Avoiding the black hole: Risk management and the global financial crisis

William Leiss says poor risk management almost caused the collapse of the world financial system. It could happen again.

by Andrew Clark

“Risk is the most interdisciplinary form of study you can imagine,” says Leiss. “Every field of study has something to contribute, from the basic sciences to applied sciences to the social sciences.”

The interdisciplinary nature of risk management is a natural fit for a man whose original degree is in history, who has a doctorate in philosophy and whose work has taken him from examining the health risks of electromagnetic fields to assessing the safety of Canada’s blood supply system.

Now he’s turning his attention to a concept he calls “black-hole risk.” He describes this as a risk so dangerous that when you look in to see how bad it might be, you can’t see the bottom. It’s a risk so great that recovery from its negative consequences may not be possible.

“The threat of these past 18 months to the world’s financial system is a black-hole risk,” says Leiss while seated in his office at the R. Samuel McLaughlin Centre for Population Health Risk Assessment at the University of Ottawa. He points to the effort necessary to prevent a complete financial meltdown. “The size of the effort worldwide was $14 trillion. And it’s not over yet,” says Leiss. “That gives you some indication of how big the black hole was.”

This June, University of Ottawa Press published his book Systemic Financial Risk, an analysis of the current financial crisis. The book examines the decisions, and their consequences, that led to the near collapse of the global economy. And it offers some prescriptions to ensure it doesn’t happen again.

Leiss says one of the paradoxes of risk management is that the better we become at assessing risks, the more comfortable we feel taking them. He says that’s one of the reasons why the world’s financial system came close to collapse. “It goes back to the importance of the interdisciplinary aspect of risk management,” says Leiss. “When I started reading about banking and financial issues, I discovered there were these complete silos of analysis.”

Leiss says some very smart people failed to understand, and practice, the basics of sound risk management. “I found just one example where the author tried to bring in risk management paradigms, where questions were asked about how you manage risk.” But Leiss says the mania over deregulation in the financial sector in the United States caused too many practitioners and policymakers to be blind to the dangers of what they were doing.

What Leiss finds particularly frustrating is that there were plenty of warnings signs about the dangers ahead. “I found a major source in the investigative journalism of the New York Times. It offered indispensable insight into what was happening.” But Leiss says too many academics in the financial field were loathe to take the journalism seriously. “You won’t find a single article in an academic journal that references the journalism,” he says. “These are the silos you encounter. It’s part of the explanation of why we didn’t see this coming.”

If practiced properly, Leiss says risk management by its very nature forces people to look outside their silos. He also says if the world financial system is going to avoid more trouble, we will have to manage risk much more effectively the next time around. Leiss says a more robust regulatory system is key. So, too, is greater international co-operation among the world’s financial powers.

But Leiss says that there are serious obstacles to real reform and to the proper practice of effective risk management. He cites the power of the banking and financial sector— especially in the United States—as the most serious barrier to change. 

“We know how to do it,” says Leiss. “The question is whether we have the will to do it properly.” 

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