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Market Turmoil 2008; Two Lessons Learned

I am writing this entry as the US government is feverishly working on measures to prevent the financial system from a collapse. The very same pundits who were yesterday busy predicting the brightest of futures and unstoppable growth of the market, act today as if they have “known all along” and readily dispense new prophecies.
Not a day goes by without another analysis of this mother of all roller coasters and I bet even Playboy will publish one at some point. Not to be outdone, I want to share with you two lessons, which I took away from it.

Test your models

You may or may not know this, but financial institutions employ scores of exceptionally bright people with advanced degrees in math and physics to develop and maintain various financial models. Among those are models for financial risk management, which are very similar if not the same across the financial world and employ a well-developed mathematical apparatus.

These people, referred to as “quants”, are very well compensated. I mean, half a million a year is not uncommon. The question that naturally comes to mind is, ok, with all this mental firepower and the gaggle of people whose very job was to watch the risks, how come we are where we are?

There are a few reasons at play here, including the business and communication skills of the “quants”, the likelihood of their being listened to, and the challenges of admitting mistakes. But the key problem, I think, is that we tend to fall in love with our models.

Whatever model we subscribe to in our decision making, our work, our lives, we must take a stance that models are just approximation of the reality and not the reality itself. In this particular example, people and organizations became married to their risk management models, they held the assumptions that these models are based on, as paramount axioms; they did not allow for the fact that they may be deficient. This is not the first time it has happened, of course, and the spectacular crash of the Long Term Capital Management in 1998 (about $4 billion lost) is still fresh on the minds of many today.

If you are a project management professional, watch out for falling in love with the methodology and approaching each project with a predetermined approach. I often hear consultants say that they have a methodology for something before they know what the problem is and I want to tell their prospect – run for cover!

Be Suspicious of “Star” Performance

As many other industries, the world of finance is prone to this silly admiration of star performance where the person making money is placed above usual controls, and is so high on the pedestal that if he crashes, it will get awfully messy. It is not like the world of finance does not know what often happens. There is Nick Leeson of Barings Bank. Barings is no longer with us, courtesy of Mr. Leesons stardom status, which allowed him to take uncontrolled risks. Close to one billion dollars later, the 200-year-old bank was gone.

There is Robert Citron, a former treasurer of Orange County (I find the play of names rather amusing), who used derivatives to speculate on interest rates. He was successful for a while, so much so that his opponents, who pointed out the risky nature of his undertakings, were squashed by those above and next to Mr. Citron (he was making money!) You guessed it – his luck ran out soon thereafter, and he lost around $1.5 billion, which bankrupted the County.

Be wary of “star players” whether they work for you, alongside you or elsewhere in the organization. When we are constantly told how good we are, we become overconfident. Overconfidence, the “I have seen/done this before” attitude, fueled by the lack of external scrutiny is a sure path to a major blowup.

Don’t let your guard down.

Special announcement: On November 15, 2008, I am running a half-day version of my course on Business Cases and Decision Making as a professional development event for the Project Management Institute. Because the event is sponsored by the PMI, it costs next to nothing to attend. If you are not in the Toronto area, why not come for the event and then spend the rest of the weekend sightseeing!

You do not have to be a project manager to attend. The content of this seminar is suitable for any professional, manager or executive.To learn more and to register, see

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