Posts tagged: Risk

How Mint.com Can Fix The Banking Industry

By , February 12, 2010 2:18 am

So you are unemployed, with no job prospects in sight and a healthy mortgage and family to worry about.  You are not alone as a staggering 17% of Americans are currently out of work (sorry, U.S. Bureau of Labor Statistics, this is a more realistic vision of the jobless rate, not the 10% that you are ‘reporting’ and will subsequently adjust a year from now when no one is paying attention).  Here’s Mint.com’s spin on the real unemployment rate in America:

Now while many Americans are finding it hard to earn a wage, there is a strange thing going on with the employed folks at our country’s largest banks.  They are getting bonuses, and not in a figurative sense of ‘hey, you have the bonus of keeping your job although your performance was a bit spotty abysmal over the past few years.’  No, they are paying themselves cold hard cash partly financed by the federal (read as American tax payer dollars) bank bail-out program.  Now I understand that a few of these banks have begun to repay their financial debt to the country, but the ‘lifestyle debt’ of long-term unemployment, mortgage foreclosures, small business bankruptcies, and retirement saving losses that these banks helped create are nowhere close to being recovered.  To turn a blind eye to anything beyond the reach of their balance sheets is just another example of the lack of fiscal and moral responsibility so prevalent in modern day banking.

In nearly any other industry, these poorly operated business would be purged in typical capitalist fashion during down business cycles; survival of the fittest, Darwinism in industry.  The main reason these industry Dodos survived was because the government had to intervene and lend mega amounts of money to them.  They were so big, and supported so many consumers and industries, that letting them fail would cause massive devastation to our economy (and the world’s economies).  In fact, 15 of the top 21 recipients of bailout funds were banks or bank subsidiaries whose survival has been contingent purely on their size rather than their abilities to operate, a fact ignored when decisions were made to pay out bonuses this year.

Being “Too Big To Fail” creates an imbalanced risk/reward structure because it allows banks to engage in short-term highly profitable businesses (CMOs, proprietary trading, hedge funds) with limited consideration for the additional risk (thanks to 3rd party capital rescue), which tends to be a long-term compounding problem that grows unfettered over many years.  It essentially allows them to share the risks over a larger capital base (theirs plus the American tax payer) during crisis, yet distribute profits accumulated from their activity that leads to the crisis to themselves (through short-term incentive structures like year-end bonuses on annual financial performance).

So what can you do (and how can Mint.com help) so that this does not happen again?  Well, it’s pretty simple, fire your (big) bank.  Firing your bank is basically saying “I will not allow you to get so big that you can act irresponsibly because you are not worried about going bankrupt.”  To do this, all you need to do is move your savings accounts to a smaller, more responsible bank.  This exponentially reduces the size of a big bank, because your deposits are significantly leveraged in the modern day banking system (see the section called “Effects on Money Supply“).  Moving $1,000 dollars out of your large bank could potentially reduce the bank’s asset size by $9,000, so a lot if these jabs to shift the deposit base can amount to a staggering change.

Mint.com allows customers the opportunity to do this in their “Ways to Save” section.  Mint could take this a step forward by giving higher visibility to responsible banks or discouraging consumers (think “Didn’t Screw the Economy” rating) from moving accounts to bailout banks.  They could even flat out not allow irresponsible banks on their site, a move that would certainly be damaging to new customer acquisition for these banks.  With information that is publicly available, along with the data they are collecting consumers relationships with banks, they could create a banking watchdog system that brings the same transparency to the banking industry as they have brought to personal finance.  These types of ideas, although not necessarily beneficial in the short-term, could provide a larger pool of financially healthy individuals transacting in more stable and responsible banking industry.

So are you going to move your accounts to smaller, more responsible banks?  Would you like to see companies like Mint impact the banking industry for the better?  Chime in on the comments section if it suits you … or don’t.  I’ll be checking in to see if you did or didn’t while QAing Jeff’s latest build of Wixity.  Fun.

What is Risk?

By , June 9, 2009 10:20 am

What is risk?  When a lot of us hear this word, we automatically think that it has something to do with something bad happening.  What is risk management?  When a lot of us hear this phrase, we automatically think of “Along Came Polly.”  Risk and risk management almost always equates to incredibly awful downsides whether it be in our drive to work (car crashes), our retirement accounts (stock market crashes), or our health (heart crashes).

When we consider risk this way, we are putting unfair weight on the downside of what risk really is.  Risk is really the measure of the unexpected, and the unexpected can work in our favor as well as against us.  That means that even a crazy unexpected positive outcome, like winning the lottery, is also as much of a reality of risk as a plane crash (on island which travels through time for all the LOST fans out there).  Risk is saying that there is a range of outcomes that could happen and we don’t have a clue about what the hell is going to happen in the future.  The wider that range of outcomes, both good and bad, the more risky something is.

Peter L. Berstein, author of Against the Gods: The Remarkable Story of Risk, explains it pretty well.  He says by definition risk is a measure of the unknown, and because of that it is silly to presume and act as if we know what the future holds.  Risk management really is understanding that the future is uncertain, and preparing ourselves and our institutions to deal with the times when things are different from our expectations:

I was particularly intrigued by his comments about using optionality models in corporations as a way to value the option of waiting as an alternative strategy to acting, primarily when making decisions that you can not go back and change.  This is putting a value on the new information you can gain through the passage of time, simply by sitting back and waiting.  Most people, especially in the start-up space, say there is no time for waiting, release early and release often, iterate iterate iterate.  But what if the cost of this far out weighs the value of waiting?

Say your company is launching a new product, and you have to decide how to spend a $1 million dollar budget to advertise it’s awesomeness to the world.  Your marketing division comes to you with a proposal allocating dollars to buying Google Ad Words, a full-page ad in your industry’s top trade magazine, and a viral video campaign.  In passing they mention that the behavioral study of your existing customer base is going well, and the results should be ready in three six nine months, in time for the industry trade show.

We usually get a lot of information about how search engine marketing has the highest brand recall and  video has the best consumer retention rate and the top ten sites that have the exact demographic that we are targeting.  However this information doesn’t guarantee success; the future is completely unknown and its outcomes could range from the greatest advertising campaign of all time to the the most colossal failure destined to be top business school study material (Advertising Mismanagement:  A Case on (Insert Your Company Name Here).  But what is the value of waiting for more information to launch our advertising campaign, specifically our behavioral study?  What if spending $50,000 to finish up the study tells us exactly who to target, and we only need to spend $500,000 to reach them?  Wouldn’t that trade-off be awesome information to have?  This is possible by modeling the value of waiting to act on future information!  This would certainly help in trying to avoid “being too early,” something that venture capital firms often express concerns about.

So we know understand that risk is more than just danger, and really a representation of ranges (positive and negative) of what an outcome can be.  Risk management is really preparing ourselves for the range of outcomes that could happen, and better risk management would also involve valuing what a “wait and see” approach would be.  We do not know what the future holds, so it’s okay to make mistakes, and the sooner we realize that we can’t do anything about uncertainty (that’s not to say we can’t do anything to mitigate the impact of adverse situations), then the sooner we can be happy as a hippo.

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