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Strategy and Management Insights on the debt crisis

November 9, 2011

While so much of the world’s attention has been on the Eurozone and its debt problems, some of the questions about how it all got out of control are being answered.

An excellent article (view here) by David H Freedman in the November Scientific American “A formula for economic calamity” describes the events leading to the crash of 2008, in which sophisticated models were used by investment firms to calculate risk.  The models are ubiquitous, and fail to take onto account important forces that affect the market, such as illiquidity – which is inherently unpredictable – and the fact that though a model applies to a single institution, in practice many institutions may be using similar models and hence create systemic risk.

He also makes the comparison with models of failure in the utilities, which have been very useful at heading off large scale black outs through cascade effects across the grid.  But in the investment business, knowledge about the strength and nature of the connections between institutions is time dependent, sparse and unreliable, compared with the utilities.  Given the difficulty of this sort of modelling, he discusses the approach put forward by Nobel Prize winning Darrell Duffie of Stanford to “send simulated shocks through the organisation’s portfolio”.   As he says,” these shocks should not be assigned probabilities but should rather be used as probes to seek out where the bank might have problems”.   He suggests that if every major organisation examined the effect on them of 10 other major banks or countries failing, and shared this with the regulators, the system would be much better understood.

This links in with an interesting session, part of the Gresham College symposium series.  It asked the question:  “What makes a good regulator?” The write up of the discussion can be found here.  The basic tenet was that regulation should be for the public good, but there were lively discussions around two aspects of regulation:

  1. How can regulators stay ahead of the organisations they regulate, especially in complex areas such as utilities and finance?  What is the balance of industry experience and outsider experience to avoid “capture” by the industry?  In the US, many law firms specialise in regulation, and have seamless careers switching between regulators and the industry.  We have not developed the same cadre of people.
  2. This relates to the point made strongly by Douglas Board of MaslowsAttic, who asked – are regulators’ jobs defined so that mere mortals can do them?  What would motivate somebody who had the range of skills and competences specified, to take a regulator’s job: as he said “it doesn’t make you many friends”.

This gloomy view of the role of the regulator is one we have taken in the Long Finance Scenarios, where we suggest that unless there is diversity in regulatory regimes, global systems are likely to go under.  The draft of Report can be found here. The launch of the final report will be held at Barnard’s Inn from 9:30 to 12:00 on 25th January – for an invitation please email us at

And we held an excellent debate on “Could better corporate governance have saved the News of the World” to launch SAMI Fellow Adrian Davies’ new book “The Globalisation of Corporate Governance”.   The motion was proposed by Mark Goyder of Tomorrows Company and opposed by David Philips of PwC.  Mark pointed out that Trollope described malfeasance in the publishing trade, and David thought that there would be corporate scandals “while people ran companies”.  The event was moderated by SAMI Fellow Glen Peters, who described the approach to corporate governance in ancient Persia which involved  amputation as an enforcement practice. It was chaired by SAMI Chairman Michael Owen.

The votes at the end were two to one against the motion, a surprising  result given the topic of the day!  A transcript will be on the SAMI  web site shortly, on the SAMI newspage .

We are also continuing our series of Futures Coaching events in October, November and March 2012: for details and to sign up see the SAMI web site

Written by Gill Ringland, CEO at SAMI Consulting

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