Large scale failure

When we are confronted with a potentially large failure which seems to come out of nowhere, our natural reaction is to avoid it at any cost. For example, the response to the recent Global Financial Crisis (GFC) was “unprecedented” and “aggressive” (http://georgewbush-whitehouse.archives.gov/news/releases/2008/10/20081014.html) with an incredible overall cost of over US$11 trillion and climbing (http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/5995810/IMF-puts-total-cost-of-crisis-at-7.1-trillion.html) that will unlikely be recovered in our lifetime.

The reality is that the underlying causes of the GFC of excessive borrowing and risk taking were very similar to the Great Depression, the 1980s Saving & Loan debacle and the 1987 Wall Street crash. This serves as a reminder that large failure is inevitable – after all, the law of averages means that many times, outcomes will fall short of our expectations.

So if it is going to happen anyway, why don’t we confront potential large failure more openly with a more measured plan - or at least try to lessen the impact of failure before it becomes a problem? In part it is because a big failure and it's impacts are not something we like to be reminded of, let alone think will affect us. Many of us like to talk prospects up, even more so when things have been going well for a very long time. And we definitely don't want to leave a legacy of failure, so we will do all we can to at least defer the failure.

To me there seems to be a large gap in honestly discussing potentially large failure throughout the business cycle, This has become even more important given community reliance on large, global businesses. Failing to plan means paying substantial costs to avoid failure when there seems to be no other choice.

It is easy to find information about the numerous cases of business failure throughout history. Even Wikipedia has a list (http://en.wikipedia.org/wiki/List_of_business_failures). Although the reasons for failure become repetitive, it helps give a sense of what failure looks like, and reminds us that many failed businesses were once successful

To reduce the chance and impact of large scale failure, basic risk management can be followed. At a minimum this means establishing independent checks and balances and paying staff for long term performance rather than short term risk taking. Independent verification of activities remains the responsibility of a small, unappreciated minority of the business world, such as auditors and regulators. In boom times, these people are labelled as negative and any suggestions of better protecting the system are usually ignored or attacked (http://www.washingtonpost.com/wp-dyn/content/article/2010/03/18/AR2010031805370.html). But when boom turns to bust, we ask why these same people didn’t pick up the causes of the failure (http://seekingalpha.com/article/96955-bank-crisis-where-were-the-regulators). Instead of pointing fingers, we should insist on a stronger level of independent oversight of large businesses, both from within a company as well as outside from community representatives

If all else fails (no pun intended), an orderly run-off plan needs to be instituted to manage the community impact of failure rather than just stump up cash to deal with it another day. Unfortunately, from the GFC we have set a dangerous precedent where governments will prevent large scale failure through buy-outs and guarantees – this reaffirms the idea that failure should be avoided at any cost and that there are no consequences today of taking high risks.

Letting AIG or Citibank fail in 2008 would have probably resulted in a long, protracted depression for the Western world. But it would have reminded us that failure is inevitable, and that excessive risky actions do have consequences and exacerbate the impact of failure. Perhaps a large scale failure will remind us of the importance of caution, skepticism and austerity – all of which seem to have no place in modern life.