The Limits of Financial Risk Management: Or What we Didn't Learn from the Asian Crisis

Abstract

In retrospect, the Asian financial crisis was the canary in the coal mine that global leaders failed to recognise. While both the Asian crisis and the current one were the product of excessive leverage, moral hazard and poor risk management, the lessons drawn from each appear to be rather different: the Asian crisis was largely seen as the fault of Asian governments, while the current crisis has been primarily blamed on market actors. Does this mean that we have learned collectively from the mistaken assessments of the previous crisis? Yes and no. After tracing the links between the response to the Asian crisis and the drive towards securitisation, this article suggests that while the international financial community has avoided repeating the first major error that they made after the Asian crisis – by recognising that the problems now lie as much at home as abroad – they continue to make a second and more profound error in their response to the subprime crisis: financial leaders continue to believe that a large part of the solution is to be found in greater transparency, more accurate risk assessment models, better due diligence – in short, to provide the markets with a truly comprehensive picture of the financial instruments that are being traded. I suggest that there are two crucial problems with this assumption. The first is that it is highly unlikely that it will ever be possible to truly calculate and quantify the indeterminacies that are at the heart of the process of securitisation and the originate to distribute (OTD) model. The second is that even if it were possible to develop such a comprehensive picture of the indeterminacies involved in securities markets, it is not at all clear that financial markets will have the capacity or the interest in making effective use of that information. These limits to financial risk management not only raise some serious questions about the kinds of regulatory solutions that are currently being proposed, but also make it all the more important that we develop a politically accountable response.