I was recently quoted in the WSJ and posted some thoughts about that on LinkedIn. One of the comments that appeared through the random word generator that is the internet was the following:
“They were using Monopoly money and trading with algorithms and people needed more red flags?”
I read this comment on a gray, drizzling afternoon in Brooklyn, and had such a viscerally negative reaction to it that I immediately ducked under an awning, bent over my phone, to jot down several notes about why.
For those of you who like a window into the process, that is where this piece started: with a drab gray sky floating above the post-industrial buildings of Gowanus, and the author tucked against a brick wall furiously scribbling down notes. Here they are, with each sub-heading being the notes I jotted down.
Good Process is About Finding Signal
One way to think about quality in evaluation of investments or evaluation of financial products or offerings is to look for people who have a good track record of separating signal from noise.
To that end, categorically negative responses that throw out the baby with the bathwater are a surprisingly good indicator of a poor risk process. Keep in mind with any sort of risk evaluation, there are four essential outcomes:
- You say no to something that would have been bad
- You say no to something that would have been good
- You say yes to something that would have been bad
- You say yes to something that would have been good
Any good process will maximize 1 and 4, yet minimize 2 and 3. But it’s important to consider both ends of this process. There are plenty of people in risk functions at financial firms who just look for reasons to say no to everything and succeed. This is a wildly counterproductive behavior pattern, as it means that these institutions protect themselves from both risk and revenue, ultimately withering away into husks that no longer have a purpose for existing.
Likewise, an overly permissive process will find itself allowing risks in the door that really should have been kept out, and importantly, could have been identified in advance with proper due diligence and…