The Financial Crisis 2008

In a series of unprecedented moves, the Federal Reserve stepped in as “lender of last resort” to save a financial system on the brink of disaster.  Reuters news agency (September 19, 2008) called it an “extraordinary” rescue plan.  First it was Bear Stearns, then Fannie Mae and Freddie Mac, Lehman Brothers, Merrill Lynch, and AIG. At risk were Goldman Sachs and Morgan Stanley.  From investment banks to insurers, the very foundation of the world’s financial system had been shaken.

While there were many interesting details that chronicled the steps and missteps leading to this crisis, and while this saga will very likely change the face of banking (certainly investment banking) in the United States and probably the world, the interesting question that needs to be asked is how we got ourselves into this mess. On September 16, 2008, George Stiglitz, Nobel prize-winning economist and Professor at Columbia University wrote that the crises can be attributed to  “a pattern of dishonesty on the part of financial institutions, and incompetence on the part of policymakers.”

While getting to the cause is important, as the United States Congress proposes legislation to prevent this from happening again, it may be useful to consider what lessons all managers can take away from this tragic turn of events.

Three project management lessons seem to be worth considering.

 Managing in an Age of Complexity

The first is that we manage projects in an age of complexity.  Software applications (ERP), as one example, can be very complex when independent modules function as an integrated system.  Drug discovery (Vioxx), another example, is complex because the easier breakthroughs have already been made.  Even public works projects (Boston’s Big Dig) can be complex when constrained by existing infrastructure and social issues.

Certainly, the crisis on Wall Street has taught us that the way in which our financial system has evolved over the last decade has added an unprecedented layer of complexity to an already complex system.

Consider the players and their actions within in this system.   

1.       Prospective home buyers, motivated by increasing home prices, applied for mortgages.

2.       Mortgage brokers were happy to oblige and wrote the mortgages.

3.       The mortgages were then sold to mortgage consolidators who asked few questions as they bundled this debt into Collateralized Debt Obligations (CDOs).

4.       Then, the CDOs were sold as high yield investments to institutions such as banks and insurance companies. 

5.       Insurers like AIG then insured the debt instruments, so institutions who held these CDOs would be confident that their investment and income streams would be secure.  

Indeed this was a complex system, one built on trust (CDOs are unregulated), and one in which everyone was happy as long as the housing bubble continued to grow.

But it didn’t. 

Then, in August 2007, the bubble burst.  Home values started to fall.  Discovering that the equity in their homes was less than its value, many homeowners walked out the front door leaving the keys behind.  Now, there were more homes on the market and prices continued to fall.  Lower prices resulted in even more homes whose equity was less than the loan, and the spiral continued.

With homeowners missing payments and eventually defaulting on their mortgages, the CDOs not only became less valuable but they also became difficult to value. What were they worth?  

The CDOs were like black boxes, few could see inside, or cared to look inside. The home buyers who took out the mortgages in the first place were basically hidden from view.  Transparency was gone. There were so many players – homeowners, mortgage companies, debt consolidators, insurance companies, and banks – that it was impossible to determine the quality of the debt.  

In the end, the investment community would become a victim of the complex financial instruments they had created.

We Need Information not Data

The second lesson is that project managers need timely information to manage effectively.  Raw data is of little value; in most cases what they do not need is volumes and volumes of data in rows and columns.  What they do need, however, is information, useful information in summary form that helps them make sense of complex situations. 

Let’s get back to the financial crisis. Under better circumstances it may have been possible for data to have moved upstream as part of the mortgage loan package and become part of the CDO package. Then, the institutions holding these CDOs may have had a better chance of monitoring the quality of the debt they were holding and its value.  However, even if this were the case, falling home prices and an increase in foreclosures would have continued to deteriorate the value of the CDOs.

But the data that could have been used to expose the fragile nature of these CDOs were stored in different locations or possibly not available at all. In any event, it was not possible to bring them together.  As a result, decision makers were forced to fly blind and almost every institution, certainly the ones that failed, carried the CDOs on their balance sheets at prices much higher than they were actually worth.  Consequently investment banking firms like Lehman Brothers and Merrill Lynch were overvalued until reality reared its ugly head.

Would it have been possible for better and more up-to-date-information to have softened the blow? That’s a difficult question to answer, but the absence of information and the uncertainty expressed time and time again about the vulnerability of the system and the inflated values of the CDOs on balance sheets, certainly suggests that the lack of information contributed to the crisis.

Denial can Bring Catastrophic Results

The third lesson is that the project management office, steering committees and project managers cannot afford to be in a state of denial.  In 2006, I attended a presentation at a New York investment bank and asked the senior economist for his views on an inflated housing market that some concluded was about to implode.  He assured me …  supporting his argument with compelling data … that this was an unlikely outcome.

A New York Times article on September 16, 2008, suggested that “most of the big firms have been a day late and a dollar short in admitting that their once triple-A rated mortgage-backed securities just weren’t worth very much.  And one by one, it is killing them.”  The article continued to explain that Mr. Fuld, the CEO of Lehman Brothers, went to the Korea Development Bank to ask for help in shoring up Lehman’s balance sheet.  It failed because Mr. Fuld demanded more for Lehman than the Koreans thought it was worth.

Denial was everywhere, from the homebuyers who felt they could afford a $600,000 house on a $75,000 income, to the mortgage originators who looked the other way, to the debt consolidators who put together the CDOs, to the banks who purchased the CDOs and kept them on their balance sheets at unrealistically high prices, and to the insurers who grossly miscalculated the risks they were taking.

Lessons Learned

Complexity has increased in most industries. It is a factor in the innovative financial instruments on Wall Street, enterprise software that runs many global businesses, or  new drug development.  Organizations and their leaders ignore this complexity at their own peril.

 Information and its use to support management decision making at the strategic level is more important today than it has ever been.  No one would fly a Boeing Dreamliner without information displays in the cockpit.

 Denial is not a river in Egypt, it is a fatal error made by overconfident leaders.