Thursday, October 16, 2008

The WBS: Wall Street's Breakdown Structure

<*UPDATED 30-OCT-08*>
---see update at the end of this posting---

This entry is about the current worldwide economic crisis. It's an entry about ethics. And it's about simple, simple things that we all need to do properly, simple things that even a baby does: naming things.

A baby learns to speak by social contact and noticing things and giving them names, and with the help of their parents, grandparents, doting uncles and aunts, babysitters, and other children, they learn to name things based on feedback. BBC News has a great story on the way babies learn language here. The bottom (excuse the reference to a baby's bottom) line is that babies name things that they see, and they do it honestly and logically, based on social feedback.

Not quite the same for some bankers, it seems.

I urge you to see this story from American network CBS' "60 Minutes" news show. It discusses the "shadow market" on Wall Street. The mortgage securities that were traded showed very poor judgment and I'll cover that below. But I'd like to start with something even more flagrantly wrong and something from which Project Managers can take a lesson.

It involves something called "Credit Default Swaps". Let that name roll around in your head for a few seconds. Yes, let it swirl around up there. Good.

Before we say what they are, let's discuss how BIG they are. The expert on 60 Minutes had this to say about the market size for Credit Default Swaps: "Well, we really don't know. There's this voluntary survey that claims that the market is in the range of 50 to 60 or so trillion dollars. It's sort of alarming that, in a market that big, we don't even know how big it is to within, say, $10 trillion." Plus or minus $10 TRILLION dollars? How's that for a "ballpark estimate", fellow project managers?

Anyway, Credit Default Swaps. What are they and what do they have to do with babies and naming things?

From the 60 Minutes show, here is University of Maryland Law Professor Michael Greenberger: "A credit default swap is a contract between two people, one of whom is giving insurance to the other that he will be paid in the event that a financial institution, or a financial instrument, fails," he explains.

"It is an insurance contract, but they've been very careful not to call it that because if it were insurance, it would be regulated. So they use a magic substitute word called a 'swap,' which by virtue of federal law is deregulated," Greenberger adds.

"So anybody who was nervous about buying these mortgage-backed securities, these CDOs, they would be sold a credit default swap as sort of an insurance policy?" Kroft asks.

"A credit default swap was available to them, marketed to them as a risk-saving device for buying a risky financial instrument," Greenberger says.

But he says there was a big problem. "The problem was that if it were insurance, or called what it really is, the person who sold the policy would have to have capital reserves to be able to pay in the case the insurance was called upon or triggered. But because it was a swap, and not insurance, there was no requirement that adequate capital reserves be put to the side."

"Now, who was selling these credit default swaps?" Kroft asks.

"Bear Sterns was selling them, Lehman Brothers was selling them, AIG was selling them. You know, the names we hear that are in trouble, Citigroup was selling them," Greenberger says.

Ah. So this smells like insurance. It walks like insurance. It talks like insurance. As project managers we know that risk transfer is tantamount to insurance. So we're in line with the babies here. But the Wall Street executives went ahead and called it a "swap". Sounds like a nice thing that nice country-bumpkin folks go and do with antiques, doesn't it? Nice and clean. And by naming it something that it isn't, it allows them to work without the restrictions and laws that it would had it been named what it was: insurance.

To me the connection to Project Management is the Work Breakdown Structure. When we need to identify all of the pieces of work in a project we do this same kind of naming. We usually don't have world economies hinging on this, but we still need to be careful at this critical stage of a project. Name those pieces of work accurately, honestly, and in ways that people will understand.


Now let's talk a little more about the other financial instruments - like the subprime mortgages, and how bad judgment reared its head here. Again - a lesson learned for PMs. In this case, it has to do with leaving out the human element. Automated systems are great, but do not - I repeat - do not forget the people that are involved in your projects or you will face dire consequences. With respect to the subprime instruments, here's a segment from the 60 Minutes show:

These complex financial instruments were actually designed by mathematicians and physicists, who used algorithms and computer models to reconstitute the unreliable loans in a way that was supposed to eliminate most of the risk.

"Obviously they turned out to be wrong," Partnoy says.

Asked why, he says, "Because you can't model human behavior with math."

"How much of this catastrophe had to do with the instruments that Wall Street created and chose to buy…and sell?" Kroft asks Jim Grant.

"The instruments themselves are at the heart of this mess," Grant says. "They are complex, in effect, mortgage science projects devised by these Nobel-tracked physicists who came to work on Wall Street for the very purpose of creating complex instruments with all manner of detailed protocols, and who gets paid when and how much. And the complexity of the structures is at the very center of the crisis of credit today."

So as we all struggle with the stresses of this crisis, let's redouble our efforts as PMs to call things what they are. Let's redouble our efforts to consider actual humans (and their non-mathematical behavior) in our project planning and execution.

And let's hope our banking executives start acting more like smart babies instead of stupid criminals.

Excellent story on Credit Default Swaps here:



Andrew Meyer said...


a beautiful post showing the link between little indiscretions perpetrated regularly and the great damage can result if they are allowed to go unchecked.

George Orwell had tremendous insight on this when he said:
"The great enemy of clear language is insincerity. When there is a gap between one's real and one's declared aims, one turns as it were instinctively to long words and exhausted idioms, like a cuttlefish spurting out ink."

Being insincere, whether your a PM or a Wall St quant, is done to hide things you don't want people to understand.

Great post,


Louisville said...


Awesome post! I agree with your connection on naming things what they actually are, but I think that the lessons in transferring risk are poignant.

How easy is it to say that's so and so's risk, I'm going to transfer it... despite the fact that your project may be dependent on the task's completion? I've seen and checked that mindset in stakeholders often, as they rush to understand and complete their own personal taskers.

Its easy to throw risks over the fence and pretend like everything will be ok, but its responsible to take the steps needed to fully understand the implications behind transferring risks.


Alec Satin said...


Fascinating CBS story. To me the most amazing comment of all was the analyst at the end of the clip who said, "These guys were not very good at their jobs."

Your connection to PM is also right on target. We are often so focused on small details that we neglect to keep looking back at how each piece impacts the whole.


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