hammurabi and the ethics of finance

recently listened to what i thought was an interesting discussion between Nassim Taleb and Russ Roberts (turns out i cannot post links as i am new to this site, but if you go to econtalk and search "Taleb on skin in the game" you should be able to find the podcast)

in it, taleb argues that ethics are fundamentally a part of risk management in finance. he draws on hammurabi code, with the example of a home builder who, under a scenario where the house he builds collapses to kill the owner, is put to death himself. this is the well known eye-for-an-eye mantra you hear about growing up, and is used as an example to represent the idea that "skin in the game" can serve as a useful mitigant for risk-taking behavior.

as much as i enjoy listening to economists theorize on what should or could be, i am interested to hear from people working in risk management in finance . how has the field evolved since the great recession? how much more of an influence/voice do risk managers have on decision makers? are they the decision makers? is there any practical applications for "skin in the game" risk-taking that would more closely align the interests of those investing others' capital? have there been any innovations in this respect? does track record negate the need for "skin in the game" over time? if so, should it?

any insight/opinions from those in the field would be very interesting to hear.

Comments (7)

Jan 6, 2016 - 12:29am
SSits, what's your opinion? Comment below:

As a risk manager, I expect healthy tension between the revenue-focused, always optimistic front office client facing money salesmen and the risk gatekeepers. If there isn't tension between the two, someone is doing their job wrong.

Having the client facing guys being too risk averse is not what you want. You want then to be "go go go", bringing in every opportunity, leaving it to others to sort the edible deals from the ones that should be thrown back.

Those who can, do. Those who can't, post threads about how to do it on WSO.
  • 1
Jan 6, 2016 - 12:53am
valuenation, what's your opinion? Comment below:

That makes sense. How has that relationship evolved, if at all, since 2007?

Best Response
Jan 6, 2016 - 10:00am
SSits, what's your opinion? Comment below:

From a market and credit perspective, 2008-09 set new limits for how bad things could go in a downturn. That created a legacy benchmarks for downside scenarios which make it harder to get comfortable with deals.

Otherwise, it varies from bank to bank. I was in front office IB in a role using the bank's balance sheet until 2014 (ie putting the bank's skin in the game) and I can't recall that much change. But that's likely because my bank always had a strong risk function (mainly the Credit team in my deals) that worked closely with the front office deal makers. Also, it's likely a function of my recollections and memory glossing over things.

One phenomenon I did notice was a much heavy emphasis regulatory capital and the returns that any use of balance sheet ("return on capital" or "return on regulatory capital"). This coincided with a lot of focus in the industry on capitalisation of banks (eg Basel requirements). While we previously focused much more on IRR, the emphasis shifted to RoRC.

Those who can, do. Those who can't, post threads about how to do it on WSO.
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Jan 6, 2016 - 12:25pm
heister, what's your opinion? Comment below:

The issue here is not reality but perception. The collapse that started in 2006 and carried into 2009 created a perception that large financial institutions can for the most part completely ignore risk evaluations because when shit hits the fan the FED will be there to prop them up. Those working in the industry know that this isn't exactly the case but the average Joe on the street doesn't see it that way. If you want to do a case study on how a collapse changed the way risk management is handled, the collapse in 1929 that triggered the great depression is a much better example. The issues with the most recent collapse is that much of the underlying activity was fueled by government intervention and activity.

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Jan 6, 2016 - 3:08pm
valuenation, what's your opinion? Comment below:

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