Re:Balance -- Jim Peterson

The Airbus A380 as a Risk Assessment Case: Cracked Ribs Do Not Signal Good Health

Cause for concern are reports that European air safety officials have ordered inspections of cracks in the mounting brackets that attach the wings of the Airbus A380 – already a plane with a long history of delays, design issues and cost over-runs.

And if the bland assurances being spun by the manufacturer’s publicists – that “the cracking problem … is not a safety risk in the short- to medium-term” – reflect the company’s risk assessment attitude, then a suppressed but potential catastrophe is a matter of time – a mid-air disintegration with massive casualties and the subsequent grounding of an entire discredited fleet.

I am just winding up a month-long Risk Management teaching engagement, migrating an MBA-level curriculum to a class of undergraduates.[1]

Some recalibration has been involved. At the graduate level of business and law students, our focus is on the broken models and ineffective risk processes that have characterized the worlds of finance and banking, insurance, accountancy and professional services, over the years of the credit crisis. These run through the period -- from the collapse of Bear Stearns to that of MF Global; from rogue trader Jérôme Kerviel at Société Générale to his UBS counterpart, Kweku Adoboli; from the corruption of the American subprime mortgage market to that of Japanese corporate governance at Olympus.

Younger students stay with the basics – the human behaviors by which incentives are skewed, failures are rationalized away, and incipient disasters are hidden under the mistaken illogic that safety and soundness can be inferred, only because a breakdown “hasn’t happened yet.”

The discovery of cracks in the “rib feet” of the A380s presents a long-familiar challenge: what response is proper to the emergent symptoms of a potentially devastating event?

It is all too natural to put up an optimistic face – to admire success and to wish away the language of bad news. But the consequences can be dire:

• The late Steve Jobs may well have paid with his life for his denial-based postponement in treating his pancreatic cancer.

• The Italian liner Costa Concordia would most likely be cruising in comfort, rather than lying as a hulking wreck, had the supervisors tracking its earlier near-shore wanderings acted on the ready GPS data revealing the captain’s record of reckless behavior.

• And the signs of corruption in Bernie Madoff’s Ponzi operation were well within view, both to the SEC and to his investors, had they not chosen to turn blind eyes to the readily apparent.

Historical memory is hard to hold, especially where corporate budgets and profits and bonus payments depend on the wishful avoidance of delays, repairs and caution-based slow-downs.

But for learning directly applicable to the A380 and its cracks, my students have just scrutinized the 1986 case of the space shuttle Challenger – launched to its fatal explosion, before they were born, over the engineers’ objections that cold weather would threaten the flexibility of the eroded O-ring seals on its rocket booster.

The logical flaw in the shuttle case extends: The fact that prior launches had succeeded, despite O-ring erosion, did not provide comfort for future launches under other conditions. No more, that the A380s may have flown so far without incident despite wing bracket cracks – when such potential stresses as severe weather, hard landings or simple future wear-and-tear fatigue would change the failure calculations and render invalid the assumptions underlying margins of safety. 

In other words, paraphrasing with emphasis physicist Richard Feynman on the shuttle, “the A380 rib feet were not designed to crack. Cracking was a clue that something was wrong. Cracking was not something from which safety can be inferred.”  

In the Challenger case, seven astronauts and a space vehicle were lost to the deficiencies in NASA’s risk management. As for the A380, has any learning occurred?

As soon as my final grading is done, I will be uplifting for Paris and a spring-semester teaching gig with law students there.

But not on an A380. In its wounded state, I will be happy to book on the robust aircraft of an American airline.

 

Thanks for joining this dialog. Please share with friends and colleagues. Comments are welcome, and subscription is easy and free – both on the Main page.      

---

[1] My thanks and gratitude to the congenial community of Carthage College – faculty, administration, support and especially the students in my seminar – for a welcome and an experience as warm as this unseasonable winter in Kenosha, Wisconsin.

 

Review -- Book of the Year: Daniel Kahneman, "Thinking, Fast and Slow"

One of my students in Risk Management at the University of Chicago beat me to a reading of Daniel Kahneman’s recently-released “Thinking, Fast and Slow” (Farrar, Straus and Giroux, 2011, 418 pp.). 

A young man of few words but crystalline insights, he brought to class this terse review of Kahneman’s reprise of four decades of ground-breaking research into the flaws and fallacies embedded in judgments and choice-making:

“Too long” – he was typically pithy. “But brilliant.”

Right, on both counts. Start with the second: 

Modern English literature would have been impossible without the works of Shakespeare, if few others. The same, going back to the 1970’s: Kahneman and his late collaborator, Amos Tversky, opened whole new fields of inquiry and perception into human behavior.

Thanks to their pioneering work, we have the means to be both entertained and informed by the lessons in “Moneyball” (both the movie and Michael Lewis’s book), such as the stubborn clinging to soon-to-obsolesce folk verities by the talent scouts gathered in Billy Beane’s baseball clubhouse in Oakland.

And we can appreciate being rightly agog at the singular slogan of the credit crisis, the feckless pronouncement of Citigroup’s Chuck Prince in the summer of 2007, that “as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”   

More broadly, Kahneman and Tversky gave us the means to identify – and desirably to comprehend, although that is subject to much doubting skepticism – whole categories of sub-optimal decision-making. Consider such influences as:

• Herd behavior – and the entire population of mutual fund advisors, unable to distinguish the dubious quantity of talent in their performance from the simple effects of random luck.

• The compulsion to construct compelling if entirely unreliable stories based on tiny bodies of data – and the daily flood of the commentators’ vacuous “explanations” for insignificant price moves in the securities markets. 

• The whole industry of prediction models that are blind to their in-built exposures to rare but catastrophically destructive events – thinking, with sorrow and anger, of the graveyard population of financial structures, from Bear Stearns and Lehman Brothers to the Icelandic banks and the Irish real estate market, right on down to the “repo-to-disaster” at MF Global.

As for my student’s first words – Kahneman’s editor falls into the genre’s too-familiar pattern of over-stuffing between the covers. To be sure, the book is worth its price for its two appendices alone – Kahneman and Tversky’s landmark papers on the irresistible reliance on heuristics and biases, and the assessments of risk appetite and aversion in decision-making under conditions of uncertainty.

But it fails to distill and sharpen, for just one example, the unappreciated significance of regression to the mean in cases where hindsight attribution of causation is a cause of systemically erroneous decision analysis. 

That’s by way of quibble, for Kahneman has brought about a worthwhile trade-off: in exchange for any loss of readers deterred by an over-weight hundred pages, he has gained the achievement of a career-spanning reference work, to become dog-eared on the desks of those of us who will hope in small ways to pass his genius on to the next generation of the students of risk.  

  

This will be by way of valedictory to a difficult and challenging year -- to wish all readers a healthy and peaceful 2012 – even if the new year bids fair to be no less volatile and unpredictable than the old.

January marks this blog’s fourth birthday – celebrated in anticipation that inevitable new eruptions of corporate malfeasance, the capacities of regulators for continued mischief-making, and their continuing and frustratingly ineffective inter-actions with issuers and auditors, will all continue to provide material worth addressing. 

   

Thanks for your engagement in this dialog. Comments are always welcome, and subscription is easy and free – both on the Main page.

Lessons in Risk Management: A Broken Clock is Never Right -- It's Just Broken

The national recalibration caused by this weekend's fall-back to standard time is a reminder of the cliché recently repeated by a friend, that: 

“Even a broken clock is right twice a day ….”

Or so it is supposed, for the proposition that some information is better than none at all.

I will spare my friend's identity, since this is not personal. But as studied by my students in Risk Management, it is vitally important to scrutinize both what you know and what you don’t – and not be misled into missing the difference by the invocation of familiar but unexamined verities.

I surveyed my students – who with their PC’s and iPads and smartphones are carrying around an average of 2.5 devices providing them with the hour – of which only a fraction are readable by way of little hands pointing at a circular array of twelve numbers on a dial.

It’s the same in today’s public life: the handsome golden landmark clock in Grand Central Station is an anachronism, superseded by the blinking digital screens of the airport flight announcements, the pulsing scoreboard lights of the sports arenas and the obnoxious talking panels of the typical office elevator.

Even in the classroom for my MBA course, a sleek modern rectangular digital time screen hangs above the door.

Here’s the point: when broken, the ubiquitous digital clocks simply go blank. There is no sense in which, when non-functioning, a dark and empty display can ever be “right.”

So the claim is incomprehensible to anyone raised in a world of digital time-pieces. Baby-boomers are likely the last at risk of being led astray, having grown up with (and still using) analog time-keeping machinery.

At no time in the diurnal cycle is any meaningful time guidance offered by a crashed computer or an uncharged cell phone – or, for that matter, a dead microwave or DVD player or any of the myriad of appliances now equipped with digital clocks on which generations younger than the fogies rely.

The “right twice a day” assertion also suffers a more subtle flaw: How do you know? The question of “right-ness” is only testable by reference to an outside source. Looking at the hands of a broken clocked stopped at the classic “ten-to-two,” you may suspect being late for lunch.  But you can’t know without a working alternative. Whatever its format, no informational value is added by viewing the face of a dysfunctional clock.

The inquiry really needs to go down another layer, though, to the reason for calling on the cliché in the first place.

Examples abound where a little information is actually worse than none, especially where users are lulled into a false sense of security and over-confidence.

Unmarked and narrow country roads suffer a lower rate of fatal vehicle accidents, for example, than high-speed expressways, even if the latter are fitted with lane markers and rumble strips and crash barriers, precisely because the rural lanes demand high degrees of focus and attention, prudence and speed discretion.

Equally, day traders seduced by computer-generated graphs and charts of stock price activities are lured into the misapprehension that the flood of data is a reliable measure for predictability, only to crash and fail at the rate of amateur punters in a casino.

And on a global scale since 2007, the road to financial ruin has been littered with the reputational corpses of those who mistakenly believed that the quants’ “value-at-risk” models and their off-spring sufficed to support their portfolios of exotic financial products – among them, Jimmy Cayne of Bear Stearns, Chuck Prince of Citi, Dick Fuld of Lehman Brothers and most lately, Jon Corzine at MF Global.

Which is not to say that there is nothing at all to learn from a clear-eyed acknowledgement of the limits on the knowable. But more likely than an unexamined repetition of a maxim that is both conventional and therefore probably wrong, let the inquiry seek wisdom from the more humble perspective of the counsels of caution. 

PS: An invitation: send me your suggestions for other clichés worthy of attention and deflation. Thanks.

Thanks also for joining this dialog. Please share with friends and colleagues. Comments are welcome, and subscription sign-up is easy and free, both at the Main page.

 

 

Racing to Avoid a Crash: On the Track -- On the Street

There’s a stack of final papers in my Risk Management course – and an apero on the sunny terrace of the neighborhood café, to ease the grading process.

And a fond wish for one more class session, to dissect last weekend’s lesson in the disastrous consequences of bad risk assessment and choice-making under high-stress competitive conditions.

It happened at Sunday’s Indianapolis 500. Rookie driver JR Hildebrand had a comfortable lead going into the final lap. But instead of riding easily to victory, he attempted a high pass of a slower car on the very last corner, crashed into the wall, and slid his wreck to a second-place finish – passed by the doubtless astounded Dan Wheldon, on whom Hildebrand’s error of judgment and the fickle gods of fate bestowed a gift beyond imagination.

Aggressive, brave or foolish – the high cost of immature enthusiasm under “win or crash” analysis is not rare. Recall the Olympic gold medal that snowboarder Lindsey Jacobellis threw away on her final run at Turin in 2006, with her ill-advised showboating stunt attempt on the last bump.

My class of MBA and Finance students focuses on lessons from highly-consequential decisions, especially in failure situations – drawn from many fields into the worlds of commerce and professional services, where most will eventually work, and where senior leaders charged with risk responsibility have performed so poorly over the last four years.

From Hildebrand’s split-second choice – now part of racing lore and a life-long mark on his career record, they would take at least these two:

First, the skills and energy of the young are to be recognized and respected; a new hot-shot does command attention and can achieve greatness, whether in sport or government or a trading room. But as events at Indy showed, the converse is no less valid. Beginner’s luck is no substitute for seasoned strategy, and those surviving to accumulate the scars of experience bring wisdom that tempers rash choices.

Provided Hildebrand does learn his risk/reward lesson, in other words, he is not likely to repeat it.

Therein lies learning for business and financial disciplines, still struggling past the recent crisis. The tragically short time horizon of the designers of exotic derivatives, and the exclusion from the quants’ risk models of events beyond their recollection, created the conditions for the crushing impact of events erroneously thought to be unforeseeable.

The second lesson from Hildebrand’s choice-making looks at the structure of his decision matrix: a binary choice -- “try to pass” or “lay off” -- but with alternative and different benefits and detriments for each.

The consequences of playing safe and cautious were in his favor: there was no downside, as he was at no risk of being overtaken, and to cruise safely meant a checkered flag.

In choosing to charge the corner, on the other hand, he had negligible upside – he was already holding a dominant lead – while, as events proved, the downside of being unsuccessful was catastrophic.

(Take note, of course, that the calculation could alter dramatically – if, for one case, he was trailing and needed a last-minute pass to advance, or if he was tightly shadowed and at risk of losing his lead.)

The metaphor extends, readily enough:

Should an investment manager double down on a losing strategy, which unless reversed will bankrupt his fund? Or should the size of his positions be controlled along the way, so that no single exposure could threaten his entire firm’s survival?

Should an entrepreneur put all his capital at risk to start a new venture? To a retiree in reasonable comfort, the upside is limited, but the hazard of a failed and penurious old age is real; while to a new graduate with a long view, fortune favors seizing the greatest number of jackpot opportunities.

The under-appreciated risk-assessment obligation, all of this should suggest, lies in deliberate attention, usually overlooked, to the alternative choice: the action foregone, the rejected Plan B, the road not taken, the decision not to charge ahead.

To a rookie Indy driver with his hair on fire and his foot to the floor, this would all seem abstract, bloodless and pedantic. But it should feel otherwise to a risk officer whose strategic control over a floor of stoked-up traders is his bank’s best hope for survival through the next bubble.

Because my students are more likely, post-graduation, to steer companies and to run portfolios, than to drive turbocharged racing cars, the sorry case of JR Hildebrand’s impetuous mis-chance will keep a place in my curriculum.

Thanks for joining this dialog. Please share with friends and colleagues. Comments and suggestions are welcome, and subscription is easy and free – both at the Main page.        

 

Risk Management: Where Shall Learning Be Found?

Here comes summer.

School is out - oh happy day.

     --    Jerry Keller, 1959

Classes finished last weekend for the students in my MBA-level course in Risk Management. They are even now beavering away on their final papers: assessments of the flaws and defects in risk handling among the many catastrophic business failures of the last four years.

While awaiting their efforts and the task of year-end grading, I have two summer projects – both involving the re-calibration of our syllabus, which explores the lengthy catalog of executive and governmental bias, errors, misapprehension and general group-based follies that have defined the recent era of unprecedented excess and turmoil. The differences will be interesting.  

For one, I am asked by a professor at a near-by college whether this curriculum on the diagnostics of fallibility would deploy for a classroom of capable undergraduates. My cautious “yes” rests on the continuity and commonality of the themes:

To take only one of our subjects of study --  the group-think, dissent suppression and publicity-oriented overrides of technical competence that led to the break-up and loss of the Challenger space shuttle in 1986 were replicated in the blow-out of the Deepwater Horizon oil-well in April 2010. Are we learning anything yet?

Or – it does not require a degree in finance to appreciate that the unlearned lessons of the failed financial models that took down Long Term Capital Management in 1998 recurred in the model-driven rush to disaster that spun out of the subprime mortgage derivatives sector starting with the implosion of the Bear Stearns real estate funds in 2007.

The lessons may have evaded the decision-makers at the time, but they are well within the aptitude of a collection of above-average undergraduates.

I am less confident of my second mission – a call from the leadership of a world-class professional services organization. There, job-by-job client delivery is impeccable, but the prevailing attitude toward risk is that “we’ve always done it this way, and it works” – a view that leaves the firm hostage to an inability to distinguish skill from dumb luck.

The challenge to offering advice in the commercial world – an environment be-set by the logically flawed belief that if a problem has not arisen in the past, it will not in the future – is the lack of appetite for the same kind of time and effort that my students put into the scrutiny of multi-disciplinary learning opportunities. “Manage what you measure” is an unfortunately blinkered approach, when it is precisely what you don’t know that blows up and kills you – whether it is among the dinosaurs unable to conceive or adapt to the emergence of the faster, smarter mammals, or Bernie Madoff’s investors with their addictive blindness to the reality behind monthly account statements simply too good to be true. 

It is sensitive, to find diplomatic language in which to convey risk process deficiencies to a senior executive team, where as one commentator bluntly puts it, “They’re not good, and they don’t know it.”

One alternative, in an only slightly more nuanced articulation, is put as a question: “How can you design a strategy to get better, if you lack the skills to evaluate how good you really are?”

Studying past failures is a good place to start. That’s where my students focus their attention – working toward their own personal pay-off in superior skills in analysis and application once they are launched into the workplace.

But that’s not an approach that goes down well in the business and professional world. The humility of accepted limits comes hard to a latter-day Ozymandias such as Dick Fuld or Chuck Prince or Angelo Mozilo – their reputations along with their visages now lying shattered and half-sunk. 

So even as I search for the ways to press for improved perceptions and performance among my clients, it’s a certainty that a renewed cycle of mis-behavior, failures and collapses is brewing and will continue to feed the academic appetite for new material.

Readers having good examples under any of these headings are cordially invited to contribute to the searching.

 

Thanks for joining this dialog. Please share with friends and colleagues. Comments and suggestions are invited and welcome, and subscription sign-up is free and easy, both at the Home page.

 

Recidivism and Risk Management: Barry Minkow Goes Back to the Slammer

Son, always remember: some day, somewhere, a guy is going to come to you and show you a nice brand-new deck of cards, and this guy is going to offer to bet you that the jack of spades will jump out of this deck and squirt cider in your ears. But son, do not bet him, for as sure as you do, you are going to get an ear full of cider.

-- Damon Runyon, “The Idyll of Miss Sarah Brown” (1933)

 A question for those charged with risk management and fraud prevention:

 What’s your company policy on employing or doing business with ostensibly reformed white-collar criminals?

 And is a re-think indicated by the news that Barry Minkow, wunderkind among securities swindlers for the scam at ZZZZ Best in the 1980’s, for which he served seven years of a double-digit sentence on 57 counts, is negotiating a securities-fraud plea bargain under which he now faces fives fresh years of jail time (here).

My concern is a prosaic one – not Hollywood’s question whether his return to federal housing means that the pending Minkow bio-pic requires re-shooting of a new ending (here), or whether the February burglary of $50,000 at the Community Bible Church where he recently resigned as pastor (here) bears any of his felonious fingerprints (here).

It’s only this: Given the rate of relapse among those described by English essayist Charles Lamb as “so crooked that if they’d swallow a spike, they’d void out a corkscrew,” should a company concerned for its reputation and fiscal soundness ever yield to sentiment and invite such a fox back into its henhouse?

Experience over the years counsels against it. Examples in my own catalog include the large-company CEO convict, who finagled a reduced sentence via a convenient medical excuse, and was no sooner paroled to a halfway house than he took over its single pay-phone to peddle the rosy promises of new oil deals. Or the youthful CFO applicant who persuaded an employer of his time-served maturation, following bucket-shop charges; the naïve advice of the audit firm partner was to “keep the kid away from the cash” – unavailing to prevent a scandalous and catastrophic collapse and a portfolio of lengthy prison sentences for the entire executive team.

And it was surely foreseeable, following O.J.Simpson’s circus-trial acquittal, that his temporarily dampened symptoms of renewed personal violence would re-erupt – the only question being the period of his volcanic latency.

For a risk manager the decision-making process is a two-by-two matrix – evaluating the rewards and benefits of a yes/no choice whether to chance re-attachment to someone’s checkered past.

A successful result could yield good and honest performance – non-trivial, but likely not different from that available with many other candidates – whereas the negative – a relapse into criminality – would at minimum be seriously costly and disruptive.

On the other hand the cautious choice to forego the relationship would mean sacrificing the potential contribution of an ex-felon – again, a modest upside – although avoiding the destruction that a recidivist’s presence might cause.

The analytic process has its formulation in the 17^th-century French mathematician and philosopher Blaise Pascal’s wager on the existence of God:

Betting against the proposition, with no particular reward for being right, could – if proved wrong -- suffer the punishment of an eternally vengeful deity. Rather, the wager in favor of His existence carries no hazard if incorrect, but offers the upside of an eternity of bliss.

Minkow’s own now-former church is no doubt a repository of repentance, atonement, forgiveness and charity. Admirable qualities, all. But they should not overwhelm what is learnable from logic and experience.

Namely: the percentage of white-collar wrongdoers in the executive suites is small to begin with. But once the “contingent possibility” is established – that is, an already existing proclivity to misbehave – the risk calculus is fundamentally changed.

There is a cottage industry of ex-cons and their acolytes, working the book-and-lecture circuit and flogging scripts of penitence and redemption pitched to the credulous.

It is one thing to read their stories and even to consider the quondam relevance of their experiences. But the case is not made that they should be entrusted with access to the balance sheets of any enterprise involving other people’s money.

 

Thanks for joining this dialog. Please share with friends and colleagues. Comments are welcome, and subscription is free and simple, both at the Main page.   

Coincidence, Causation and Apple's Stock Price: Further Lessons from the UBS Dress Code

My MBA students in Risk Management study closely the hazards of conflating coincidence and causation – at best mis-leading, and at worst, acutely dangerous.

But sometimes it’s so delicious, we could only wish it so.

Last Monday, with a focus on the never-ending debate over international accounting standards based on general principles or detailed rules, I made sport of the 43-page employee dress code published in December by Swiss bank UBS (here), believing that professional guidance based on the former is definitely preferred.

And the very next day – mirabile dictu – UBS stood down (here), with a sheepish retreat to “what is important” – evidently still, the modest requirement to dress in the bank’s official colors of black, white and red (here).

This was not the grand capitulation to public opinion shown by The Gap, when it hastily withdrew its misbegotten new logo last October (here). But it makes the important point that normative behavior can be modified by non-coercive societal influence – rather than under the heavier hands of legislatures or law enforcement.

I dare not claim a causal relationship between my digs at UBS and its hasty retrenchment – no more, for that matter, did my criticism of PwC’s loopy new logo (here) stimulate a re-think on its part.

A far better case for the caution not to over-weigh coincidence lay in last week’s storm of activity around the stock price of Apple Inc. On consecutive days, January 17 and 18, CEO Steve Jobs announced an indeterminate medical leave, and the company released estimate-smashing results for 2010 – revenues up 71% and net income up 78%.

The pundits’ cacophony went in all directions, following Apple’s closing the prior Friday at an all-time high of 348. Monday’s US market holiday gave a whole extra day for the uncertainty-mongers to stir the pot.

As they did. The ride began with Tuesday’s early trading down at 326, driving back up to close the day at 340 – if only temporarily. Punters in options saw short-dated 320 puts that had closed Friday at 54 cents explode briefly to $ 5, while those betting on a quick recovery could “buy the dip.”

Then during the week, while the major indices were basically flat, both those positions were trashed; Apple peaked back above 348 on Wednesday, doing for any skittish bears, and then slumped to close at 326 on Friday the 21^st, doing the same to itchy-fingered optimists. 

It took the week for events to shake out. Apple’s roller coaster fell out of the technology news, supplanted by the board shake-up at HP (here) and Google co-founder Larry Page’s emergence to sole leadership out of the triumvirate with Sergey Brin and Eric Schmidt (here).

On Monday the 24^th the stock was back to 337, and as things stand on Tuesday it has cheerily closed above 341, looking again at its pre-tumult high.

From the perspective of long-term Apple investors (a group to which I belong, by the way), viewing a price chart over a year or even a month, the price moves over the week are an inconsequential hiccup. But to those caught in a flurry of zero-sum trades, there were real effects.

How would they have divined the reasons and the lessons?

Just as primitive peoples lit bonfires and beseeched the gods of the solstices to return the sun, mistakenly believing themselves both responsible and successful, athletes maintain their winning streaks through locker-room rituals and lucky amulets. Investors too invoke their models and their charts as if to be convinced that their decisions are guided by design and intelligence rather than the randomness of fortune.

Both those shorting Apple on Jobs’s health news and those who bought the company’s future in the narrow trough are congratulating themselves on their insightfulness and perspicacity. While those taking the opposite (and losing) positions – in both directions – are equally wringing their hands that some undetectable malign external forces – surely not their own fault – conspired to sabotage their investment strategies.

All of which goes to confirm yet again, that a hubristic over-confidence unable to differentiate skill from random luck is a dangerous substitute for the humility to appreciate that the market, like life itself, is too complex to be predictable.

Still, it would be nice if someone from UBS would call up and say, “thank you.”

 

Thanks for joining this dialog. Please share with friends and colleagues. Comments are welcome, and subscription is easy and free, both at the Main page.

Book Review: Tony Judt Has a Few Last Words

Ill Fares the Land, by Tony Judt, Penguin Press, 237 pages

“Ill fares the land, to hastening ills a prey,

Where wealth accumulates, and men decay."

-- Oliver Goldsmith, The Deserted Village, 1770

Although I had devoured Tony Judt’s sweeping prize-winner, “Postwar: A History of Europe Since 1945” (2006), I had missed the April release of “Ill Fares the Land,” for which I am obliged to a regular reader.

If there is reason to celebrate Judt’s ability to bring forth his extended essay under the terrible burden of his terminal battle with ALS – and there is – it is no less lamentable that his premature death in August removed him as promoter and advocate on its behalf.

Even if some months late to the task, I am impelled by the strong suspicion, much as I would love otherwise, that this space shares few enough readers with Judt’s regular platform, “The New York Review of Books.” 

Judt paints with eloquence the debased world of “conspicuous consumption of redundant consumer goods” – enabled by the retreat from the postwar achievements of interventionist governments in areas of security, prosperity and social services. Instead are the unprecedented wealth disparities of the last thirty years, especially in the United States and the United Kingdom but throughout advanced economies globally, with all the attendant costs and consequences falling disproportionately on the increasingly disadvantaged: social alienation and depression, failed education and mental and physical dysfunction.

Judt points to the confusion sown by self-interest pursued and based only on maximized individual economic advantage, with “minimal reference to extraneous criteria such as altruism, self-denial, taste, cultural habit or collective purpose” – even while the advocates of unregulated free markets drove into the abyss of the credit crisis of the last three years under the “false precision” that because “they didn’t know everything, as a result it turns out that they didn’t really know anything.” 

As Judt sees it, the reduction in trust and cooperation on which the social cohesion of the modern state critically depends, has given way to policies driven by fear, selfishness and bigotry – manifest in communities segregated and gated-off both physically and culturally. The ominously frightening consequence, when government cannot function on trust, is that it will move to do so by intrusion and repression, and ultimately by violence.

In the way of polemicists since Jeremiah, Judt in his outcry for a new form of social discourse does stop short – or so it could be charged, by those for whom words of inspiration only come alive in action. For his rhetoric flags, both on the particulars of a process for a new form of engagement across the spectrum of political principles, and even more on the blueprint by which the headline topics of a just and caring society might be realized.

Which takes nothing away. Voices on Judt’s behalf need to be raised, post mortem. His legacy is one of those small works that emerges from time to time, well ahead of the readiness of even sympathetic audiences to grasp its ultimate impact.

To punch its weight, however, would not have meant stints on the Oprah show or Comedy Central. Even writing for an American audience, Judt has a style, exemplified by his use of both diacritical marks in the word “dèbâcle,” that must have prepared him for an underwhelming reception in the popular audiences.

Which is fine. “Ill Fares the Land” was never destined for wide readership. The population of conservatives genuinely qualified and inspired to engage a substantive conversation with its content could probably convene in a closet; other pretenders on the Right would fall among Judt’s targets as having prospered personally – he would say, selfishly – from the subsidies and support of the active operations of government through the course of “the American century.”

Meanwhile, know-nothings at both ends of the political spectrum will not appreciate a work demanding more cerebral engagement than Fox or MSNBC, nor will they stick with the task of reading to chapter two without their lips getting tired.

For myself, I happily leave to the professional ideologues the debates over the relative analytic purity of Judt’s vision for a renascent substantive form of civic engagement.

Here’s the thought: take an evening off from the cacophony of the electronic media, and invest the time and mental effort to wrestle with these messages. When a sufficiently receptive audience has done that, the process will be well begun of extending the foundations for a sustainably re-envisioned global society of both compassion and decency.

 

Thanks for joining this discussion. Comments and reactions are welcome, and subscription is free and easy – both at the Main page.

 

Does Anyone Really Want to Be an Accountant? A Tailgate Survey

Last Saturday I was part of that great autumnal experience – tail-gating and a football game at a major American university.

For non-US readers perhaps unfamiliar, the rituals partake of religious cults: Adherents converge in vast throngs, dressed in exotic pilgrims’ vestments of bizarre colors. They drink copiously of the sacred brew, they invoke the spirits of sunny weather and the glow of victory, and they noisily exhort their muscular youth to inspired feats of glory.

Secondary to its storied gridiron history, this school is also a major supplier of feedstock to the accounting profession’s voracious appetite for new recruits, through its large departments of accounting and finance.

So because my generation’s children have grown to be college students and fresh alumni, the convivial afternoon gatherings around grills and coolers in the stadium parking lot also gave a chance for some rough field research on that age group’s attitude toward their studies and the state of the profession’s process of self-renewal – first-hand inquiry of bright young graduates prepared for the bottom rung of a new career ladder.

Caleb Newquist, Francine McKenna and the Junior Deputy Accountant give a lot more attention to the dynamics and travails of the firms’ recruiting and retention issues than I can. But the results of four discussions amid the marching bands and the waving pennants, although plainly anecdotal and unscientific, do give pause:

• One new accounting graduate, having spent a Big Four internship assigned to the box ticking of Sarbanes-Oxley compliance work, was bailing out on debits and credits altogether and re-orienting for law school.
  
• A second, well into a master’s program under-written by a large firm where his job offer awaits, is primarily motivated to obtain his degree and pass the CPA exam by the salary bonuses that are promised at each step.
• The youngest new alumna, celebrating her last weekend before reporting to be junior audit staff in a major-city office of another of the Big Four, expressed her ambiguity in the phrase, “My life is about to be over!
  
•  Meanwhile the eldest of the group, an ex-survivor of three staff years in yet another large firm, is wildly happy having moved to a new position as financial controller at a division of one of her former clients.

A large-firm leader once put it to me that the main purpose of hiring new university graduates is to cultivate staff accountants to become the next generation of managers and partners. If so – although the depth of malaise revealed by my brief survey of this decade’s best and brightest may not generalize – neither is it cause for confidence in the profession’s ability to stay on top of the talent level demanded for the retention of its reputation and credibility.

Those engaged with both our students and our future are advised accordingly.

Postscript:

Our celebration took place at a leading church-affiliated school, seriously conservative in its theology, culture and politics. Although it would never condone the burning of a Koran, it is likewise not likely to permit the opening of a mosque on its campus any time soon.

For all the atavistic hoopla around the game, Saturday was also the ninth anniversary of September 11. It was an affecting moment, to stand with 80,000 people in a moment of silence for all the casualties of that awful day, to join in a prayer of remembrance, and to unite in the nation’s anthem while our flag was raised high and lowered in honor to half-staff.

In that context, the home team’s inability to hold off the visitors’ last-minute scoring drive for the win seemed not to matter quite so much.

 

Thanks for joining this dialog. Please share with friends and colleagues. Comments are welcome, and subscribing is easy – both at the Main page.     

 

Business Models and the Search for Success: A Tale of Two Cities' Bicycles

 

Summer’s over. And with the fresh school term, I’ve started a very exciting new teaching gig -- “Accounting & Finance” at the Northwestern Law School in Chicago.

The proposition for law students is compelling: Just as any adviser or advocate requires the tool of literacy to access the verbal wisdom of treatises and books and briefs, the ability to engage with significance anywhere in social and commercial enterprise requires basic familiarity with the grammar and syntax of quantitative financial information.

Our first class pitched right into the topic of business plans, the tools for searching out sustainable business value, and the assessment of business decision-making as supported by the integration of strategy, investment and operations.  

For which, the week’s news was rich with pedagogic opportunity: BHP Billiton’s hostile play for Potash Corp., HP’s extravagant out-bidding for 3Par to steal a competitive march on Dell, and the optimistic willingness of three wealthy Brazilians to stump up over $3 billion in hopes that Burger King can be flipped one more time.

With all that context, the curriculum probably lacks time for this comparison of two business models – which is too bad:

During our recent extended stay in Paris, I made extensive use of the Velib program – the network of urban-designed bicycles rolled out in 2007.  Launched with 10,000 bikes at 750 stations across the city, it has doubled in three years – there is a station every 300 meters across the city, with 75,000 daily users and twice that number each summer weekend day.

As a basic part of its business plan, the program incentivizes short trips -- the first half-hour is free. I easily earned out my € 29 subscription – one morning using five different bikes to cover appointments from the 5^th to the deep 16^th and back.

So I was bemused, at the end of the summer, to see a proud announcement heralding the start of Chicago’s B-Cycle: six stations between the John Hancock and McCormick Place, and a grand total of 100 bicycles.

This is not a business plan that can be substantively real – but only an illusion of long-term sustainability and success.

For example, the Chicago program promotes the notion of commuter usage (here). But there is no access at the commuter rail stations. Nor in the critical population centers of Lincoln Park, Wrigleyville or the South Loop. Where are the bikes where the potential riders are – Old Town, Lincoln Square, the Clybourn Avenue corridor? Or to serve the student population – on the campuses of Loyola, DePaul or UIC?

Velib launched in Paris with critical mass, sufficient to have an impact on its urban lifestyle. My friend, a senior executive at the OECD, promptly sold his car; he uses Velib to commute except in extreme winter, when his cost to take an occasional bus or even a taxi is a minor offset to his overall savings. 

The business plan is familiar: when Fred Smith prepared the debut of Federal Express in 1973, not a plane flew nor a package moved until he had coverage of 25 cities – enough to re-shape an entire national business culture.

Velib does have issues – vandalism is higher than expected, and to manage uneven usage around town, there is now a rewards program for riders who return bikes to high-demand stations. But the program is here to stay. The Velib website is attractive and informative (here). There is an iPhone app for news and station locations. And in characteristic French fashion, this spring a comité d’usagers was selected as an official forum and sounding board for riders’ concerns.

On the commercial side, the advertising giant J.C. Decaux, which sponsors the program in exchange for the advertising opportunity, is in it as a business –complementary to the city’s political agenda of reducing private auto traffic and pollution.

Weather in the Windy City is not conducive to a year-round bicycle program, of course, no more than it is – regrettably -- to credible year-round artisanal markets. Chicago may lure the occasional summer tourist to pedal the shoreline of Lake Michigan, a precious resource that Paris cannot match -- although even there, the quais are entirely closed to cars on Sundays. Lake Shore Drive should be made so people-friendly!

Just before the summer ended, I took Velibs back and forth from our apartment in the 6^th to the supermarché across the Seine, to buy dog food and olive oil. Until Chicagoans can use B-Cycles the same way – to work, and for errands within a 20-minute riding radius – it is not a credible plan, but only a costly publicity stunt.

 

My thanks to our daughter Julie for her Velib research, done for a project for her Environmental Studies class.

Thanks for joining this dialog. Comments and suggestions are welcome and invited, and subscription sign-up is free and easy, both on the Main page.

Lessons in Risk Management: A Hierarchy of Learning from Ignorance

The seemingly indestructible baseball legend Satchel Paige asked, “How old would you be, if you didn’t know your age?” *

I’ve worked during this summer vacation to review and refresh the syllabus of my MBA-level course in risk management and decision-making, where the related question is, “How smart can you be, if you don’t know your own ignorance?”

At its core, the course seeks to identify potentials for success, from the lessons of failure. Recent weeks have provided an abundance of “teaching moments”:

• Tony Hayward’s long-postponed but inevitable defenestration as CEO of BP – another demonstration that public perception of a tone-deaf executive’s culpability will prevail – incidentally inflicting major collateral harm to what had been an advancing discussion on the benefits of splitting the roles of corporate chairman and chief executive.
• By contrast, Goldman Sach’s achievement of a speedy and affordable settlement of the SEC’s suit over a toxic subprime mortgage-based derivative product, for the relative pittance of $550 million. Love or despise the “vampire squid” – Goldman will survive and thrive in no little part for its ability to maintain both calm and quiet under pressure, keeping beneath the flame-throwing and appreciating the benefit of avoiding additional fueling of the short-lived news cycle.
  
• The release by WikiLeaks of a massive volume of raw documentation from the Afghanistan war. The trove will be well-combed by future historians, but even on a superficial reading of the official manipulations, naïveté and mendacity, the fundamental lessons remain unlearned -- from China, Algeria, Viet Nam and Afghanistan itself -- that short of annihilation, no level of mighty foreign military technology will prevail in a house-to-house conflict against forces able to blend seamlessly into a village-level local population.

Thinking with students about these scenarios, with special concern for the availability of awareness and action in time to actually affect an outcome – that is, before the inflection point at which a threat tips over to become a disaster – there emerges a kind of hierarchy of learning opportunities. Consider: 

• As the last of the helpless dinosaur population dwindled around the tar pits, while tiny furry mammals disported at their feet, the combination of climate change and evolution reduced their survival chances to zero.
• Innocent species lacking defensive measures were equally doomed – including those wiped out by humans, from carrier pigeons to the great whales.
  
• Human societies also innocent in their ignorance have doomed their viability – whether the Easter Islander destroying their only timber sources to replace their great canoes, or the Greenland settlers unwilling to adopt the diets and hunting techniques of the natives (see Jared Diamond’s “Collapse,” 2005).
• Further up the ladder of chargeable responsibility is the blinkered denial built into herd behavior – no better exemplified than by the last-gasp claim of Citigroup’s Chuck Prince in the summer of 2007, that, “As long as the music is playing, you’ve got to get up and dance.”
  
• And finally – or at least to stop just short of conduct warranting indictment – there is the evidently deliberate and self-interested exploitation of the credulous, wrought by Goldman and its now-isolated foot soldier, Fabrice Tourre, in designing a financial derivative with characteristics maximizing its likelihood of failure.

As I would like my students to learn from such an array, in daily life no less than in the classroom, the ability to avoid the next problem is measured by the capacity to take heed from the last. 

*My review last May of Larry Tye's delightful biography of Paige is here. 

Thanks for joining this dialog. Please share with friends and colleagues; comments and suggestions are welcome, and subscription sign-up is easy – both at the Main page.

 

Drilling Down Into BP's Risk Management: A Process As Blown As The Well

“I never went to bed with an ugly woman. But I’ve sure woke up with a few.”

-- Country songwriter Bobby Bare

The failure of BP to “top kill” the Deepwater Horizon well brings to mind Blaise Pascal’s difficult question, how to strategize the unanswerable question whether God exists.

As he came out, to assume the positive and be right is marvelous, and to be wrong is of little effect; to assume the negative and be right is no worse than neutral – but to be wrong is damning.

Looked on as a matter of risk management – rather than as a much-debated philosophical or spiritual conundrum – Pascal’s challenge sits on top of the list of lessons from the events just ahead of the catastrophic blow-out in the Gulf of Mexico.

That is, if it were a final examination question in my MBA class – where we search for the lessons from failures in decision-making across a broad range of business and personal activity -- it would be hard to improve on the Deepwater Horizon disaster. The catalog of avoidable errors in analysis and performance is long and troubling – for example:

• Increased safety measures can mask heightened risk, especially where early signs of trouble are ignored as “close calls.”
• Increased complexity of technology alters the risk profile at the frontier of safety margins. 
• Management over-ride of on-the-spot warnings discourages honest communication and conceals bad news under the pressure to deliver success.
• Group-think and herd behavior are exacerbated by the over-confidence that mistakes past achievement for future safety.
  

Briefly put, the central theme in BP’s failed process was the consistent mis-measure, in its concededly risky choices, of Pascal’s potential up and downside gains and losses – related to what the statisticians confuse us all by referring to as Type 1 and Type 2 errors.

Examples abound, from the modestly consequential to the highly destructive. Consider:

A driver is low on gas. If he chooses to stop immediately, he gains the certain security of a full tank, foregoing the possibility of a modest savings. Whereas, if he carries on in search of a station with a lower price, his maximum upside is a few dollars gained, but his downside is to be marooned awaiting rescue by the roadside, or worse.

Or this: The space agency NASA must decide whether a shuttle launch can safely proceed in cold weather. Postponement to a warmer day means a modest loss of time, for the sake of mission safety – whereas pushing for a “go” decision can at best achieve budget and reputational success, but only with the risk that the frigid conditions will cause an explosive failure of the rocket’s booster (q.v., the 1986 loss of the shuttle Challenger and the lives of its seven astronauts).   

How extensible are the lessons of BP’s questionable decisions – the use of a riskier well casing, under pressures of time and budget, or the premature substitution of lightweight seawater for heavier drilling fluid, under delays costing $500,000 per day (here)?

At the level of individual risk tolerance, consider two insurance scenarios: Taking a pass on auto collision insurance saves the premiums, and puts at risk only the replacement cost of a total wreck. But choosing not to buy long-term health care insurance runs the uninsured risk of a debilitating and devastatingly expensive illness.

Or for investors: excess portfolio concentration in pursuit of incremental performance ignores the question, “How bad could this possibly get?” – as learned to their sorrow by Bernie Madoff’s clients and employees with their savings in Enron’s retirement program.

Consequences vary. Pick a bad restaurant, and the only loss is an evening’s sub-standard dining. But fail to hedge a naked short, and the losses could be ruinous. 

Corporate risk management depends for success on similar decision-making dynamics: Is a bet-the-company strategy acceptable? Is it even recognized?

Whatever the assessments made by Bear’s Jimmy Cayne or Lehman’s Dick Fuld or Countrywide’s Angelo Mozilo, they mis-evaluated their exposures to disastrous downsides – no less than the bureaucrats of NASA or the over-seers at BP.

On the other hand, betting Pascal’s wager the wrong way risks the wrath of an angry deity – which in the long run may be worse.

 

Thanks for joining this dialog. Please share with friends and colleagues. Comments are invited and welcome, and subscriptions sign-up is easy – both at the Main page.       

 

 

Trust Matters: Charlie Green and I on Ethics Training, Corporate Standards and Society's Limited Expectations from Government

I talk often with Charlie Green -- author, speaker and consultant, and expert on the theme of trust in business relationships. His blog, Trust Matters, is a ready and regular source of wisdom.

We spoke at length this week, on a broad range of related subjects. Charlie has posted the interview as the latest in his series of Trust Quotes. Here are several excerpts:

CHG: What concerns do you have about the effectiveness of teaching about trust, ethics and governance in the business schools and universities?

JP: It’s my belief that much of the teaching is at best ineffective and at worst a misleading waste of time – although I am sensitive to the way this is received among my colleagues in academia. Jeff Skilling and Andy Fastow were celebrated as executives to be admired, and either one would have scored an A+ on any university-level course in ethics or governance.

****

CHG: Both “doing good” and “doing well” are byproducts of a cultural devotion to doing business from a certain set of principles? Care to say something about what those principles look like?

JP: One of the finest defense lawyers I ever knew, the late Peter Fleming, had nothing but scorn for elaborate codes of behavior – governance, accounting principles, whatever. His guidance required one page: “Can you credibly defend this decision in front of a jury?”

****

CHG: What can we reasonably expect from government by way of contribution to good corporate behavior?

JP: I’m a deep skeptic on the ability of regulators to either detect or to deter bad behavior. Not that oversight and enforcement are not necessary. But it seems to me pretty clear that the post-Enron imposition of Sarbanes/Oxley did not lead to an outbreak of virtue.

Look at the many examples over the last three years....Law enforcement is by nature always going to be reactive, behind the curve of the inevitable misbehavior of those who would burst the limits...It goes back in part to why societies evolve their laws and codes of behavior. People don’t become law-abiding because more laws are passed.

I invite you to the interview in its entirety. And Charlie and I would both welcome your reactions and comments.

Thanks for joining this dialog. Please share with friends and colleagues. And if not a subscriber, please sign on at the Main page.

The Future of Goldman Sachs: Sound, Fury, and the Human Appetite for Risk

 

If correctly read, the thermometer on the temperature of the body politic suggests that the public fever of the last weeks on the SEC’s charges against Goldman Sachs has broken.

A reader expressed her cooled reaction to Goldman’s design of an exotic, tradable mortgage-based product on which the shorts and longs were symmetrically affected: “Why not – after all, that’s what they do!”

It’s not just Warren Buffett's avuncular cheerleading at the Berkshire Hathaway shareholders’ meeting in Omaha, however directly interested, or the related embrace of the mainstream media (for both, see the NYT’s Andrew Ross Sorkin on May 3, here).

More, the brevity of public attention proves again Samuel Johnson’s 18^th century observation that “nothing focuses the mind like a hanging” – whether the present dependent subject is the British Parliament, BP’s oil containment efforts or the Greek noose around the neck of the Euro.

As it moves off-screen, Goldman’s future does not depend on the usually attenuated inter-connections between Main Street and Wall Street. It will lie, rather, in the hands of law enforcement officers, whose reputation enhancement will incline them to nick off a pound of flesh or two and move on to resolution; legislators ready to take up other posturings; and, especially, clients and trading partners whose self-interest will be well served by Goldman’s robust survival.

Which, the more I ponder, is as it must be.

Populist outrage at the business model behind Goldman’s esoteric designs always lack emotional coherence – the unease of those uninformed and unfamiliar with the operation of complex financial products showing again that a little information can be worse than none at all.

As the behavioral academics say, it’s very much to do with how the issues are framed.

For one example: conventional reaction would likely be negative in response to an opinion poll, “Would you support wagering on the length of a human life?”

Yet that is the entire basis for the life insurance industry, which – no less than Goldman’s Abacus product – is in the long run (costs, time value and enterprise profits included) a zero-sum proposition. Large pools of underwriters’ capital wager on the uncertain but ultimate timing of the inevitable mortality of those on whom the bets are made.

And a broad range of legitimately insurable interests are required – it only being frowned upon to allow, for example, the sole care-giver of a fragile elder to take a large policy for his own benefit.

Likewise, while the disconnect between aspirations and responsibilities played no small part in the foundational irrationality of the credit crisis, ownership of a family home has been widely promoted as a virtue. Meanwhile, despite the faint odor of disrepute not unlike that sometimes attached emotionally to short sellers in the equities markets, a niche market for reverse mortgages develops, by which the home equity of aged owners is bought out under pricing based on lifetime occupancy and actuarial expectancy tables.

Even at the personal level, the comparison has always been striking between motorcycle riders in America – who dutifully keep to their lanes although exercising a libertarian right to ride bare-headed – and those in France, for whom helmet compliance is inviolate but so is the chance to careen around traffic and down the dividers.

All of which shows that variations in risk appetites are pervasive, ranging from the ubiquity of casinos and lotteries to the cultural variations in personal safety judgments to the stream of innovations in mitigation techniques – whether product safety devices or hedging derivatives.

So while the particulars of Goldman’s innovations would, and will, outstrip the comprehension of its outsiders – beyond the atavistic spasms of short-term insult at the sheer amounts of money involved – its fundamental instincts are no different from those broadly inherent in the animating principles of human society in general.

In other words, they are part of us.

 

Thanks for joining this dialog. Please share with friends and colleagues. And if not a subscriber, please sign on at the Main page.

 

 

The SEC's New Rule 201 on Short Sales: Taking a Bear Position on Over-Regulation

(Paris, France) – Second thoughts on first impressions: a revisiting of my early disdain (here) for amended Rule 201 of the U.S. Securities and Exchange Commission – a new restriction on short selling that imposes an “uptick rule” – a circuit breaker that would be triggered by a one-day stock price drop of ten percent or more.

The reflective mood may itself have been triggered by my vernal equinox relocation to this European base, for the spring and summer – with possible impact on my publication schedule, but also a refreshed exposure to perspectives on this side of the Atlantic.

(At this point, it would be obligatory for mainstream media to pause for a white-bread definition of short selling and a summary of the SEC’s rule. Happily in an evolved environment, all that is needed is this link to the SEC’s release of February 24, which in turn leads to Chairman Mary Schapiro’s speech, and the supporting staff paper – to all of which the curious are referred for details.)

I have observed the debate on short sales restrictions to be binary and polarizing – that, as with handgun control or gay marriage or abortion rights, coherent but non-negotiable views reside at the ends of the spectrum, with compromising positions difficult to articulate inside the black-or-white extremes.

Events over the last two years leave me less sure. On the one hand, it’s hard to generate much sympathy for the special pleading of John Mack of Morgan Stanley, or of Lehman’s Dick Fuld before its September 2008 collapse – especially with the recent release of the Proustian-length exposition by bankruptcy examiner Anton Valukas (here). 

Nor, in pursuit of honest symmetry, is there any popular sentiment for reining in the pernicious speculative effects of upside exuberance. Imagine the vitriol that would be poured on a regulatory rule imposing a “downtick rule” before buying a stock experiencing a daily uplift of ten percent.     

And yet, even the ursaphobic are deserving of respect – some days, the bear really does eat you.

Which leads to the hard and subtle question: how much regulation is the right amount?

And there, I suggest, the SEC’s “10% price drop” is a filter with much too large a mesh.

As its staff paper spells out, on an average day from 2001 to 2009, a 10% trigger would have hit some 4% of covered securities – and nailed some 1.3% even during an interim period of supposed low volatility.

For a sympathetic but skeptical observer, government interference at the two-sigma level is just way too much. 

Not least, the administrative burdens on both market participants and the regulatory agencies themselves will be enormous, yet with no more than SEC's repeated say-so on the benefits to broad-based legitimate activity, while consuming energy and resources better deployed to the real problem cases.

Many examples demonstrate that where a sector’s violations emerge from a very small part of the population, enforcement efforts that are imposed universally achieve only massive waste and minimal effect -- where targeted programs would be more effective at far less cost and disruption: 

• Most modern automobiles are essentially clean and non-polluting; the bulk of vehicle emissions come from a very small number of “dirty” cars and trucks – which can be effectively identified by mobile, low-cost “drive-by” monitors rather than broad and expensive inspection programs.
• Recall the Clinton-era imposition on personal charitable donations, requiring useless acknowledgement letters that have done nothing but stuff files and eat up time, paper and postage while adding no benefit to IRS tax enforcement.
  
• Transportation “security” in the post – 9/11 era has reduced the effectiveness and civility of air and rail travel at every level, all to the anxiety and unease of the general public -- but at the imposition of full body pat-downs and loss of gels and toothpastes, has failed to identify dangerous shoes and underwear – when contrasted with the nearly-invisible (and when well-used) highly-focused intelligence.

And closest to the subject, as I asked recently (here), what good has been accomplished by all the expenditure of corporate and agency time and budgets required under the Sarbanes/Oxley law – ostensibly functional for six full years as of the undeterred collapse of Lehman Brothers and the worldwide financial markets oscillations that followed?

Recent research brings forth the learning that the causal factors for the types of problems cited above are not uniformly spread through a population, but cluster within a small sub-set of the whole – a proposition that calls for dramatic re-engineering of law enforcement and regulatory policy.

A good place to start would be with short-sale limits calibrated to the really impactful – not 4% per average day, but perhaps 4% per year – situations that would be recognizably dramatic, readily identifiable and agreed as worth attention on a consensus basis, while generally leaving alone both the markets’ longs and shorts.

Thanks for joining this dialog. Please share with friends and colleagues. And if not a subscriber, please sign on at the Home page.