the US. In war, the military industrial complex makes bucks, gains power and can operate worldwide with little restraint. Is no one concerned about Blackwater with its 140,000 mercenaries and building a military training complex in the United States. TheBushies sit on the Board of the Carlyle Group, a financier of war making materials.
Our country is in trouble, the people's rights are being stifled everyday, witness the voter fraud allegations assessed by the Repugs against ACORN. I am so glad that a new generation of Americans led by Obama is ready to take back the country.
I leave this with you when it comes to Palin's idiocy about the Iraq war. Thomas Merton said it best:" The God of Peace is never glorified by Human Violence."
Blackwater scares the crap out of me. I'm wondering who is going to use these Merc's and when....
Richard Overy's Book "Why the Allies Won" is a hard-nosed look at what allowed the Allies to prevail in WWII. A key element is that the US took a very empirical, honest appraisal of its performance on the battlefiled. We did not hide our failures our overblow our accomplishments the way the Japanese or Germans did. This allowed us to improve throughout the war while they moved deeper into self-delusion.
The lesson is one has to be painfully honest about how things are going, whether it is battlefield performance, business performance or our personal accomplishments and shortcomings. Too much cheerleading, insistence on belief over facts, and "we're number 1" demagoguery" will only lead us into the ditch. Maybe we are entering a period of renewed realism about what we can and can't do. To know one's weaknesses makes one stronger not weaker.
Wen we view our government as a risk manager, instead of as representatives of the people, we have lost all concept of democracy. When Gov. Jon Corzine, already a Governor of New Jersey, and the former CEO of Goldman Sachs, becomes a spokesperson for Obama on MEET THE PRESS, we are ignoring the role that the investment shell game has already played in the destruction of our economy.
Are we going to see a new Treasury Secretary (Corzine) from Goldman Sachs become Paulson's replacement? Are tax cuts to perpetuate US economic policies forever?
As a believer in Green Community-based Economics, I am not looking forward to substantial policy changes from an Obama administration. The bailout is a modified model of Hoover's Reconstruction Finance Corporation, I swim against the panic of Democrats, Republicans and millions of others in this country. So be it.
Obama will be a step up as far as competency goes. Making a transition to a green, sustainable economic foundation would be a real improvement. The next peak oil bubble is already looming on the horizon.
The knowledge risk incumbent now in American politics is setting us up for scenarios that wil continue to worsen, not improve. Jon Corzine is unlikely to lead usout of the situation where poverty continues to increase its impact on the lives of so many people. I look forward to the day when mitigation becomes as important as risk avoidance.
Well said. The efforts of the Republicans is to get the pyramid scheme restarted as quickly as possible, to keep the flow of money from the middle class to the wealthy class going. We have seen nothing from the U.S. government that is even remotely likely to get real business back on track. Instead we are seeing schemes to fund the schemers. Now we have ponzie schemes being perpetrated on the general public and sold as investments. The New Deal has been destroyed, and we are heading down to the abyss of poverty. Vote Republican, and keep all those useful productive programs going - the war on drugs, the war on terrorists, the war on welfare moms, more prisons, more three strike laws to ensure more prisoners, more privatization. Thats the stuff we need, that will build up the middle class. More Wall Street bailouts, that will stop that pesky re-distribution of wealth thing. Dead in its tracks. Lets not put any money in the Smalll Business Administration, some of those silly people might start a new business and get some of our money. Lets kill Fredy and Fannie, they are the real problem, making all those low cost loans. Lets not invest in infrastructure, its our money and we are going to keep it. And most important lets make sure that evil public education system is dead at last, home schooling for all, thats the ticket.
The issue of infrastructure is a double-edged sword today. I am unequivocally in support of public investment in public infrastructure, whether education, railroads, mass transportation, resource management of healthcare. But Congress has already restricted our options for the future with the $1 trillion bailout.
State governments, such as California, are facing financial bankruptcy and are in line behind investment markets for new credit lines to just pay current state employees. We sit passively between that rock and that hard place. Rescue is not the same as recovery.
Tax policy, monetary policy and fiscal policy will change but the structural inequities will not be addressed.
In the not too distant future we will have no choice but to return to a Community based economic system. We have been in a fantasy world of pick all the low hanging fruit and eat the seed corn. Both Corzine and Paulson are in this mold, maybe Corzine less so because he got out of GS earlier than Paulson.
The problem right now is how do we prevent the kind of collapse which rampant deflation would bring about. The only way out is to print money. And then slowly put into effect the new ideas, new technologies which will produce a more self-reliant society. I noticed that one of the recent MacArthur grants went to a guy who is growing lots of food in an urban setting. That is the wave of the future.
As a water planner, I encouraged a focus on developing local industrial growth that was integrated with local agriculture and local consumer markets. The case you give about the recipient of the MacArthur grant is one such case in point. The source of conflict arose from local administrative staff of municipalities who see "growth" as an end in itself. Real growth is a product of sound and stable investments, not from shuffling the deck when the cards are marked.
The Bush administration "cooked the books" and intentionally falsified "evidence" relied upon by the American public when they allowed the invasion to proceed. It was a close call, and John McCain encouraged the gross dishonesty by the Bush administration and helped to cover up the fraud.
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