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Business, Featured - Written by on Friday, October 17, 2008 13:11 - 6 Comments

Don Tapscott
Wikinomics and Risk Management

The economic “risk bubble” has broken, and it’s going to take significant changes to restore long-term confidence in the financial services market. In Risk Management 2.0: Overcoming the Current Financial Crisis and Restoring Stability and Prosperity with a New Perspective on Risk, Bob Tapscott and I outline how this industry needs to be redesigned to reflect the principles of Wikinomics. I invite you to read this new research project:

I look forward to reading your thoughts on this new approach to the global marketplace.



6 Comments

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Tel
Oct 18, 2008 8:46

While all the problems you describe are real (especially the onselling of opaque risk instruments), and while your proposed solution seems physically achievable. There are still some fundamental problems that you are up against here:

Banks have evolved to protect the privacy of their customers, and this goes way back into the history of banking. Admittedly, police and government have managed to get their snoop into the affairs of citizens (even the Swiss banks have started handing over information) but the level of transparency that you propose goes far beyond this, and many existing privacy advocates are going to fight it. Privacy does form a bulwark against intolerance (and thus saves lives) so it might be sensible to protect it. Think about the implications of a system where all transactions were a matter of public record — do we want that?

A good fraction of the wrongly categorised risk was KNOWINGLY mishandled (a good old fashioned scam) by people who were drawing substantial remuneration and who were very comfortable with a broken system so long as they got rich. We all know very well that the majority of the scamsters will never be brought to justice and the usual tradition in these affairs is that the most senior and most important are always the best protected. You ask why so many intelligent people couldn’t see it coming and the answer was of course they could see it coming, they just figured the scam might last a bit longer and they didn’t want to rock the boat. If your system seriously threatens to properly clean up the system, then it will not be implemented. This particular swamp is undrainable. Such corruption happens in every country; some hide it better for a while, but China, India and all the “powerhouse” economies are full of dodgy little pocket stuffers, and always have been. Now we find that the US banking system was rife, no surprise when you think about it in the bigger context, and I promise you that there will be scammers next year, and next century.

The other thing is, this is not a global crisis. Yeah I know the news media keep repeating what they are told to repeat but there’s plenty of shares I can name where their prices just shrugged off the recent “crash”, take a look at:

http://finance.google.com/finance?q=ASX:CBA

Over the last 6 months, there has been some volatility but overall CBA is reasonably stable, I doubt it will trend up or down significantly in the next 6 months either. Americans have always believed they were the center of the universe but increasingly we are seeing that the universe continues to function regardless of what the US wants to do. The Euro is looking like the new world reserve currency and the US economy is rapidly weakening, mostly due to poor leadership and outright denial. We could talk a long time about falling education standards, offshored jobs, weakening technological lead, too much dependence on oil, but you no doubt know all that. The US has floated on a sea of foreign investment for a long time, now the investors got burned and sea turns shallow and the US is going to have to go back to keeping themselves afloat (which will be hard work). Tweaking bank regulation won’t change any of this. Pretending to save the world won’t help either.

Twowan
Oct 20, 2008 0:13

Re-learning Trust. Re-learning suspicion.

A crisis like this is positive as it forces people to think for themselves and to have them stop trusting blindly everything because it has some corporate logo or a government seal on it. The rating agencies are clearly worthless. Any rating of an investment product is bogus! Any further trust in them is insane. Yet, they’re still here and don’t seem to be worried at this point!

Banks are truly built on trust. In 1900, they used great architecture and marble counters… Now, they use FDIC seals which is a better tool to mystify as one places way too much trust in the government. One forgets to remain suspicious… At least, when you live in the Congo, you are always extremely suspicious of any authority. That’s probably why their leaders bring their money to Wall Street. A hard lesson!

Yes, maybe the big lesson for the world is that you can’t trust the USA anymore. That’ll be Bush’s great legacy. In foreign affairs or in financial affairs, any trust is gone. That’s probably a good thing because this kind of trust is a bit crazy in the first place. We must learn to become suspicious again…

This is why the solutions offered in this paper are so interesting. Trust can be built through scrupulous peer intervention. I don’t naturally trust the system but if a lot of people not only support it but scrutinize its core mechanism, my trust will definitely increase. Take any system… Like the subway system. You trust to use it because others do so in great numbers. Tunnels don’t collapse regularly. Trains don’t explode at random. Yet, it’s not a trust-worthy system by lack of critical information. Why isn’t the train maintenance schedule on the website? Why isn’t the conductors evaluations made public? Why isn’t the entire accounting public? Why don’t the passengers vote for the head of the company? Yes, it’s definitely a system I do not trust. It’s not because a lot of people use a system that you can trust it. Just like Google should not be trusted! When will the data mining algorithms become public???

If the future banks are to adopt the solutions proposed, the customers will have to learn true suspicion. They will have to force the banks to reveal everything and trust them with their money or not. Actually, a true international “peer bank” should be founded that puts in place all that you propose. I’d surely sign up!

As far as Tel’s comment about making everything public, it is possible if you are allowed anonymity. Trust and anonymity go hand in hand. I should be allowed a “numbered” bank account. Bank privacy should be written in the constitution! For that to happen governments need to trust me for a change!

Tel
Oct 20, 2008 6:13

So you have numbered bank accounts, and one particular account is a home loan and we have no particular details about that home (just the city and the price) and no particular ideas about who owns the house or the account.

How is anyone supposed to evaluate this for risk?

Some other differently numbered account is a car loan, and various other numbered accounts are credit cards, are they all the same guy? No one will ever know.

You can have any formula you like, without good quality input data, the results are useless.

Twowan
Oct 20, 2008 20:44

A bank account is not a loan. A bank account is your money. A loan is other people’s money.

But when you look at the current credit mess, it almost looks as though US borrowers could just have been unknowns wearing masks. They still would have had their loans… like candy at Halloween.

With derivatives, it doesn’t matter who takes the loan in the first place as loans are amalgamated in a product… Nobody cares about who lives where. They just care about the return on investment. Do you think Moody’s reviews every single family loan attached to a financial product? Of course not. It’s just formulas and algorithms. Rates of failure linked to a battery of conjectural data. They don’t have the resources to check everything. But in a system like the one proposed by the Tapscotts you would have the manpower by making the information public. You now have a large crowd of client-controllers-auditors who all do a little piece of the work. In that case, and only in that case, you really get to truly analyze the source. Good quality input data is there, but you need to find a way to mine it.

True, by making the information public you have privacy issues. Suddenly, because of a loan, you could know everything about your neighbor… Therefore, the data has to be real yet it has to remain somehow anonymous.

What is a numbered bank account? It is a pledge from the banker to whom you trust your money that he will not reveal your identity to outsiders. The banker does know who you are. Now, when he pays someone for you, he puts HIS good name forth not YOURS. Trust must be extremely high. Just the same, that same banker can loan you money but that still doesn’t mean he has to reveal anything about you to others. If he transfers the loan to a third, it is HIS name on the paper and not yours. Yes, you can have numbered bank accounts and it doesn’t change anything. Historically, this actually was the norm before big government stepped in and forced all banks to make all records public… to the government! (the counterpart was probably to insure the money i.e. the birth of FDIC)

We’re back to the question of trust. If I can’t trust individuals anymore, I just might trust a system controlled-supervised-managed-organized by a multitude of individuals.

Wikinomics » Blog Archive » Caveat Inventor?
Nov 5, 2008 14:50

[...] Hedging and risk management are on the tips of everyone’s tongues these days: Don has written thoroughly about it, and “risk managers” seem to be the only people on Bay and Wall Streets who [...]

Tel
Mar 15, 2009 3:13

Hey, revisiting an old Featured Article here… I’m big and bold enough to admit I was wrong about ASX:CBA and it did go further down after a plateau of stability. At the moment it is down around 50% of it’s peak value, and I guess in real terms it’s a bit lower than that given the fall in value of the Australian dollar. Things are worse than I expected, but I’m not ready to panic just yet, I still feel that Australia’s position is reasonably solid.

Anyhow, more interesting is the “Lending Club” which you can find at https://www.lendingclub.com/ and I’m not plugging for them (nor in any way involved) it just seems relevant to the article above. The “Lending Club” found a good balance on the privacy issues. In essence, they work as a broker between borrowers and lenders (and they take a 1% middle-man cut, probably less than most banks). As a broker, they have access to more private information about both borrower and lender than they ever allow the borrower and lender to have about each other. This lets them do the basic checks for false ID, obvious fraud, etc. Then the borrower can choose how much information they want to reveal about themselves, depending on what gets them the loan, and what interest rate they are willing to pay. Thus, a market equilibrium should develop between privacy and price… with room to allow for personal preferences on both sides.

There are a number of reasons why this type of loan market is more stable than the current banking system. Primarily because “toxic” debt is kept localized to those particular lenders who made the decision to buy into that particular loan. At Lending Club, the buck stops at the genuine investors (as it should do) which is much better than having a bunch of fly-by-night agents who make the deal, repackage the debt and sell it on, then scoot.

In addition, lenders understand that they do not have money “at call” but instead they buy Notes which pay a regular return. Those Notes can be resold (a bit like the share market) but the new buyer gets all the same information about the Note that the original buyer had (it does not get repackaged). Lenders who need their money back can wait for a buyer to come along, or sell their Notes quickly at a loss so a natural market equilibrium forms in the market for second-hand Notes.

It will be interesting to see how the mainstream banks react to this, and what the Government regulators decide to do with it.

Now available in paperback!
Don Tapscott and Anthony D. William's latest collaboration, Macrowikinomics: New Solutions for a Connected Planet. Learn more.

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