Risk management book that doesn't make you snore

 "Get me a pad and pencil," Dad would say. The family would roll their eyes.

My father was an engineer. When you asked for an explanation of something technical, invariably it involved diagrams and backgrounding. To Dad, nothing was ever simple.

Mom's favorite story was about a gas stove. He was halfway through explaining the First Law of Thermodynamics—did you know there was more than one?—when she shouted, "I just want to know how to light the new stove, Steve!" 

In spite of the eye rolling, in time I did come to appreciate the lessons. So now you're clear that neither length nor detail necessarily throw me. 

But when it comes to articles about risk management, typically my eyes glaze over.

All too often, risk management articles in the trade press become hopelessly arcane.

Now, I know financial matters grow complicated, and I know that modeling isn't based on the Reader's Digest version. Hey, if a surgeon was roving around my digestive system, I'd hope he'd have read something more complex than my ninth grade bio text.

But the thing of it is, if banking is a business of risk, by nature, shouldn't risk management occasionally be spoken of in plain English? Must everyone be a quant or a corporate governance maven to get it?

Last week in Reporter's Notebook I spoke about an interview with some folks at Wolters Kluwer, in which Christina Speh, director of new markets and compliance strategy, made a case for compliance officers condensing their messages to boards to ensure better communicate of the key messages. Could Risk Management stand a bit of the same, at least a streamlining?

Which brings me to Dan Borge, who will begin blogging about risk for bankingexchange.com in June.

Who wrote The Book of Risk?

When I was assigned to handle the risk management report for our April magazine, I resolved that I would try to bring a human face to risk management--simply because that was the only way I'd understand it.

And when I thought about what I'd committed myself to, I thought of Dan Borge (pron. Bor-gee). Every time I'd interviewed  him over the years on a risk subject, my eyes hadn't glazed over. So I contacted him, and you can read the full version of the resulting article here.

Ordinarily, our website doesn't run reviews about books a decade or more old. But when preparing for my interview with Borge, I read his The Book of Risk (Wiley, 2001) and felt more bankers ought to know about it.

What can a 12-year-old book say, post crisis? Actually, the book anticipated a couple of things that happened later, but what set it apart was that it was not a book written for the risk fraternity, per se.

In 244 clearly written pages, Borge explained risk management for anyone to understand, as an approach to life. At the very beginning, he wrote:

"This is not a risk management textbook. A textbook would require more rigor and detail than either you or I could stomach. There are already many excellent sources available on risk management that meet that need. Nor is this a How-to-Risk-Manage-to-Success-in-Ten-Easy-Steps book. I don't believe that either risk management or success is reducible to simplistic rules or recipes that anyone can follow. I do believe, however, that there are general principles of risk management and that if  you are aware of them, you have a head start in making better decisions."

Borge does what he promises. As he describes, he puts the reader in the driver's seat so they can understand how risk management involves making decisions. But he stresses that risk management, appropriately practiced, is not just about avoiding danger, but also about spotting and capitalizing on opportunities.

That was something that had never occurred to me before.

But this early comment resonated: "The advent of risk management as a distinct profession has created a babble of obscure jargon that can confuse and frustrate the uninitiated. As usual, the experts want to discourage their paying customers from doing too much for themselves."

Unfortunately, as Borge later observed, elsewhere, sometimes the in-house experts did their own thing off in a corner. No one worried about or cared about what they did or said, and this contributed to the crisis.

A pity, because, in Borge's words, "The purpose of risk management is to improve the future, not to explain the past."

A point Borge comes back to again and again is the role of a risk manager, which is different from a scientist. A scientist's job is to dispassionately study something to the nth degree, in order to arrive at the uttermost truths of  matter.

That's not what a risk manager does: "The risk manager's first concern is achieving useful results, not gaining a clearer picture of the truth for its own sake."

In fact, something that jumped off the page, considering the import of the idea post-crisis, is Borge's point that risk management is not the province of  historian, either.

"As we all know, history can teach us valuable lessons," he states, "but it cannot automatically give us an accurate picture of the future--and it is only the future that we care about when we make risk decisions." (Emphasis added.) When one considers the now old-hat observation that the models Wall Street used leaned too heavily on history that didn't repeat itself, this is a very significant reminder.

When I read this paragraph, I double-checked the book's copyright date--2001--and wished more risk managers had read it in the early 2000s: "There have been many fiascoes in the financial world that were attributable, at least in part, to leaning too hard on statistical models that were overly dependent on historical data and uninformed by seasoned judgment about future possibilities."

Another interesting section discusses the dangers of assuming that correlation of data always yields conclusions that you can and should act on. The danger lies in confusing correlation of data with a cause and effect relationship, and also in not having the entire picture to learn from, sometimes.

This reminded me of a friend's observation that since too much scotch and soda, too much bourbon and soda, and too much whisky and soda all make you drunk, the thing to do is to leave out the club soda.

We all know that's a lot of seltzer.

Don't fall for financial quackery—or your own whims

Borge discusses the importance of understanding the real odds involved in various situations versus the perceived odds. And he capsulizes a warning against snake-oil quacks:

"Risk decisions are inherently personal and subjective, so ‘experts' pushing one-size-fits-all solutions are to be viewed with caution and skepticism. If a decision has important and uncertain consequences, you should try to find the decision that fits  you, not someone else."

Borge presents clear explanations of the concepts of hedging, insurance, and leveraging, all facets of risk management that can get utterly opaque.

And in an interesting chapter, he delves into human nature and the risks to good decisionmaking of these human traits: overconfidence; optimism; hindsight; pattern seeking; overcompensation; myopia; inertia; complacency; and zealotry. And he makes the point that the opposites of all of these traits can wreak their own havoc on decisions, at times.

Yet Borge's final chapter stresses something that perhaps got lost in the runup to crisis:

"As powerful as risk management techniques can be, you must use them with judgment--judgment that appreciates and compensates for the limitations of risk management models in particular settings. Good risk management is not a branch of artificial intelligence or expert systems, for the goal is not to replace the human brain but to extend its reach and amplify its power."