Archive for September 2008

What’s $700 Billion Among Friends? – Part 2 of 2

September 28th, 2008 — 5:07pm

Like the last one, this lengthy (sorry!) post is also written jointly with Sanghamitra Dutt.

Even if the Administration got a $700 billion blank check, no one could guarantee a resolution of today’s crisis. Network effects can still bring down others. For example, so far GM has only wanted a few measly billion dollars of a separate bailout to make investments that it has ignored for decades. If the financial crisis hits GMAC (see the last post), that amount will quickly become a few measly tens of billions. Add a few more incidents and we’ll be in “We don’t remember ever saying $700 billion would be enough” territory.

The question we should discuss in depth is whether a successful resolution of this crisis will automatically forestall another similar one. Not by a long shot! Irrational exuberance is not rare (think of the 17th century “tulip mania” and the tech bubble a decade ago). Indeed, given our networked world, new crises will emerge much more often and with devastating effect unless we strengthen the role of our financial regulators by explicitly making them responsible for managing negative network effects.

Had the House Republicans objected to the bailout because of the lack of such regulatory measures, I would have sympathized with their position. (Strengthening these as a part of the conditions attached to the bailout bill would have been easier than trying to get these adopted once the crisis fades from public view.) Instead, their finding religion after facilitating the dismantling of existing regulations (see, “S.E.C. Concedes Oversight Flaws Fueled Collapse” in The New York Times, 27th September), is nothing but a cynical election ploy.

Simply restoring the status quo will not help; the problem with how our financial networks operate is that individual players have very little visibility across it expanse. So no one sees problems arising early enough and even innocent bystanders get dragged down. To correct this situation, Congress should authorize/enable five critical steps, which are based on my “Design Principles” for networked organizations:

1. Unify the structural relationships among the myriad of regulators. Some time back, recognizing that the lack of cooperation among intelligence agencies was problematical, Congress unified the intelligence agencies under one national office. Though the execution was flawed, the idea was sound. We need a similar step now. If one financial regulator has weaker standards than the others, in a networked world, all financial institutions will still be exposed. I am not recommending centralization of all regulators; I am arguing in favor of legally mandating a coordinating structure that can drive the next four steps.

2. Require regulators to create processes to identify possible emerging crises and empower them to mandate proactive corrective action. In a networked world, seemingly local events traverse great distances rapidly and strike with devastating power. No one pays them attention initially, and even when some get affected, others consider themselves safe. Chairman Bernanke identified (“sensed”) this crisis a year ago; earlier this year, their was much wider awareness of the sub-prime crisis, but most people did not expect AIG to go bankrupt. Today GMAC and others are still at risk.

Assembling coherent corrective actions (“respond”) to head off a growing crisis is even harder. No individual company can do so; collectively many can, but few CEOs would be gutsy enough to expose their own companies if they did not have to. JP Morgan Chase bailed out Bear Sterns only because the Treasury protected it against losses. It is anyone’s guess whether its acquisition of WaMu without similar government protection will help or hurt it.

Moreover, and this is critical, in a networked world, responding to a specific effect of a crisis does little to stop it. That is why the rescue of Bear Stearns, Freddie Mac, Fannie Mae and AIG did not calm the markets. WaMu got liquidated calmly, but now Wachovia looks like the next domino. Stopping the entire crisis cold requires enormous power. That is the real value of the $700 billion. It is large enough to send a strong signal that the government is ready to tackle not AIG or Freddie Mac or Fannie Mae, but the whole enchilada.

To prevent future crises, we need regulators armed with strong sense-and-respond capabilities. Which is why in the last post, I took Secretary Paulson and Chairman Bernanke to task; they sensed (how?), but did not respond (why not?). The how must be analyzed and turned into a robust, replicable process not dependent on the Chairman’s brilliance; that process should be used by all regulators. The why not may have embedded in it serious policy and legislative implications, which must be addressed. For example, if the regulators had no authority to order AIG or Freddie Mac or Fannie Mae from acting in ways that put everyone at risk, they should be given such authority. Note also that the other “safety net” built into the system – the rating agencies like A.M. Best, S&P and Moody’s – also missed the emerging crisis. Were they all asleep at the switch, or were there fundamental underlying issues to which no one paid attention?

3. Require the Treasury and the Fed to immediately begin negotiations with major foreign regulators to create a consistent set of ground rules. The media has reported that European governments are demanding cooperation from the US and the Fed is responding. (E.g., it helped the European Central Bank and others, contributing to a $60 billion liquidity injection to ease the tightness in the LIBOR market.) The real question is: what should the Treasury and the Fed do proactively for the future? America’s financial networks don’t end at its borders. So, it will be difficult to sense the next emerging crisis without the collaboration of foreign regulators. Recent media reports have indicated foreign regulators, even from other G7 nations, grate their teeth at the patronizing behavior of senior US officials. Without a sea change in attitude among US officials, we will continue to be at risk. We must negotiate with them rules and regulations that are consistent across national boundaries. We have to ensure that robust, replicable processes are adopted by everyone. And we have to ensure that knowledge of impending crises are passed on to other regulators quickly. When UBS earns a huge chunk of its revenues and profits in the US, it is no longer a European bank. When Bank of America earns a huge chunk of its revenues and profits outside the US, it is no longer an American bank.

4. Create new analytical tools to better predict effects of market events. National Public Radio reported on the 27th that when he was a professor at Princeton, Chairman Bernanke, co-developed a computer simulation (“Financial Accelerator”) with the type of analytical capabilities mentioned in the last post. If Princeton has this, I sure hope the Fed and the Treasury do too. And yes, let’s share this knowledge with foreign regulators – or adopt their tools if they have better ones. Equally importantly, we need to authorize the regulators to mandate the adoption of such tools by every major financial institution. We have to get past the “one lender – one borrower/one lender – one sector of borrowers” mindset criticized in the last post. I am mindful of the fact that in the post “Beware the Model All Logic,” I cautioned against blind reliance on models; nevertheless, not using essential decision-making tools is equally bad.

5. Use modern information technology to cross link approval structures. As our financial institutions are becoming larger, lending silos make approval decisions about risks in their market niches without talking to each other. Consequently, it is not unheard of for different arms of an institution to offer the same creditor different types of debt with inconsistent legal rights and responsibilities. As such the institutions are losing the ability to see and understand their total exposure across their networks. When crises loom, they can’t tell how they could be affected. (This is a manifestation of a problem that affects all networks: distribution of work across time and space compromises visibility.) This confusion is mirrored externally by the existence of a myriad of (albeit defanged) regulatory bodies with overlapping jurisdictions.

To assure better visibility and to facilitate analysis of complex decisions, we must use modern technologies more effectively. For example, technology can flag problems that could arise from inconsistencies far more quickly and more thoroughly than a human can. Being forewarned, decision-makers can now act – or be held accountable for not doing so. Regulators should be empowered to demand the implementation of modern IT both within their own bailiwicks and also to transfer critical information on a timely basis to regulators. The regulators should be able to use the information to question executives about actions that could threaten the network – and force them to cease-and-desist.

Implementing this guideline will raise all sorts of difficult policy questions about protecting proprietary information, the governance responsibilities of Boards and the like. But that is the fundamental conundrum we are not wrestling with today: modern technologies have created the networked world. We have embraced the networks with both arms because of the benefits they offer, but we have not re-thought how our laws, strategies, processes, values, analytical tools and yes, even technologies, must be updated to function within them.

There’s no question that many executives involved in the present crisis were rapacious and deserve to be penalized. There is also no question that many policy setters are ideologues who would like to do nothing better than demonize each other rather than solve problems. But unless we actually reform the underlying mindset, processes, tools and technology, we – and other major economies –will be doomed to shelling out trillions of dollars of pocket change ever so often.

Comment » | Business Environment, Business Tools, Company Performance

Looking for Risk in All the Wrong Places! Part 1 of 2

September 23rd, 2008 — 1:21pm

I was trying to avoid writing about the financial crisis since it is hard to say anything substantive briefly and in order to stay away from politics. However, since my book’s subtitle refers to averting crises, I cannot. So, here is the first of two posts. This one expresses three ideas: (1) We need a mindset change from a bilateral to a multilateral (or networked) perspective in business. (2) Unless work practices change, such crises will recur. (3) The (regulatory) culture must change, for it affects perceptions of risk.

20+ years ago, I was a junior banker at an American owned international bank. Today, I understand finance from a strategist’s perceptive, but am not an expert. So, my wife and business partner, Sanghamitra Dutt, has co-authored these posts. Before we co-founded Ishan Advisors, she was a Managing Director at a “money center commercial bank.” In the 1990s, the US Office of the Controller of the Currency recommended that other major banks adopt the information and analysis packages she had designed for use by her bank’s top managers and Board.

Let’s understand that financial innovation did not cause this crisis. Financial innovation has been with us ever since Europeans reshaped the world centuries ago by creating the first stock market. Nor is the complexity of innovations the problem. As an MBA, I had considered doing a Ph.D. in Finance and had learned risk analysis at levels beyond those taught to my peers. So, when my bank entered the new commodities lending business, I got tasked to understand the credit issues – and these to teach others, including my bosses. That fact did not depress our stock price or sink the markets! Blaming innovation for the crisis is akin to blaming Edison for destroying the livelihoods of candlestick manufacturers.

Now consider a simplified description of how financial institutions assess risk. Let’s say Bank A asks an analyst to evaluate whether AIG is a good credit risk. She would study its financials (including confidential information) and pass a judgment. However, unless Lehman Brothers was also A’s client, no one would analyze its financial statements in depth. If both were clients, any direct interactions between them would be looked at, but no one would necessarily evaluate how a failure of a partner of a Lehman client could affect AIG. To address such broad issues, an analyst would be asked, “Given our capital structure, should we be comfortable with our exposure to all financial institutions in this particular sector?” He would perform “what if analyses” (or “stress tests”) and posit an opinion. A group of senior executives would debate these analyses and reach consensus on policy, keeping in mind the revenues A was earning (no risk, no reward). A’s board might provide oversight over this decision (by mandating “portfolio limits”) but would not delve into details. It could not; look at a few annual reports to see for yourself how many Board members of financial institutions actually have deep financial expertise.

If you asked any executive involved, “Can you precisely describe a situation that could cause every financial institution in the market to implode over a matter of a week?” they would probably answer “No.” The idea would seem irrational, given this type of analysis and decision making. Scientists have established that humans are notoriously bad at estimating, understanding and acting on probabilistic information.

The root cause of the crisis, then, is the limited ability of financial institutions to estimate risk that arises from sources beyond their immediate trading partners. In the past, they operated as relatively isolated organizations linked loosely to each other by specific transactions. Today, they form a global network that is constantly managing flows of monies; here, any institution’s failings can affect every other institution it touches.

Yet, they lack the management mechanisms essential for this changed world. Their standard risk approval mechanisms, anchored on an “one lender, one borrower” and “one lender, one sector of borrowers” mindset, are outdated. Their standard tools of risk analysis focus on individual institutions or sectors and cannot reveal risks buried in the network. The data they have available to do any analysis is weak: these are usually, but not always, available in the US and less so in Europe; they are usually unavailable or unreliable for institutions from the rest of the world. So, without being the demons they are being made out to be, financial managers have for long been on the edge of today’s crisis.

The loosening of regulatory requirements, particularly under the present administration, exacerbated this weakness by encouraging a culture tolerant of imprudent risk. We can recall saying “There goes the neighborhood” when investment banks abandoned the partnership model and became common stock companies. When their partners’ personal wealth was at risk, they were more cautious. Even when risks were apparent, important people looked away. Consider The New York Times report (“A Professor and a Banker Bury Old Dogma on Markets” September 21) that Secretary Paulson praised Chairman Bernanke for identifying the possibility of today’s crisis a year ago. He meant to praise Chairman Bernanke’s brilliance; we were outraged. Messers Paulson and Bernanke, what did you do over the last year to head off the crisis before it occurred? If you did nothing, why not? If you did act behind the scenes, what caused you to fail? Congress should ask these two gentlemen these questions before giving them a blank check.

Keep in mind that the paucity of financial information about ‘Rest of the World’ institutions suggests the possibility of a widening crisis. Think of this not as the falling of “another” shoe, but in terms of a well shod millipede! Foreign banks with exposure to Lehman could be grossly weakened by its bankruptcy. Their weakness could precipitously weaken other US banks that are (thus far) healthy. Some European banks have already lobbied for their share of the $700 billion and in principle, Secretary Paulson has already acquiesced to their request.

Moreover, what about the “non-bank banks” in the US economy? GE and GM get more than 50% of their profits from their financial arms. GE might be financially sound, but will the meltdown be the straw that breaks GM’s back? Trickle down network effects can reach pension funds, state and local governments and the like.

Networks at their best, are wonderful. Networks that are not managed appropriately are deadly. Nokia and Ericsson tried to teach us these lessons. Too bad we haven’t learned them yet.

1 comment » | Business Environment

Pyromaniacal managment

September 14th, 2008 — 7:09am

My wife considers me a workaholic; naturally, I disagree. On our European vacation, I did not work at all. I read The European Wall Street Journal only twice — and that too because when the blazing Milanese afternoons forced us to retreat repeatedly into our hotel room, I had run out of books and the hotel’s management treated all weekday guests as business people.

An August 12 article (“Sounds like a combined position? It is”) caught my eye. It reported: “Call it a sneaky way to get more work for less money. U.S. companies in some sectors that are cutting back on manpower aren’t eliminating positions entirely, bur rather have taken to melding a midlevel position with a more junior one – then advertising it as a junior slot, offering a low salary.”

I have to confess that the article left me dumfounded. Does anyone actually think that this is a smart way of doing business? Consider the logic inherent in the idea: “We have a managerial/executive position that is important enough to preclude its elimination, even in these tough times. However, it really does not matter if we offer it to an unqualified person.”

Let’s take this logic into another field – how about surgery? “Doctor X assisted in 15 (pick an appropriate number) heart surgeries while completing his internship. Let’s make him the Chief of Cardiovascular Surgery of this hospital, since we can’t afford to hire an experienced surgeon with management experience.” Or, consider a parallel to the specific example (of a contract manufacturer) in the article, “Doctor X has assisted in 15 heart surgeries. Since we cannot hire both a cardiovascular surgeon and a gastro-intestinal surgeon, we will combine the two jobs and have him do both. We should be OK, since a senior surgeon will check in on him occasionally.”

Would you go to such a hospital for a surgery? If the logic sounds asinine in medicine – or engineering or professional team sports or a dozen other fields – why is it not asinine in the running of a complex business? All these years, I had believed that the only field of human activity in which you could (routinely) find such sheer stupidity was politics. I guess the good news is that I am still living and learning.

Near the end of the article, the Journal quoted experts saying that such measures “… tend to backfire in the long run …” and “… when jobs are poorly combined, the strategy can also be bad for the firm …” because the company may be “… cut(ting) into the bone, into the things that are really adding value to your customers …”

The house can burn down and the experts are worried about the possibility of a long term decline in real estate values? Here’s what I would have said, had I been asked, “If you are a customer of such a company, immediately conduct an quality audit of everything you got from them. Also, find a replacement provider immediately. Then you won’t be singed when your provider crashes and burns.” To the Board of the provider company, I’d say, “Would you give a match and lighter fluid to a pyromaniac? No? Then fire the person who made the hiring decision. That’s an executive you can do without, particularly during tough economic times.”

Comment » | Leadership, Organizational structure

Membership has its privileges (and should be privileged) Part 2 of 2

September 7th, 2008 — 8:43pm

Visa’s failure to honor its promises on the Upside program (See the post “Visa – We Aren’t Even Where We Promise to Be.”) left us desperate. S was borrowing cash from her cousins to pay her bills (many youth hostels only accept cash, and the types of eateries they were patronizing prefer it). And we were losing valuable time on our vacation.

I am an American Express Platinum card member. With little hope, I called them for help, telling them up front that I did not expect them to be able to do so. The customer service staff who heard my tale raised my hopes by saying that she was sure Amex would be able to do something. She connected me to an got “Amex Global Assist” agent – after she had relayed to him accurately my entire tale of woe.

Immediately on taking over the call, the Global Assist agent proposed a solution. Since S was by now in Salzburg, Amex would wire the money to Western Union and S could pick it up at any of its 50 locations there. “Only €250?” the agent asked me, “Are you sure? You can send much more. Mr. Mukherjee,” As he delved deeper into his solution, he realized that Austria did not allow minors to receive money. So he asked me if there was anyone over 18 in Salzburg whom S trusted? If not, he’d craft a different solution. I told him about S’s cousin. No problem, he said, we will send him the money. And then, he set up a 3-way call with S. He wanted to see if he could find a Western Union near her youth hostel that was open at that time of the night (10 pm), so that S could get the money immediately. After getting S on the call, he described the forms Western Union would ask my nephew to fill and the responses my nephew should give. He said that if anything went wrong, S should call Amex immediately (collect, of course) from the Western Union office. He provided a case file number to quote to whichever of his colleagues took the call. Then he told me – casually – that since this was an emergency, Amex would waive all fees. Truly, membership has its privileges.

In my last post, I argued that Visa could not deliver baseline Plan and Execute effectively. Moreover, I noted that it was tarnishing its brand by allowing partners to use it to sell services that Visa/they could not – would not – deliver. A different way about thinking about the second point is: membership in a network should be privileged — it should be restricted to those who are capable of upholding the network’s branding.

In contrast, American Express flawlessly displayed its mastery of the other three critical capabilities of a great networked company: Sense, Respond and Learn. It was ready to Sense the occurrence of a type of event that could happen to any of its members, though it could not anticipate who would be affected, to what degree, when, where, why or how. Once it sensed an individual occurrence, it immediately Responded with a semi-custom solution. No one told the Global Assist agent what to do; Amex’s culture, processes, technology and yes, network, enabled him to find a solution for my specific problem, even though it had nothing to do with Amex. And then, the very next day, Amex contacted me to get my views on how well it had met my needs. Undoubtedly, someone will analyze its handling of this event to see what Amex could Learn from it for the future.

My wife and I resolved to talk about Amex’s performance to our network of friends and business partners. I have already urged several people to upgrade to a Platinum if invited to do so by Amex; the $400 annual fee is worth it. And yes, while we cannot stop using Visa cards because of its wide acceptance, we can – and will – use our Amex cards whenever we have a choice, and particularly for all large purchases (our MasterCards will get next priority and Visa the last). Given our travel and spending patterns, there’s no question that whatever Amex invested in its Sense and Respond effort to help us, it will earn back – and a lot, lot more – in a handful of months, maybe even weeks or days.

Now if only I could interview the people who designed this capability for my next book …!

If you’ve had experiences similar to the ones described in these two posts, do let me know. I would be really interested in understanding what you learnt from them and how they affected your subsequent behavior.

1 comment » | Business Environment, Business Tools

Visa – We Aren’t Even Where We Promise to Be, Part 1 of 2

September 7th, 2008 — 8:39pm

This tale of two companies operating in the same networked world fell into my lap when I didn’t want it to do so. To keep it digestible, I will tell it over two posts. Even so, each is long; bear with me, for there are key issues here for today’s companies.

While my wife and I were vacationing in Switzerland and Italy, my daughter (“S”) (17+ years), niece (17+) and nephew (19) were backpacking through Switzerland and Austria. Our paths crossed for only 2 nights, in Wengen. Each teen had a debit card; after searching extensively, we loaded $1,000 of S’s hard earned summer-work money on “The Upside Visa Prepaid Card,” a program “specifically designed for the younger generation and their family (sic)” ( The website, with its prominent Visa logo, explicitly said, “The card can also be used to withdraw cash at the tens of thousands of ATMs which have the Interlink or Cirrus logos. In a nutshell, it combines the safety of an FDIC-insured bank and the universality of the Visa® network …” The possibility of cash withdrawal is also discussed under FAQ.

In Wengen, S told us that she had not been able to get money at any ATM. We called the customer service number (which promptly charged the account $0.99) and were told that S had the wrong password – even though Visa/Upside had provided it. It took us a couple of days to get a new password, since we did not have with us the information needed for a change. By then, we were in Milan and S was in Innsbruck. She called us; the card was still not working. We paid Visa/Upside $0.99 to talk to an agent named Sami, who told us categorically that the Upside program did not work with ATMs. After a long argument, he personally verified from the website that our complaint was valid. Chastened, he promised to email Visa technical services (relevant fact: everyone involved spoke of “Visa”). In exactly 4 hours, he said, we would hear from a person with more authority than he had about what could be done.

7 or 8 hours later, we called back Visa/Upside ($0.99 again, plus our international calling charges) and after arguing with the agent, got to speak to the call center manager, Taylor. Taylor cried crocodile tears (“Do you think I like hearing about your 17 year old being stranded?”). Yet she continued imply that that we were wrong the Visa/Upside program; it was not designed to work at ATMs. She supposedly could not access Sami’s work files. Visa’s policy only promised customer responses to in 48 hours and so, Sami she said, could keep his own promise of a faster response when he returned for his next shift (in 7 hours). And no, we could not speak to her boss.

Our suggestion of a human-to-human intervention (e.g., authorize a correspondent bank to pay S €250 across a teller counter) just couldn’t be done, “even by Visa’s CEO;” our request for such help simply meant that we did not understand modern financial systems. My wife, who was until a few years ago, a Managing Director of a money center bank, took that one well! I too learnt a new lesson about the powerlessness of a CEO of a global institution; this one had escaped my understanding in all my years of working with top executives. Taylor, however, did authorize a credit for $0.99 to S’s account. Her generosity warmed our hearts.

The baseline performance requirement for any company is Plan and Execute well. Visa/Upside failed to deliver even at this level. It had not given Sami – and what is worse, its call center manager, Taylor – the capabilities to address a genuine problem created by its own inability to execute its website promise (plan). Moreover, 3 weeks after these incidents, Sami’s “4 hours” and Taylor’s “48 hours” have still not elapsed in the time that ordinary mortals experience. And if either did let anyone at Visa/Upside know about the untruth on the website, no one has acted to rectify it.

But in a networked world, the Visa business unit responsible for the Upside program is guilty of an even greater sin: lending its brand to partners who are at best incompetent and at possibly, dishonest. A couple of days ago, I finally noticed the very small print on the website: Upside is offered by a no-name bank under license from Visa. Had we noticed that the first time, we would not have put S’ money in its care, just as we don’t make online purchases at no name websites. A very brief online search effortlessly revealed other instances of failure by other Visa partners offering similar peace-of-mind programs to teens and their parents (“They still haven’t returned my son’s money”).

I wanted to complain to Visa itself, here’s what I found on its website: “If you have a question about your account, please contact the financial institution that issued your Visa card.” In other words, go complain to the people who did you wrong! I am sure that Visa can escape legal liability for the failure of its partners, but I have no doubt that it is compromising its most important asset: its brand name. In The Spider’s Strategy I urged executives to adopt the Hippocratic oath when dealing with consumers in a networked world. In a world in which the logos of blue chip companies can be mortgaged for billions of dollars, some executive officer at Visa should review the processes and decision making culture that is allowing such shoddy business practices to thrive. Individual consumers may not have much power against the huge financial resources of a large company, but they have their own network – the Internet – to tell their tales to the world at large.

Comment » | Business Environment, Business Tools

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