Financial Engineering is Just the Tip of the Management Engineering Iceberg

There’s a temptation to see Wall Street’s exoti-toxic creations as sui generis, unconnected from the “good” businesspeople out there and from the sound principles being taught in business schools, executive education programs and consultancies.

Unfortunately, that’s not true. All the securitization, derivatives, synthetic securities, credit default swaps and exotic risk models were not the lone result of a sector run amok. They arose from precisely the same management thinking being taught to auto manufacturers, pharmaceutical firms, airlines, accountants and agriculture.

You can boil it down to three beliefs.

• The first is to look at your business as processes, and to break them into ever-and-ever smaller pieces.
• The second is to outsource any process which isn’t strategic to your business and which can be done more cheaply by someone else.
• The third is to tightly measure the processes, both outsourced and internal, and then to manage them according to process-based metrics; the shorter the time-frame and the more precise the measures, the better.

Any MBA from the last ten years (maybe twenty) can swear that these are commonly accepted—and most of them will say they themselves have considered them bedrock beliefs. Even that they are “obviously true.”

Watch out for “obvious truths.”

Those three beliefs explain the financial industry’s meltdown.

1. Take a bank. Describe it as a set of processes—e.g. the mortgage lending process–and all its constituent processes.
2. Outsource the pieces of the mortgage lending process; e.g. farm out loan acquisition, servicing, credit approval; then sell off the loan itself, to be further sliced and diced and securitized.
3. Sign short-term contracts with the above outside services; make the payments transactional rather than pay-over-time, and link them to tightly defined benchmarks and indicators.


One effect is to make the set of processes more efficient and more global–at least on paper (though many golden crumbs also stick to the new process owners along the way).

But–n the name of lowered costs and risks–we ended up with higher costs and higher risks. It’s because those three beliefs also gave us something else.

An industry in which:

• no one player (or regulator) any longer owns a piece of the whole “mortgage lending process”
• no one player has significant time-based interest in the integrity of the whole business
• players are connected only through adjacent fragments, through short-term transactional fees, and by proxy metrics 2-3 steps below and shorter than final long term results measures.

You couldn’t design a better system to encourage obfuscation, greed, and lack of trust.

Those same core beliefs are at work in mainstream business, eating away at the superstructure of business trust like termites in the beams. They are insidious because we think they are best practices.

They are common practices, but hardly best. They separate the future from the present, allowing people to suck forward the present value. And they separate the parts from the whole, allowing a failure of integrity.

We can do better.