Risk Management is Dead, Long Live Risk Mangement

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Risk Management is Dead, Long Live Risk Mangement

At this writing George Bush will be out of office in 15 days.  Only two in ten of us will even remotely regret that event.  The rest of us can take a deep breath and, with a real sense of closure tell ourselves “at least we’re done with that experience”.  Not so much the rest of the problems we face.

 

It is interesting to note that during a time when regulatory oversight was reduced to a mere whisper in the economic frenzy of loose credit that the risk management profession confined itself to vast and complex exercises in complying with whatever rules were left standing.  The Sarbanes Oxely Act, passed in 2002, which required transparency and accountability in the financial reporting of publically held companies created windfalls for risk management professionals but has had virtually no effect on the unwinding of the financial system and the onrushing collapse of the “real economy”.  It’s as though we were polishing the brass door knobs on the Titanic when she hit the iceberg.

 

Risk management as we have known it is dead.  To be sure, there are those walking the hallways of financial institutions and global corporations who carry the title of risk managers but they must either be in a state of total denial or severe anxiety.  Based on the idea that analytics could predict negative events and somehow magically ensure that they not occur, the profession has hung its hat on a construct that has become a self-fulfilling prophecy of failure rather than providing the safety it advertised.  It’s going to get tougher and tougher to get executives and their board members to listen to presentations about cataloging so called risks into neat piles while the building is metaphorically on fire.

 

So what is the profession to do?  Well, certainly there will be continued employment for some folks in the quantitative analysis field as banks and other holders of derivatives continue to try to understand what if any value these “structured financial products” have left.  As wealth continues to evaporate that is going to be a herculean task indeed and one that will likely consume a good deal of resource over the next several years.  There is also a glimmer of hope in the eyes of the audit community as they anticipate the next cycle of regulation and the massive amount of work that will be required for financial institutions to comply with them.  A note of caution here however, there simply won’t be the money lying around to provide the huge fees that accompanied Sarbanes Oxely.

 

I would argue, however, that neither of these efforts are exercises in the management of risk.  Valuing assets in a deteriorating economic climate is part of financial operations.  Complying with laws and regulations is just that – and only the most generous framework will see it as a very small component of managing risk going forward.  It’s not that we need a new definition of risk management; we just need to get back to the one we used for thousands of years before we deluded ourselves into the certainty of numbers created on false assumptions.

 

To manage risk we need to ask two questions: what do we want to achieve and how to we want to achieve it.  If we make widgets do we want to make gold plated widgets available to only the wealthy, flimsy widgets which we can mass produce and sell at a low price and resell as they fall apart, low cost well made widgets that last essentially forever, or some other manner of widget making.  Clarity of purpose is the primary requirement for managing risk.

 

Once that is established we need to make sure that everyone in the widget company knows the strategy; everyone, not just a select few. 

 

So far all we have really done is align the widget company with the more enlightened view of good management.  The process of managing risk comes when we ask the employees to identify what it is that they do that contributes to the success of the strategy and then (and here is the real difference from what we are doing today) project a risk profile into the future in assessing their current (not past) ability to make that contribution.

 

Managing risk is about looking forward, not backwards.  To be sure, looking forward may seem daunting for the next several years.  Many if not most companies will be too preoccupied with cost cutting to embrace a proactive approach to risk and those that survive in that manner will no doubt emerge bleary eyed and wondering how they managed to make it through.  But there will also be those companies that shift their focus from their stock price and P/E ratios toward a sustainable model that galvanizes their resources (albeit a smaller set of resources) in the service of that model.  They will manage risk in the same way it was managed in the effort to cross the oceans, build bridges and skyscrapers and get to the moon.  They will manage risk in the service of what they want to achieve.

  

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