The current financial unpleasantness has come as a bad shock to just about everyone out there. Although lots of experts have been predicting a collapse in the housing market for many years, things seemed to be trundling on.
If you look carefully, you see this effect quite often – things are hanging on despite all sense and logic. I call it “The Hanna Barbera Moment” in honour of the cartoon. You know the sort, the bad guy has run off the edge of the cliff and is still going on as if there was earth beneath his feet. Then he stops, looks down, realises nothing is there, and plummets. It would appear the whole of the global financial system has managed to have its Hanna Barbera Moment, and is still crashing down. The inevitable consequence of this is bad news on every front – people out of work, huge uncertainty for the cashflow of businesses, and international currency rates that are bouncing around faster than a bouncy ball. How one can attempt to plan in this climate is beyond me.
When the story gets to be told, I wonder how much the computer will be blamed. By this I mean the rise of the personal computer as a business tool. This might seem a somewhat strange concept, but bear with me. First, let’s start with a few underlying truths. The banking system used to be straightforward – high-street banks were run by the local branch manager, and he or she scrutinised what was going on. Want a mortgage? Of course, but expect a grilling first. Over the past 20 years, this role has disappeared to be replaced by “The Computer Says Yes” on terminal computers being fed by a central computer system that made its own judgement – and then decided to lend anyway.
Next up, we have to remember that the financial system tries to make itself look very clever and complex, but the fundamental principle is simple. Take a pile of money, preferably someone else’s, and move it from heap A to heap B. In doing so, take a slice off the top for commission and fees. Then, hopefully, you’ll get the chance to move it from heap B to heap C, taking fees again. Finally, if you’re really lucky, you get to move it back from C to A, taking the necessary slice yet again. And round and round it goes.
Now, it’s clear this works just fine, but there are bottlenecks in the system. Anything you can do to make it go quicker means more transactions, and that means more slicing off the top. In essence, this is what happened with the computerisation of stock markets, banking infrastructure and so forth. Crank the handle quicker, and more transactions happen in a day.
Then we have the role of the spreadsheet. Now, I’m not going to have yet another rant against Excel and its somewhat grotesque inadequacies. No, the problem has been the people using it. Excel has become almost the standard tool for doing financial analysis, risk analysis and so forth. The reason is obvious – pop in some numbers, do the sums, maybe even run a wizard or two, and bingo, out pops the answer. I’m simplifying hugely, of course – but it’s clear that a fair bit of the City of London’s trading was done in Excel worksheets, where it’s terribly easy to massage a cell, tweak a number, and fiddle with a ratio, especially when your bonus is based on the loveliness of the numbers you can squeeze from the worksheet.
The reality is that maths is hard, and statistics even more so. Modelling risk isn’t easy either, and is very much harder when you have no idea what the real risk is of the thing you’re analysing. Strange, isn’t it, that we can have field-to-sausage tracing on beef and other meat products, but packages of debt can be bought and sold with absolutely no idea of what was actually inside? And again, just like the banking trade, if you can make things go faster and faster then there’s more margin. Then build a rewards structure which, in essence, pays you for risk undertaken during the current year, not for the long-term real risk as it plays out, and you’re staring down into a dark chasm.