Spending the holiday weekend with family in North Carolina, I had an interesting conversation with one family member about the BP disaster. He happens to be a retired oil and gas engineer with 25 years of experience designing offshore drilling platforms. I call that a voice of authority on this issue.
We got into a conversation about risk management and what went wrong in the Gulf. I said we needed to insulate regulators better from the corrupting influence of industry and set new rules about drilling. He raised the (valid) point that the technology is moving too fast for regulators to keep up with such prescriptive rules.
So what’s the solution? Slow down progress? Maybe. At least sometimes that’s appropriate to avoid such unintended consequences, but could you imagine if all R&D was managed like Big Pharma?
The argument this family member was making was that industry was actually in the best position to understand the state of the art and appropriate risk controls. They knew what needed to be done on the BP platform. They just didn’t do it. Proof, I said, that the profit motive meant they could not be trusted to self regulate (isn’t that called Corporate Social Responsibility anyway?).
The answer is for regulators to act like good managers, monitoring the design and good functioning of the system, but leaving the individual actors with autonomy of time, team, and technique. In Dan Pink’s book Drive he uses the analogy of scaffolding. Give your employees the tools to succeed, then get out of the way.
I’m in no position to say how regulators should monitor the risk management systems in place at oil companies. I don’t have the experience. But I can tell you from my time on Wall Street, this approach, had it been enforced, would have gone a long way to limiting the risk exposure that brought down the financial system (almost).
Our back office systems couldn’t accommodate the structures the desk was inventing. If you needed to know the present value of a deal, it took a spreadsheet, not a couple key strokes at a Bloomberg. We had stacks of unconfirmed trades because the back office couldn’t keep up. I don’t blame them. You had the lowest paid employees in the back, some just temps, and the highest paid employees in the front, foot pressed on the accelerator.
Trading should have been halted a long while back, until banks had a handle on their books because it seems pretty clear they didn’t. A financial services equivalent to the freeze in deepwater drilling (although that specific policy might itself actually be misguided). A good trader should always know the value of his books at the end of the day. No one could have predicted precisely what the consequences would be, but the risk in the system was apparent.
Regulators should consider this notion of managing the system and not the individuals before Congress gets too prescriptive with the financial regulation overhaul and hamstrings the efficient capital markets that have contributed so much to our economic success. What we need are regulators that are ready to stand up and say no to interest groups making a lot of money on the status quo.