To help us better understand what led to the causes of the financial crisis, Congress set forth a commission to investigate the roots of the causes. The commission was given a broad mandate with subpoena power to tackle issues such as the role of exotic financial instruments and credit rating agencies, compensation, and the failure of regulators to manage risky lending at banks. (Labaton, 2009)
How can we implement preventative measures, to a failing economy, when we cannot agree on what we need to prevent?
With almost everyone having a vested interest in the state our economy is currently in, how do we stop the onset of another financial crisis and mitigate the risk involved?
With the financial crisis of 2007-2009 costing consumer’s wealth to diminish by trillions of U.S. dollars (Martin Neil Baily, 2009), the American people have the right to be angry and demand information that will shed some light into what lead up to the crisis.
The American people should be more involved and take action to insure their risks are being identified and that proper steps are being established to mitigate that risk. One way we can look at risk management is through Cultural Theory and how we can use it to ensure we don’t fall victim to another major financial crisis.
Cultural Theory says that the way that people think of risk is not just “a” key driver, but that it is “the” key driver for group organization. (Ingram, 2009) Cultural Theory was originated in the work of anthropologist Mary Douglas and political scientist Aaron Wildavsky. The two co-authored the 1982 book, Risk and Culture: An Essay on the Selection of Technical and Environmental Dangers.
One of the main concepts being looked at in the Cultural Theory of Risk is the cultural map that it had produced. (Mamadouh, 1999) The cultural map, that was produced, forms a two dimensional topology that helps identify the ways that people approach risk and suggests that there are at least four groups. (Ingram, 2009) The four groups are broken down as followed:
An excerpt of what is suggested to be taught to students taking a class on Cultural Theory of Risk can give us a basic explanation of the four groups. (DebitAge.net)
- Individualists believe in Nature Cornucopian. No matter how much humans disturb nature, it will handle it -- just like the sides of the cup are so high you can't shake the ball out of it. This myth of nature shows that there's no need for controls (grid) or cooperation (group), and people can be left free to exploit nature as much as they like.
- Egalitarians believe in Nature Ephemeral. This is just the opposite -- any little misstep and nature will come crashing down, like a ball balanced on a hill. Unfettered competition (low group) is therefore a threat, as is giving authority too much power, which it may abuse (high grid).
- Hierarchists believe in Nature Perverse/Tolerant. Nature can be exploited freely within certain well-defined limits -- but if those limits are passed, a catastrophe will result. This justifies having strict authority and experts who can determine exactly where those limits are, and then enforce rules that prevent people from crossing that line.
- Fatalists believe in Nature Unpredictable. There's no way to foresee how nature will react to any stimulus, so there's no point in fighting over how to manage it. Instead, you should just try to roll with the punches.
By now you might be asking yourself, “How does the cultural map apply to risk management?” We can use the cultural map to help us identify the groups responsible for managing risk. Each cultural group will have different risk strategies base upon the type of group or group hybrid they belong to.
For example, a banking institution with a CEO and CFO that fall within the cultural map as Individualists would find risk management as a threat to incoming profits. You may also find that within the group Hierarchists, one would take risk based upon a well written policy that sets limits on the amount of risk that should be taken.
Policy that sets out limits to establish thresholds and address risk was part of everyday life, for many companies, prior to the 2007 – 2009 Financial Crisis. (Nocera, 2009)
All four grid/groups have their place within the development of risk management but one was deemed an outcast and shunned by the other three groups, that group is the Fatalist.
One such accusation comes from the handbook of Public Policy Analysis, “… under conditions of adversity, policymakers resort to “fuzzy gambling.” In its extreme, fatalist form, any decision making is senseless.” (Frank Fisher, 2007)
Why were fatalists, often the group being written off and just where were the fatalists during the Financial Crisis of 2007 – 2009?
To identify the root causes of the financial crisis, we would need to seek out those companies that stand out. Companies like Goldman Sachs, the one Wall Street firm that was not, at that time, taking a hit for billions of dollars of suddenly devalued mortgage-backed securities. (Nocera, 2009)
Why was Goldman Sachs immune to this initial crisis?
In 2006, Goldman’s various indicators, such as Value at Risk or VaR, began to suggest that something was wrong. This same VaR was used by most of the Financial Institutions that collapsed during the crisis. VaR could be considered a type of policy to mitigate risk using a quantitative value and I would be led to believe that such policy to be Hierarchist in nature.
Nassim Taleb, a Fatalist, would like to suspend the current version of VAR as potentially dangerous malpractice. He also says,
“I maintain that the due-diligence VAR tool encourages untrained people to take misdirected risk with shareholders', and ultimately the taxpayers', money.” (Taleb, 1997)
Goldmans held a meeting of about 15 top level executive manager and several risk manager to take a closer look at the mortgage-backed securities and how the market felt.
The “feeling” indicated that the market was going to get worse before it would get better, so they decide to rein in the risk and thus ultimately side stepping the disastrous financial crisis. (Nocera, 2009)
Goldman Sachs stepped out of the Hierarchist group by choosing to ignore meritocracy and choosing a fatalist viewpoint by believing that they could not foresee the future and preparing for unseen events.
Fatalist views are not that of passive risk management, they are active views that are misunderstood. The fatalist understands that the future cannot be predicted by quantitative measures and embraces the unforeseen future and sets policy based on the “feeling” of current events. As Nassim Taleb describes in the Black Swan, the name of one his books and a term he uses for unexpected events, is that everything the experts think they know about forecasting is wrong, and if you think you can predict the future performance of the stock market from a study of past trends, you're gonna be losing lots of money. (Wolfe, 2008)
Nassim helped bring the fatalist views to the forefront of risk management and is now seen, in some venues, as a rock star. In light of the financial crisis, let us no longer fear the fatalist’s approach to risk and embrace it as an equal amongst the cultural groups.
References
Frank Fisher, G. M. (2007). 3.4.3 Isolates: "surviving without Resistance". In G. M. Frank Fisher, Handbook of Public Policy Analysis: theory, politics. and methods (p. 300). Boca Raton: CRC Press.
By: Joseph Dustin
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