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A Camry is not a Pinto and a T-Bill is not a Synthetic Swap

January 27, 2010

Toyota is at the top of their game.  Good for them in stopping production of their best selling models until they can figure out what’s causing the accelerator pedal to stick in the 3-2-1- blast off position.  The lesson they learned is not from the Tylenol recall, but from the Ford Pinto scandal of the 1980’s when a document was put forth allegedly claiming Ford did a cost benefit analysis, concluding it was cheaper to pay for the fatalities than to recall millions of cars for an $11 repair.  For those who can barely recall this, Ford produced a compact car, one of the first import fighters, with this nasty design flaw whereby, in a rear end collision, a bolt could puncture the gas tank, transforming the car (as was said at the time) into “the barbecue that seats four”.   Ford lost a very public court case, and paid millions in damages but more importantly, it began their slide which took basically a generation of new drivers unfamiliar with the Pinto debacle from which to recover.  Everyone is saying this is a big hit to Toyota’s reputation for quality, but I disagree.  To me, it shows a company willing to get it right and not willing to sell a car it knows to have a serious defect.  Imagine going to a dealer to buy a Camry and hoping yours won’t be the 1 in 10,000 that will run away and kill you. Remember how Audi handled the Audi 5000 issue?  It cost them 20 years in the US market.

Now in today’s Bloomberg there’s an article saying Wall Street is recovering from the recession based flight to quality and going back, very aggressively, into those Synthetic Swaps which caused all that havoc only a year ago.  Why?  Well, first of all, these exotics are hugely profitable which is a very good thing.  Secondly, the people who buy them are very sophisticated money managers at big pension funds and the like.  The problem is not the instrument, but the originating entity who may be so leveraged it will need a bailout if all the Swaps trigger at the same time.  How would we fix this?  The usual answer is regulation but that’s not what’s needed.  The biggest problem with these exotics is the lack of a simple engineering risk mitigation process called Failure Mode Event Analysis where we take the worst case scenarios at a market level as well as by portfolio and work them through, trying to see how to mitigate risk up front.  Perhaps the best path forward is an SEC run Financial Services FMEA committee of SMEs and Quants (no lawyers or Compliance people), mapping out these complex instruments,  finding out which begets what when failure occurs.  This ties in to our Toyota discussion – stop selling them until we understand them and fix them appropriately.

As we write and read this posting, the world’s political and economic leaders are rubbing shoulders in Davos, networking and overdosing on truffles.  It’s where real business is really done.  Reports are last year’s speakers, mostly bankers, were replaced with regulators this year, with everyone trying to figure out how heavy a burden will be imposed.  Worst yet, small business (a leading area of job growth) tends to borrow from regional and Community banks who, until they figure out the new rules of this new game, are not lending no matter how much the President begs and jawbones.  So let’s stop the rush to regulating to look like we’re doing something.

OK, there’s various schools of thought on who began this crappy economy, but with all due respect, Financial Services is any economy’s source of ‘vitamin green’ and making it as hard as possible to raise capital or borrow is not the answer.  Making it as hard as possible to write instruments you don’t really understand makes sense.  Stopping issuing exotics until we dissect them and deeply understand the interactions between various complex instruments, maximum leverage levels and such makes perfect sense.  Then you regulate only those factors and combinations needing oversight, do it fast and let the economy recover.

Toyota didn’t wait for a judge to tell them what to do, neither should Financial Services.

Rich Eichen is a Managing Principal of Return on Efficiency, LLC, who’s website is http://www.growroe.com and is one of their senior turnaround leaders/CROs, Program and Interim Executives with over 25 years experience reshaping companies, Operations and key initiatives. He can be reached at richard.eichen@growroe.com

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