Radical Collaboration

There are situations that require collaboration if they are going to be resolved in a manner that produces the largest combined benefit or the smallest combined loss.  This is not the “greatest good for the greatest number” objective of socialism – it is simple efficiency.  Collaborative results can be greater than competitive results.  It is the reason that a sports team where everyone is playing the same strategy does better than the team where each individual seeks to do their personal best regardless of what everyone else is doing.

There are also situations where the application of individual and separate and uncoordinated actions will result in a sub optimal conclusion and where the famous Invisible Hand points in the wrong direction.

You see, the reason why the Invisible Hand ever works is because by the creative destruction of wrong turns, the individual actions find a good way to proceed and eventually all resources are marshaled in following that optimal way of proceeding.  But for the Invisible Hand to be efficient, the destruction part of creative destruction needs to be small relative to the creative part.  For the Collaborative effort to be efficient, the collaboration needs to result in selection of an efficient approach without the need for destruction through a collaborative decision making process.  For the Collaborative effort to be necessary, the total cost of the risk management effort needs to exceed the amount that single firms could afford.

Remember the story of the Iliad. It is the story of armies that worked entirely on the Invisible Hand principle. Each warrior decided on his own what he would do, how and when he would fight.  It was the age of Heroes.

The stories of the success of Alexander and later the Roman armies was the success of an army that was collaborative.  The age of Heroes was over.   The efficiencies of the individual Heroes each finding their own best strategy and tactics was found to be inferior to the collaborative efforts of a group of soldiers who were all using the same strategy and tactics in coordination.

There are many situations in risk management were some sort of collaboration needs to be considered.

The Gulf Oil leak situation seems like it might be one of those.  BP is now admitting that it did not have the resources available or even the expertise to do what needs to be done.  And perhaps, this leak is a situation where the collective cost of their failure is much higher than society’s tolerance for this sort of loss.  But the frequency of this sort of problem has to date been so very low that having BP provide those capabilities may not have made economic sense.

However, there are hundreds of wells in the Gulf.  With clear hindsight, the cost of developing and maintaining the capacity to deal with this sort of emergency could have been borne jointly by all of the drillers in the Gulf.

There are many situations in risk management where collaboration would produce much better results than separate actions.  Mostly in cases where a common threat faces many where to overcome the threat would take more resources than any one could muster.

Remember the situation with LTCM?  No one bank could have helped LTCM alone, they would have gone down with LTCM.  But by the forced collaborative action, a large group of banks were able to keep the situation from generating large losses.  Now this action rankles many free marketeers, but it is exactly the sort of Radical Collaboration that I am talking about.  It did not involve any direct government funding.  It used the balance sheets of the group of banks to stabilize the situation and allow for an orderly disposition of LTCMs positions.  In the end, I beleive that it was reported that the banks did not end up taking a loss either.  (That was mostly an artifact of depressed market prices at the time of the rescue, I would guess.)

The exact same sort of thinking does NOT seem to have been tried with Lehman.  If Paulson could not find a single firm to rescue Lehman, he was not going to do anything.  But looking back and remembering LTCM, Paulson could have arranged an LTCM style rescue for Lehman.  In hindsight, that, even with government guarantees to sweeten the pot would have been better then the financial carnage that ensued.

Perhaps Paulson was one of the free marketeers that hated the LTCM “bailout”.  But in the end, he trampled the free market much worse than his predecessors did with LTCM when he bailed out AIG without even giving any thought to terms of the bailout.

Collaboration might have seemed radical to Paulson.  But it is sometimes needed for risk management.

Explore posts in the same categories: Action, Enterprise Risk Management, Financial Crisis, Regulatory Risk, Systemic Risk, Tail Risk


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One Comment on “Radical Collaboration”

  1. jpberliet Says:

    This is an excellent paper that addresses challenges that are rarely discussed. A very useful contribution.

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