Book Review: Managing risk in the world of money-minded fools

Book Review: Managing risk in the world of money-minded fools

By ANIRUDH VOHRA | | 27 February, 2016
Author and journalist Greg Ip.
American author Greg Ip takes up the subject of risk management in his new book Foolproof. It’s a must-read for those interested in the dynamics of a consumer society, writes Anirudh Vohra.


Author: Greg IP

Publisher: Hachette

Pages: 326

Price: Rs. 399


Along a French motorway, Greg Ip caught sight of a thought-provoking sign, “La vitesse aggrave tout” — “speed makes everything worse”. The faster we drive, the more extensive the damage when something goes wrong. In the run-up to the financial crash, consumers and even policymakers had come to believe that smart regulators and forward-thinking bankers had made the world of money a much safer place.

In another instance, after a fatal US air crash in 1989, a vocal campaign came close to convincing the Federal Aviation Administration to require all child passengers to have their own seats. But cost-benefit analysis showed that while such a measure would prevent five aviation deaths over a decade, an additional 82 road deaths would be caused if families chose to drive rather than pay for dearer plane tickets.

As this book makes clear, the FAA’s refusal to bow to political and emotional pressure is a comparative rarity. Humans are constantly tempted to try to eliminate risk, yet safety — or our sense of safety — often contains hidden dangers. Forest managers now mostly choose to suppress fires rather than letting small areas burn, which could limit more devastating blazes.

Over the years Greg Ip has transitioned from financial journalist and follower of the latest economic news to something higher. His surveys of the US economy were well worth pulling out of the middle of the Economist and keeping as a reference.

As per Ip’s new book, Foolproof, when people believe they are safe, they take more risks – they drive faster, in motoring terms – and “speed makes everything worse”. Or as the economist Hyman Minsky, whose work Ip revisits, puts it, “Stability is destabilising.”

The financial equivalent of driving faster was consumers taking on bigger mortgages or hefty payday loans they may never be able to repay; or banks loading up on complex financial instruments packed with US sub-prime home loans that would eventually blow up in their faces.

The book examines this phenomenon through a range of examples. Constructing giant levees to contain mighty rivers makes people feel safe enough to build on the floodplain, making the consequences of future floods far worse. Introducing helmets and face masks in American football has increased some kinds of injury, because players can use their heads as a battering ram. Risk-taking is natural behaviour, “inherent to the human condition”, says Ip as we discuss his thesis, and he doesn’t have a neat, catchy solution to the challenge of reducing the dangers of modern life. He argues that we need to take a more grown-up approach, accepting that some risks are worth taking, even if that means the occasional disaster occurs. “We have to be realistic about what we can achieve, taking risks is fundamental to economic progress,” Ip explains.

And while some policymakers would like to regulate away risks altogether in the financial world, he says, “I can’t think of a way to have a crisis-free economy that wasn’t a risk-free economy, and I don’t think we want that world.” There are some sensible maxims that can help us to be “foolproofers”, as Ip calls it, that “space makes us safer”. For town planners, that might mean designating parks and farmland for flood waters to flow into, for example, instead of allowing intensive housebuilding on the flood plain. In finance, it means one thing, forcing banks to hold more capital — the money invested by shareholders, which acts as a shock absorber when things go wrong.

But perhaps the greatest revelation from Ip’s exploration of the world of risk is that we should accept that sometimes, disasters happen, and policymakers’ job is to minimise their impact, not to engineer them out of existence. As he says, “A world with no car crashes or plane crashes would have to be a world with no cars or planes.”

Over the years Greg Ip has transitioned from financial journalism and follower of the latest economic news to something higher. His surveys of the US economy are well worth pulling out of the Economist magazine and archiving properly.

UBS’s chief executive recently told staff at the bank they could take more risks and should not be afraid of making honest mistakes. Britain’s Chancellor of the Exchequer has declared a “new settlement” with the banks, heralding an end to the cycle of tougher regulation.

Ip is scrupulous about not favouring one side or the other in the tug-of-war between what he calls “engineers”, always tempted to step in, and “ecologists”, who prefer to stay flexible for fear of unintended consequences of man-made intervention.

The book starts by wrapping examples of the perils of foolproofing into a lengthy overview of how pressure built up during the “Great Moderation” before the financial crisis. Ip recalls confronting Paul Volcker, former Federal Reserve chairman, with the accusation that he and his successors fuelled risk appetite by implying, through their actions, that they would rescue the economy, “He tilted his head, narrowed his eyes, and glared at me. ‘I’m not going to accept full responsibility,’ he said. Well, I asked, how about partial responsibility? He laughed. ‘No’.”

But Ip also points to the perils of bursting bubbles and crimping enterprise. One study suggests a large part of the platform on which digital successes such as Facebook now thrive was built during a boom by fibre optic companies that then went bankrupt, “Knowing whether a bubble is worth its bust is seldom obvious in advance.”

Exploring how to live with his central paradox, Ip argues for more “space” around risks — floodplains, fire breaks, capital buffers for financial companies — and for more banks to be allowed to “fail safely”.

His conclusion that the only systemic solution is to blend the best ideas of engineers and ecologists sound is a very, very simplistic.

But as many examples of irrational risk-aversion or risk-taking show, human nature renders more sophisticated fixes futile. Ip asks the mayor of a resort why people build on the waterfront where hurricanes have repeatedly destroyed lives and property. “Life is a chance,” he responds. “And let me tell you something else, water sells.”


Page 212, which explains rather well why hedging risk with zero-sum derivatives cannot protect the system as a whole, if you stand up in the stadium you can see the game better, but if everybody stands up then we’re back to where we started.

After pages of fawning at Goldman’s allegedly incredible risk management he dares to mention the fact that their protection against AIG failing had been bought from other banks like Citibank that would go down together with AIG and was thus a sham. Given how many interviews this will cost him from the ban on him that will ensue, that’s really rally cool.

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