The Plight of the Banker — The Quants Ignored the Messenger

Plight of the Fortune Tellers


My author Riccardo Rebonato has the job title ‘Global Head of Market Risk’ for the Royal Bank of Scotland Group. Until a few months ago this was unambiguously impressive. Now, rather like a watch officer on the Titanic, events would seem to have overtaken him. Riccardo though is one of the few members of his profession who can legitimately claim to have warned us all that things were not at all well in the world of financial risk management.

His 2007 book Plight of the Fortune Tellers: Why We Need to Manage Financial Risk Differently’ was, we believed, an important and rather controversial work – given that the message it carried was effectively a critique of the (then) masters of the universe.  The book did not attract the level of media attention and sales that we had expected. It could be said that the book was not an easy read (though it is, unlike his previous books, completely free of jargon and mathematics) but perhaps of more significance was its timing. In late 1911 nobody would have been terribly interested in an expose of poor maritime safety by a director of Harland and Wolff, but immediately after the sinking of the Titanic such a book would have been dynamite.

Re-reading Riccardo’s book now in early 2009, after his bank has been rescued from near collapse by a huge government bail-out (forgive the nautical pun), the cries for help are quite plain to see. I take the key messages in the book to be:

1.      Bank regulators and commercial bank risk managers were increasingly reliant upon and bedazzled by the apparent brilliance of sophisticated quantitative models. Riccardo himself was a high priest of the modelling world – which is why the book was so surprising. He pointed out that the enchantment with over-specific probabilistic models was a dangerous trend. To say that regulators and risk managers were missing the wood for the trees would be an understatement. The ‘quants’ in the banks were too busy calculating the probability of an individual leaf dropping on a wet Thursday in June to bother with looking up at the horizon for approaching hurricanes or forest fires.

2.      Bank bosses did not appreciate the mathematical subtleties of the models they were presented with. They knew they needed to comply with regulations – but these in themselves became the motivators for increasingly risky arbitrage. Risk managers were deployed to tick the right boxes, while with supreme irony the real action was moving into risk areas ( the so-called ‘securitisation’ of dodgy assets) that were completely contrary to the spirit of the Basel (II) Accords.

3.      Rating agencies, wittingly or unwittingly, became caught-up in (or even instruments of) the shenanigans of risk ‘posturing’ (my term).

In a nutshell, Rebonato was alerting us to the perversion and abuse of quantitative techniques in risk management and regulation.

It was a noble book. No doubt he would write it differently today with the benefit of hindsight – but it still carries a valid and extremely important message which all involved with risk management (regulators, policy makers, practitioners and academics) could usefully take note of.  To ignore such a messenger would be to risk learning the wrong lessons and making the same mistakes again.