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March 2009

February 2009

Risk Management Pitfalls

The Harvard Business Review has an excellent article on "Six Ways Companies Mismanage Risk", by Rene Stulz, in its March issue. (Link is to the executive summary, which is available for free online.) The six ways are:

  1. Relying on historical data. The issue there is that you might not have historical data that is relevant for the situation at hand. For instance in the mortgage industry, "those data didn't cover a period during which the market saw a downturn while a large number of subprime mortgages were outstanding." In addition, risky asset classes tend to be correlated with each other (even more so in periods of crisis), which further increases risk in positions held by the banks. In a sense, financial innovation has made historical data useless, or downright misleading.
  2. Focusing on narrow measures. The author takes issue with the concept of daily VaR (Value-at-Risk). For instance, if a company's daily 99% VaR is 50 million dollars, there is only a 1% chance that the company will lose more than 50 million dollars in a day. But this is meaningless "when the firm is stuck with the portfolio for a much longer period" - in other words, the losses are not necessarily limited to a day when it takes longer than that to unwind positions. The author also gives an interesting example related to UBS and its failure "to keep up with the dramatic changes in market conditions." The author also points out the fact that VaR does not give any idea of how big the losses can be when they exceed 99% VaR, a fact that is well-known by now (I still don't understand why no magazine mentions the concept of Conditional Value-at-Risk, which takes the average of the losses in that 1% of bad cases).
  3. Overlooking knowable risks. This section abounds in real-life anecdotes about four categories of risk: (a) risks that are managed by another unit ("Risk managers often distinguish among market, credit, and operational risks, which they measure differently and in isolation.") (b) risks incurred by hedging (the example of high-yielding Russian debt, where hedge fund managers mistakenly thought they had hedged against default risk and exchange-rate risk, was quite enlightening), (c) market-concentration risks (the assumption that markets are frictionless, and what happened to LTCM), (d) value-assumption risks (when "transactions are too infrequent to provide clear price signals")
  4. Overlooking concealed risks. Desk traders are rewarded for taking risks, and it is easier for them to take such risks if they are not well-monitored.
  5. Failing to communicate. The message there is that risk managers need to be able to explain what they are doing to the board and the CEO, and resist the temptation to "overstate the company's ability to measure risk." Again, UBS is given as an example.
  6. Not managing in real time. Risks in finance change very fast.

The author does offer a few suggestions to improve risk management systems. In particular, he recommends to perform scenario analysis, in the spirit of disaster management. His idea is that you shouldn't spend so much time trying to estimate the probability of a crisis, but instead have a strategy in place for the day it does strike.


Ottawa Oddities

Stanley Fish has a post on Denis Rancourt on its New York Times blog ("The Two Languages of Academic Freedom," February 8, 2009). Rancourt is the tenured professor and self-proclaimed anarchist at the University of Ottawa who, in Fish's terms, decided to hijack (he calls it "squatting") the physics and environment course he was scheduled to teach, told students on the first day of class that they would all be getting A-pluses and that, rather than covering the material mentioned in the syllabus, he would urge them to become political activists instead.

Here are some sample quotes by Rancourt, as excerpted in the NY Times blog: "our societal structures . . . represent the most formidable instrument of oppression and exploitation ever to occupy the planet," "schools and universities supply the obedient workers and managers and professionals that adopt and apply [the] system’s doctrine — knowingly or unknowingly", "[grading] is a tool of coercion in order to make obedient people."

Based on that admittedly limited amount of information, it is reasonable to conclude that, while Rancourt hides behind the concept of academic freedom, which he distorts to say that he can do as he pleases (he has ideas about how to contribute to the greater good and refuses to subordinate his desires to the most basic unspoken contract, such as actually teaching the course he has been assigned to), what he really does is craving the spotlight, and resorting to extreme measures to get noticed.

It's hard to believe this man got tenure, although maybe that won't surprise those who think he is manipulative rather than idealistic, and was quite capable of submitting himself to the university's "dictatorial" rules for his own personal gain, i.e., getting a job for life. Helping his students get a job by giving them a good education is apparently another matter, although Wikipedia suggests he did manage to convince quite a few this was all for their own good, and the website emphasizes that Rancourt's approach was all "student-centered", whatever that means. It might simply be called "pandering" by most people. (I do not know Rancourt and had never heard from him before this morning, so I only base my comments on Fish's blog posts and a couple of documents on the Web.)

Every department has a "special topics", seminar-based or experimental course that faculty members can take turn teaching, and I initially did not understand why Rancourt had not taken this approach - students would have been a lot more receptive to his message if they had willingly registered for a course in political activism. Then I clicked on Rancourt's webpage, and it seems that not only does he have other ways to express his views, such as a weekly radio magazine, but he also taught a formal course on activism in Fall 2006, which he says was shut down by the administration. He also has a long and well-documented history of provoking the university, according to the Wikipedia page, and some of his claims - for instance, that his dismissal is due to the Zionist lobby - don't do his credibility any good.

I don't think particularly highly of anyone who views universities as instruments of coercion and exploitation. This kind of rhetoric is completely ridiculous - if grading is "a tool of coercion to make people obedient", I wonder what Rancourt thinks about sports (maybe the Olympic gymnast won't mind if all the other competitors get a gold medal too), or schedules (I'm coerced to show up at the airport to catch my flight!), or red lights and one-way streets and highway exit - not entry - ramps.

But I have to admit I'm curious - what makes someone jeopardize his career in such a dramatic fashion? why did he feel his voice would not be heard unless he resorted to this stunt? did he seriously believe he could bribe students (giving them A-pluses in exchange for their silence about the true course content), and isn't that one extreme example of the coercion Rancourt claims he opposes? or did he secretly hope he would lose his tenure, in one of the most publicized acts of self-sabotage in recent memory?

Fish says that the case is about academic freedom, and professors' outrageous sense of entitlement. I can't help but think that - in the same way that some criminals at the end of their rope supposedly want to get caught - Rancourt must have yearned at some level to leave the university, but couldn't bring himself to cut his ties without a bang. He certainly didn't do things halfway.


Grants and Academia

Stephen Quake, a professor of bioengineering at Stanford, wrote a guest column about the academic life in a New York Times blog (Letting Scientists Off the Leash, February 10, 2009), and more specifically about the importance of getting grants. As scientists progress in their career, their main task becomes to secure funding for their research programs; they typically do little hands-on research by themselves, training students to perform these tasks instead.

Quake wonders how much of a researcher's salary should be provided by the university in order to help scientists think outside the box, as opposed to running after the latest buzzword to get money. In many experiments-heavy fields, one cannot perform research at all without grant money, which is necessary to buy equipment. Quake was lucky to get some very innovative ideas of his funded through atypical programs, but he worries that the conservatism of review panels impedes cutting-edge science.

This is of course a complicated issue - I was surprised to read that 75% of some faculty members' salaries come from research funding, because I always thought this only affects summer salaries, which represents at most 25% of yearly pay. (Note that nine-month salaries, guaranteed by the university, are paid over twelve months unless the faculty requests otherwise, so professors do get paid over the summer even if they don't have research grants.) I also felt that Quake's view that, "without a grant there might not be food on the family dinner table" was overly dramatic, and a very distorted take on reality.

Quake also drops hints of faculty members being worried about their mortgages, but what about the people who lose their job (all of it, not 25%)? Does he think they aren't worried about their mortgages too? In this economy, guest columnists might want to choose their words a little more carefully. (The deli employee at the Giant supermarket, who works there as a second job to make ends meet and keep his son at a top liberal-arts college, mentioned the other day that store customers have been drastically cutting back on the amount of meat they buy, and have been shunning the top names in favor of cheaper store brands. His wife's commissions [she works as a travel agent] have plummeted and he worries he's going to lose his main job, which he already lost a few months back before finding a similar position elsewhere. And then Quake writes about academics worried about food on the dinner table - what kind of bubble does he live in? There's always plenty of food on my dinner table, and organic one to boot. At least tenured faculty members like Quake have job security, and if academics don't like the size of the mortgages in Northern California, they can move elsewhere.)

Quake's post doesn't enhance the image of academics, unless whiny is the new cool. Yes, transformative ideas are difficult to secure funding for, and anyone who has been reading my blog for a while knows I'd love to see basic research get more money from the government. I wish that Quake had emphasized the sense of lost opportunities instead - who knows whether the ideas that didn't get funded will be implemented one day? what if their inventor loses hope and decides to leave academia? what about the lives of the people such ideas would have helped? This staggering sense of lost opportunities is what motivates taxpayers and their Congressmen to put more money into science and engineering. It is truly sad to go into scientific research to help change the world, and be prevented from making a contribution because no one agrees to give you money.

A recent article in Nature emphasizes this point (Research funding: closing arguments, February 5, 2009, p.650-655). (Sorry, I can't post a link. You have to be a subscriber to view it, or at least your university has to.) It describes the case of two academics with stellar track records who were recently denied funding and are considering leaving science as a result. The message I took away from the article is that there are many scientists with good ideas and good grant proposals out there, and, although highly deserving, they are not getting funded because of the agencies' limited budget. This is not exactly breaking news, but it helps putting faces on the problem and makes the issues of closing down an experimental lab much more real.

In an update at the bottom of the article, one of the researchers did secure last-minute funding for the one grant that kept her lab running, and the other doesn't seem to be seriously considering quitting academia; however, this does vividly illustrate scientists' predicament. Another excellent website advocating an increase in the NIH [National Institutes of Health] budget is brokenpipeline.org, which asserts that "An unprecedented five consecutive years of stagnant funding for the National Institutes of Health is putting America at risk—slowing the pace of medical advances, risking the future health of Americans, discouraging our best and brightest researchers, and threatening America's global leadership in biomedical research. Unfortunately, President Bush's budget proposal recommends a sixth year of flat funding for the NIH in 2009." I particularly recommend the "A Broken Pipeline?" report.

The need to improve the funding situation in academia has nothing to do with faculty members worrying about their mortgages. It has to do with discoveries within grasp and yet not being made because agencies don't have enough money.


Science and the Stimulus Plan

Obama's first weekly video address ("fireside chat") as President has drawn over one million viewers on YouTube. In the five-minute-long address, the President provides a summary of his Recovery and Reinvestment Act, nicknamed "stimulus bill" in the press (a five-page overview of the bill is available here, on the website of the Senate Appropriations Committee).

I first read the New York Times article about the boost the bill would provide for education ("Stimulus Plan Would Provide Flood of Aid to Education", January 27, 2009), so I was surprised to learn the plan seeks to "triple the number of science fellowships" (see here for a transcript of the address) - the NY Times makes no mention of that part, maybe because fewer readers care about scientific research than about other very worthy programs such as Pell grants for needy college-bound students, maybe because post-baccalaureate education in science and engineering is sometimes considered closer to professional training than to traditional education, or maybe because the amounts involved are tiny compared to the size of the whole package. It represents, however, a sizable increase in the money devoted to federal research.

The summary of the bill on the Appropriations Committee bundles science with infrastructure in the second item by size ($165 billion out of $888 billion in investments and tax cuts), although science only represents $4.1 billion, to be shared by the National Science Foundation (NSF), NASA and NOAA (the National Oceanic and Atmospheric Association, presumably to study global warming) - this amounts to less than 0.5% of the total stimulus package.

The AAAS R&D Budget and Policy Program, which analyzes research and development initiatives in the U.S. budget for the American Association for the Advancement of Science, has come up with a much higher figure, including R&D facilities, capital equipment, and research efforts in the health and energy sectors: it estimates that "the just-released Senate draft of the 2009 economic stimulus appropriations bill contains $11.9 billion in federal research and development (R&D) funding, $9.7 billion for the conduct of R&D and $2.2 billion for R&D facilities and capital equipment. The recently approved House version of the bill contains more R&D funding, $13.2 billion, with slightly less for the conduct of R&D ($9.5 billion) but more for R&D facilities and equipment ($3.7 billion)."

This fact sheet from the Office of Speaker Nancy Pelosi places the price tag for scientific research at $10 billion; it also states that the package puts "the NSF budget on track to double over the next seven years, as called for under the America COMPETES Act". Better still (and underlined in the original document!), the $2.5 billion for NSF would "support an additional 3,000 new NSF research awards and would immediately engage 12,750 senior personnel, post-docts, graduate students and undergraduates." While the actual numbers will certainly change again before the bill is passed, the plan gives significant hope to the scientific community that the administration is serious about investing in research for the long term.

Predictably in light of the amounts involved, The Washington Post mentions that the stimulus package "has come under attack from Senate Republicans and some Democrats alarmed by its roughly $900 billion price tag" ("Obama Defends Stimulus in Effort to Get Bill Through Congress", February 4, 2009), and science could become a victim of lawmakers' price-cutting efforts. (From the Post: "Moderate Republicans are trying to trim the bill by as much as $200 billion," or about 25%. Good luck.)

Science spending would be an easy item to eliminate, as it is not tied to any specific constituency with clearly identified representatives in Congress; furthermore, the link between tackling the current economic crisis and maintaining America's standing in terms of scientific research is tenuous, at least from a short-term perspective (hence, the prominent place given to R&D infrastructure in the bill, such as lab construction). Senator Olympia Snowe from Maine, "a moderate who has been considered the most likely GOP vote in favor of the plan, said [on February 3] that she cannot support it until items that would not do enough to stimulate the economy or create jobs are dropped" (also from the Post). Academic research will not stimulate the economy, and it will not create jobs (with the exception of research assistantships, although those are not generally considered as employment). But it will support innovation, which is critical to ensure a robust recovery.

The Post article ends on a positive note for scientists: "The chamber ended the night by unanimously accepting an additional $6.5 billion for research at the National Institutes of Health, pushing the cost of the Senate legislation -- for now -- to more than $900 billion." Are lawmakers finally making the funding of innovation and scientific research a priority? Let's hope it stays that way when the time comes to pare down the bill.