In the comments section of another post, Curmudgeon57 writes: “I’m not sure it was that everyone [investors, banks, etc.] ignored risk because they thought that the government would step in. I just think they ignored risk.”
That reminded me that I somehow forgot to promote this story I wrote for our magazine’s Global Business section. It begins:
Over the past two decades, Wall Street and the rest of the financial ecosystem became obsessed with the quantification of risk. Assigning numbers to the chance of something bad happening is a centuries-old endeavor–mortality tables have been used to devise insurance premiums since the 18th century. With modern computing power, though, financial engineers captured, packaged and sold risk exposure in startlingly new ways. Buying protection against a bad corn harvest or a spike in interest rates was just the beginning. Over time, as instruments became more complex, a huge shift occurred. Risk itself became the thing to trade–and to make money on. In the process, risk was redistributed to the people who could best handle it, making everyone safer.
Except that last part wasn’t true.
There are many lenses through which to view the worldwide financial crisis as it has rippled from soured loans to banks’ balance sheets to the credit markets and, finally, into the real economy. Lenders were greedy, people lived beyond their means, government abdicated its responsibility to regulate. Through all those explanations runs the thread of risk–and how it was mismanaged. Financiers, as well as the investors who bought their wares and the ratings agencies that evaluated them, agreed that by applying the proper equations it was possible to, say, bundle a bunch of subprime mortgages, chop them up and sell the pieces as fairly safe securities, even as they were leveraged to the hilt. Why? The mathematical models–backward-looking and based on just a few years’ data from an asset bubble–said so. “As an industry, we let financial tools be a substitute for human judgment,” says Kevin Blakely, CEO of the trade group Risk Management Association. “There’s been such an earthquake in the industry, people are saying we have to do it differently.”
You can read the rest of it here.
Barbara!