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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" We very desperately need a new economics that sees market failures--and accurately prices risk--much sooner than the current brand." You can't have a "new" economics, you can have a new economic system but economics is economics. If we could see market failures coming there wouldn't be any market failures. As far as accurately pricing risk, it is part science and part art form along with ones tolerance for that risk. That's why different firms come to different conclusions and make markets. Whether you agree or not with what led up to the war the major mistake initially was shutting down all of the Iraqi institutions and alienating the Sunni population right from the beginning. The realities of the Middle East were never going to allow the Iraqi's to embrace us as liberators. Especially not after the US led UN sanctions drastically reduced their standard of living over the last 10 years or so.
As to leadership, I agree Obama is the thoughtful one but so was Jimmy Carter and that's what I'm afraid of. While Obama is thinking, Pelosi and Reid will be running the country. McCain is certainly more impulsive , you can call it erratic if you want but at least he throws out some ideas and gets some conversations started on different issues. Obama is very careful and waits to see which way the political wind is blowing. That's not leadership.
Oh good lord.
That is why the guy is winning - because he takes too long to make considered and informed opinions. Does it not occur to you that the fact that the guy beat out an "inevitable" candidate for the nomination and is on track to become president - BECAUSE he takes the time to not only become completely informed but carefully plans and executes those plans?
The guy has a veritable ARMY on the ground that is working tirelessly to help him win. You think that is not leadership?
Do you people even READ your posts to see how stupid they sound?
Nope, they just cut and paste the most outrageous talking points....
So you have to constantly make erratic and impulsive choices to be a leader? This is why you Republicans can't see the terrible damage you have done - your minds are so polluted by all this John Wayne bullshit that you don't know what true leadership is. I hope one day you WAKE UP and realize that this isn't some damn western where you rescue the girl and ride off into the sunset. There are REAL problems, REAL people and REAL suffering, and it's all about to get REAL BAD!
So well put...
......mebbe its why the Repubs have now forgone inviting REAL people to their rallies and have settled for 'bringing on the empty horses' .
If it is Obama that is the one who you say, "waits to see which way the political wind is blowing" then why was he one of the only ones that stood up and made a speech about why it was wrong to go into Iraq, why has McCain continually followed his lead in everything from using the word Change, to copying his mortgage help for home owners facing foreclosure. Please, quit watching FOX "news" and start researching the candidates and their policies more closely. This continual comparison between Sen. Obama and Jimmy Carter is actually pretty funny and one of those FOX talking points - dead give away. A couple books you may like to pick up and read, "Blackwater", "State of Confusion", "The Audacity of Hope", in "The Prosecution of George W. Bush for Murder" - by Vincent Bugliosi, details ample evidence of how the administration cherry picked what they wanted us to hear and discounted everything that said there were no WMD's in Iraq, also to counter that read "Cobra II" written by conservatives that show how awful the preparing of this "war" was.
Missed in the discussion is the scale of the risk. It is one thing to bet one's paycheck on the outcome of an event. It is another thing when the collective bets imperil a nation. It would seen that the guardians of the national checkbook should be vigilant to such risk. This is where risk management is nontrivial but essential.
Nice story!
Bucks
Dallas
http://TheDemoCats
"Ninja loans" ... Entertaining and readable and right on the money Jared has put his finger on something solid here ... risk management ehhh ... well written.
I've always wondered why things couldn't be explained to people simpler so they could understand ... then I thought "if things were explained simpler ... people would understand".
No such things as Ninja loans the correct term is NINA "No Income No Assets" the jobs were always verified the incomes were not. This is a guy writing about something he has no knowledge of .
The acronyn is NINJNA. It means, no income, no job, no assets. The "no job" means the applicant does not have a job that can support the monthly payment. The problem with these loans were that there was little or no verification. Why verify if it would mean the loss of a sale. Now sshall we addres other real estate problems: second mortgages, home equity loans, upside down mortgages
Jared, what a superb article!...So sad that the MSM cannot figure any of this out...It is so frustrating to watch them ramble and giggle about nothing at all and do so little... I would love it if you could be the press secretary to explain this to the MSM.... It is going to be prettty ugly out here...
Sorry - there was no 'faulty intelligence...' Bush and Cheney purposely lied about WMD.
yes, Bush and Cheney not only lied, they bribed a former Iraqi govt official to write a false affidavit "proving" the WMD theory. According to the new book "The Way Of The World" (written by a Pulitzer Prize-winning journalist), they paid him millions AND gave him a resort villa to retire to, in return for a document they forced the CIA to write and in turn the CIA bribed this man to write.
why haven't we impeached Bush?
Why haven't we impeached Bush?
We should have impeached him three years ago, at least.
leftLibertarian, I agree with you. "Faulty intelligence" was just another red herring. Bush/Cheney not only lied about WMD, they manufactured false evidence by ordering the CIA to force a former Iraqi official to forge an affidavit. This is documented in the new book "The Way Of The World." It is written by a Pulitzer Prize-winning journalist, who wrote for The Wall Street Journal. The CIA prepared the proposed false affidavit, then bribed the man to copy it out in his own handwriting. The man was paid millions and given a luxury resort in a foreign country, well hidden from these awkward questions.
PLEASE, somebody explain to me: Why haven't we impeached Bush?
I do not know whether you can say that their models were all wrong....I am afraid that they had all the models, just chose to ignore the most realistic in favor of the model with the most financial reward.... Temptation WORKS....
Yet another example of the liberal press hard on the Obama campaign trail. Hey liberal press, at least call yourself a commentator and not a reporter. You can’t even report the weather without a spin.
What can you say about a primarily GOP-sponsored investigation of Palin, and how your benevolent Fox News trying to put a spin to it?
When something negative is said about Palin, you guys are willing to turn a blind eye, despite the truth.
Her preparing a speech for the secessionist group Alaskan Independent Party is nothing to all the "shady" associations of Obama.
Here is a tip: look up Psychological projection.
And your yet another example of a GOP baby crying because the media won't be your bullhorn like Faux Noos.
HuffPo is liberal press -- thanks for the obvious. It's also a pretty minor player in the messages people get every day. The rotation on CNN is "Obama-Ayers", "Bradley Effect", ACORN... repeat -- a constant drumbeat of anti-Obama negativity. The same list for McCain-Palin would be a mile long, and suck up several days of news cycle just to get through the list once. But, noooooo.... we couldn't touch the little sensitive pair with a real expose.
Educate yourself. You're seeing one small piece of the elephant.
I guess they can't all be "fair and balanced".
This is an excellent analysis.
Thank you for an argument that is so objective and makes so much sense.
What an excellent analysis. For weeks I have been trying to put into words what it is about the candidates that sets them apart from each other. You hit the nail on the head.
Did I get this right? It's to risky not to change! More of the Same is far more of a risk than Change!
It is interesting that any Democrat could support BO after learning that he gave 800 grand to ACORN in the primaries-not a rumor, a fact. Initially he tried to hide it by saying he paid them for lighting and staging ( which would be 10 grand by the way ) so then he finally had to cop to it. After witnessing the fraud and thuggery that transpired in TX firsthand, I knew it had to be BO and ACORN-I had heard of the money he paid them long before MSM bothered to report it. Now, his campaign donations are being investigated. We thought, wow-how can anyone raise more money than any other candidate in history? Illegally, that's how. I went to the Center for Responsive Politics and within 1/2 an hour I found 3 people who had donated over the max-without refunds. I am one person. That doesn't even begin to touch his overseas contributions and his relationship with Odinga. He is the dirtiest politician I have seen in a long time. I am a Dem and campaigned for Gore and Kerry.
What does this have to do with risk management?
you know it is kind of like the Bill Clinton stuff...Would you rather have a man who lines his pockets from NO BID contracts or one who lies about his sex life? we all know who we would choose..
McCain is more of the same, no transition team needed... absolutely you can count on it, faith -based more of the same...
There's plenty of evidence our leaders were fully aware of the risks of most of their misadventures. They just didn't care. They had a plan without any care about the consequences.
As for Wall St., they also were fully aware of the risks but didn't care and did everything they could to keep any regulation from interfering. The largest heist in history, and so far they're escaping culpability.
I say let the REAL free market run its course, and make those go under who played the risk game, and we'll start over again, this time with sensible regulation and monetary policy. There will be pain, whether bailouts occur, or not, so let's stop throwing money down the hole with these companies who knew better.
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Predicting the future is difficult but if trends continue I feel very sorry for President Bush.
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He may go down in history as the man who broke conservatism and the Republican party.
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Wow. Thank you again.
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