Corroborating industry experts’ views, even CEOs such as George F. Colony, increasingly believe unregulated financial instruments invented by Wall Street are responsible for the untimely demise of some of the biggest Wall Street firms leading to the near nationalization of the Wall Street.
Commenting on how some arcane Wall Street financial instruments magnified the current economic crisis, George F. Colony, CEO of Forrester Research, believes automation is outstripping human common sense. While automation and computers can do much good in the world, Colony says, it should be done under close human surveillance.
Writing for his blog, Counter Intuitive, Colony says that with increased dependence on the business automation processes and less of human interference, the current economic crisis was bound to happen. “Automation and computers do much good in the world. But we have stepped over the line into a world where, without the check of human common sense and understanding, they can do great harm,” he says.
Citing two of the recent technical mishaps, pertaining to Google’s mistaken dissemination of old United Airlines news resulting in a precipitous UAL stock slide and the exotic, computer-generated financial instruments leading Wall Street into fatal waters, Colony believes, both these instances have contributed to great loss of money and reputation.
“In the first case, an automatic system unchecked by human beings made a mistake resulting in massive damage to an already fragile public company. But that’s nothing compared to the wreckage caused by the inscrutable mortgage securities in the second instance,” says Colony explaining how Google’s crawler erroneously posted a six year old news story on United Airlines inclination to file bankruptcy in 2002 as a current top story.
Writing further, Colony details how in the earlier days, a great deal of human trust and conviction were extolled as the primary virtues for running a banking business successfully.
“My father was a part-time banker who loved to extol the virtues of what he called “small town banking.” It was all pretty simple: his bank took deposits and loaned that money to people who the bank officer had gone to high school with. This was important, because bankers are not the highest IQ animals on the savanna — they needed good doses of trust and information to sleep at night,” writes Colony in his blog post last week.
Forty years since the sane days of human trust and conviction, Colony says, automated complex algorithms and arcane mathematical tools have apparently replaced the trust and information of old days. “Step forward forty years to sub-prime mortgages. Using complex algorithms, Goldman, Lehman and others created securities that blended mortgages of divergent risk. The trust and information of the old days was replaced by computer models and arcane mathematics,” Colony points out.
The lack of transparency and regulatory oversight of the immense and critically important market for credit default swaps has been indicated as being a fundamental catalyst for the current worldwide financial crisis, such as the collapse of Lehman Bros and AIG, and the precarious financial circumstances of other financial institutions, a recent SEC report said.
While between one and three trillion dollars worth of financial assets have evaporated as a result of the unregulated credit default swap mechanism, according to estimates from SEC, credit default swap market is close to a whopping $58 trillion, which is highly vulnerable to easy manipulations as it completely lacks transparency and is largely unregulated.
Interestingly, Warren Buffett, the billionaire investor and the Chairman of the Berkshire Hathaway, famously described derivatives bought speculatively as “financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.” In Berkshire Hathaway‘s annual report to shareholders in 2002, he said, “Unless derivatives contracts are collateralized or guaranteed, their ultimate value also depends on the creditworthiness of the counterparties to them.”
In an advisory note to CEOs and other decision makers in a company, Colony envisages few simple rules to efficiently handle decisive situations.
“Apply a simple rule: “If it (an automation process) doesn’t make sense, it doesn’t make sense.” Don’t believe that computer-driven models can reside beyond the realm of human understanding. Either grasp their import, or pull their plug,” he says.
Secondly, Colony is of the opinion that, risk assessment and management programs (perhaps within Sarbanes) should be placed on alert to identify the Hals (read risky automation tools) in your company. “Pinpoint the danger and if you are the leader in the company, never be afraid to say Andy Grove’s favorite business word: “No,” quips Colony.
- Read Credit Default Swap: The Next Crisis
- Read Lehman Credit – Default Swap Payout Could Climb as High as $365 Billion
- The Monster That Ate Wall Street