Managing Risk is Not Enough
Late last year, I sat in a meeting in which several bankers were present. During the meeting, one of the bankers said something that in retrospect belongs in the highlight reel of “famous last words.” The comment went something like this: “We’re bankers! We understand risk, because it’s our business. We know how to manage risk. That’s why industry and government are looking to us to solve risk-related problems.”

As ridiculous as this statement now seems (especially to those of us whose retirement funds have been decimated) I’d argue that the statement holds true—even in a grizzly market. Yes, good bankers do know how to manage risk—their own risk. Which is why the best investment bankers view a recession more like a sabbatical, while the rest of us have to figure out how to keep food on the table. And even as the government is coming to the rescue, the Fed won’t be doing the risk management part: they’re paying bankers to figure out how to get out of the mess they’ve created. Talk about a win-win!
Not that these guys aren’t suffering. Here’s a bit of anecdotal evidence of how bad things have gotten:

This is a finance guy making a ton of money and he was trying to decide whether he should sell the country home in Connecticut, the apartment here in the city or the 8,000-square-foot dream home in Oregon that he just finished…  (from “End of an Era on Wall Street: Goodbye to All That“)

A dilemma for sure, but global financial crises demand desperate measures.

Markets Transfer Risk, Not Trust

The foundation of modern financial markets is seeped in the mathematics of probability. Over the years, rules and regulations have been piled on to promote competition and reduce overall risks. The results are compelling. And something in the human psyche tells us that since these guys are so much better at managing their own risk—and they obviously are, since they have several luxury houses at their disposal—then maybe we should trust them to manage our risk too. A market allows us to transfer our assets to someone who can navigate a risky terrain better than we might ourselves.

But risk management in itself doesn’t guarantee collaborative outcomes—that is, outcomes in which gains and losses are shared proportionally—nor does risk management inexorably produce social trust.

Clearly, the current crisis is as much about a breakdown in social trust and a loss of social capital as it is about debt ratios and credit freezes. We’ve already seen how even an injection of more than a trillion dollars won’t allay lenders’ anxieties. If you’re not an actuary, the reason is obvious: anxiety isn’t a risk equation, it’s a human emotion. Anxiety is symptomatic of a collapse of trust.

The problem with words like “anxiety” and “trust” of course is that they’re mystical to the mathematical mind. How’s a actuary to calculate the value of trust futures? or social trust default swaps?

Restoring Social Trust

What the world needs now is a renewed social trust. Until recently, social trust seemed like an intangible commodity with a will of its own; it couldn’t be systematically cultivated, measured, forecasted, or valued. But a growing canon of research into successful resolutions of social dilemmas demonstrates that collaborative arrangements are more likely to emerge when certain conditions are met. It’s time to develop mechanisms that foster pro-social behaviors by supporting natural processes of recognition, reciprocity, and community awareness. Most of the fundamental research is available to build such a system, so it’s more a matter of applying these ideas to real world relations, institutions, and markets.

Laws of Relation Revisited: Codifying Pathways to Trust

A few years ago, I challenged the software industry to take ideas about trust from various branches of science (such as game theory, social science, evolutionary biology, and psychology) and produce a system that greatly improved the likelihood of collaborative outcomes and improvement in social trust. The system could then be applied to trust-related problems on the Internet, such as spam, identity theft, and credit fraud. If such a “trust leavening” could be invented, it might even be applicable to a wider range of problems, including stronger trust in financial markets.

To design a trust system, there needs to be some workable theory on trust that explains how it’s created, how it’s maintained, and how it’s used. The theory needs to be intellectually accessible to a wide range of professionals. Just to get the conversation started, I offered three “Laws of Relation” (which are really more like postulates at this point). They are:

Law of Relational Symmetry

The party in control of the terms of a relationship controls the relationship and, in the absence of symmetrical countervailing controls, will eventually exploit the other participants.

Law of Relational Risk

Contribution to the relationship that is not met proportionally by the other participants is a loss to the contributor.

Law of Relational Projection

Any party with more than an informational interest in a relationship is a participant in the relationship.

As it turns out, financial markets illustrate these laws rather well.

The first law says that exploitation will occur in asymmetrical relations. Who controls the playing field in financial markets? The SEC? The Fed? It seems in many cases, the large investment banks who continually added exotic financial instruments, pushed for rule changes, and lobbied for reduction in government oversight. The prevailing belief in Washington was that these are smart guys who know how to manage risk. As it turns out, they were easily the smartest guys in the room and they were exceptional at managing their own risk, but not motivated at all to think of market risk. The average investor has almost no say in matters regarding market rules, so the relation was systematically slanted in favor of the rule makers.

The Law of Relational Risk predicts that collaborative outcomes are more likely when all parties experience a loss proportionally. The losses on Wall Street have been catastrophic, but not for everyone. Many of the people directly involved in creating this mess won’t suffer from the crisis the way some of the shareholders or general public will.

And the Law of Relational Projection distinguishes participants from on-lookers. One thing that has been a surprise to everyone is how interrelated and interdependent we’ve all become. Interdependency can be a vital pro-collaborative element to relations (per the Law of Relational Risk). In fact, it’s our agreement on a shared conflict, our mutually assured financial destruction–that has formed the basis for cooperation in congress and among world banks. But the strategy only works well when these relations are explicit. Instead, as our home loans have been sold, resold, hedged, and bet on through derivatives of derivatives, it’s no longer clear to anyone who is a participant and who’s a bystander. So what’s happened is that people who were believed to be bystanders have brought the house down with little or no accountability.

Designing Pro-Collaborative Systems
Few of society’s existing institutions are set up to support collaborative outcomes, and so exploitation is inexorable. With an informed understanding of elements that promote collaboration and trust, we can greatly improve our institutions, including financial institutions. I’ll continue to present my ideas on how to do this in follow-on posts, but I hope that professionals from a wide range of disciplines will contribute their ideas as well.

Innovation is the major strategic challenge for just about every organization today. But it is an elusive goal. This great post by Brad Kolar on his The Question of Leadership blog advises, “Want to innovate? Stop trying to be innovative and start solving problems.” He talks about the fact that successful innovation does not start intentionally. It starts by identifying hard problems and getting to work on them. Solving problems creates value.

This is a hard thing for organizations to swallow. They are accustomed to the command-and-control approach where making something a goal is the first step to getting it done. I’ve seen companies that have as a shared goal “to become more innovative.” This means that the personal goals of everyone in the organization include something about “being more innovative.”

But a manager cannot order someone to innovate! He or she has to create the environment where there is enough freedom and the right resources so that their employees can and will innovate. In this view, the manager’s role is to help frame the problem, convene the conversation and get the right people to the table. Continue reading »

Larry Downes had a great blog post a couple weeks ago on The Writers Strike and the Battle for Virtual Value. Downes points out that the traditional media, with whom the writers were negotiating, have not figured out how to make money on the internet. Nevertheless, he asserts, they spent over $2 billion fighting about “revenues that do not yet exist from channels that have not yet been created.”

Contrast this with the recent New York Times editorial by songwriter and author Billy Bragg, The Royalty Scam. Bragg tells the story of Bebo, the social-networking site that grew to 40 million members in two years and, in Britain, apparently ranks with MySpace and Facebook in popularity.

A couple years ago, Bebo founder Michael Birch asked to meet Bragg after Bragg had lobbied MySpace on its proprietary rights clause. Birch assured him that Bebo would always put the interests of artists first—although this “support” never included any kind of royalty to the artists contributing content. Last week, when Bebo sold to AOL for $850 million, Bragg observed:

The musicians who posted their work on Bebo.com are no different from investors in a start-up enterprise. Their investment is the content provided for free while the site has no liquid assets. Now that the business has reaped huge benefits, surely they deserve a dividend. Continue reading »

I resolved to start blogging about intangibles when I read a recent article in Fortune about soybeans called, “How Brazil Outfarmed the American Farmer.” The article explained how the Brazilians have used cutting-edge technology and well-designed market networks to become a dominant player in the soybean market. I saw this as just the latest proof that, as Thomas Friedman put it, “The World Is Flat.”

I believe that we have a lot of work to do to learn how to manage the intangibles that determine the winners and the losers in this “flat” world. And the American farmers are just the latest in the long line of businesspeople on the losing end of the intangibles game.

Fortunately, around the same time, I met Denise Caruso, who runs the Hybrid Vigor Institute and edits this blog. We became acquainted after she wrote a wonderful piece in the New York Times, “When Balance Sheets Collide With the New Economy” which highlighted the inadequacy of financial reporting to deal with the knowledge economy.

Denise explained how knowledge intangibles are invisible in financial and managerial reporting. They are also often passed over in decision making—in the assumption that “soft” issues cannot stand up to the rigor of traditional analysis.

But it is the soft issues that count. Continue reading »

The U.K.’s Parliamentary Office of Science and Technology (POST) functions something like the late lamented U.S. Office of Technology Assessment, killed off by Newt Gingrich back in the ’90s. They regularly publish brief but fairly comprehensive, interdisciplinary reports with cross-sector relevance on trends in science and technology.

POST recently published three POSTnotes entitled “Ecological Networks“, “Smart Metering of Electricity and Gas” and “Autism“. The first two POSTnotes for 2008 were on “smart” materials and systems, and synthetic biology.

You can subscribe to the POST reports yourself, by sending an email to: mailto:post@parliament.uk.

“Ecological Networks” considers the possible conservation benefits of ecological network implementation in the UK. Ecological networks are intended to maintain environmental processes and to help to conserve biodiversity where remnants of semi-natural habitat have become fragmented and isolated. Continue reading »

Today’s ‘Inside Higher Ed’ blog posted an interesting analysis of tenure versus interdisciplinary research. Nice to see these issues getting aired on a broader stage, although the argument sounded familiar to our ears.

In 2001, Diana Rhoten and I wrote Hybrid Vigor’s first white paper on roadblocks to interdisciplinary practice, that included tenure as well as several other factors that continue to relegate interdisciplinary scholarship to 2nd-class (or so) status.

It’s called ‘Lead, Follow, Get Out of the Way: Sidestepping the Barriers to Effective Practice of Interdisciplinarity.’ You can download it here, or here:

http://www.hybridvigor.net/interdisciplinary-practice/publications/lead-follow-get-out-of-the-way

The WELL, one of the oldest online communities still in existence, is hosting me as guest author for a two-week conversation in its ‘Inkwell’ book discussion topic about Intervention — and whatever topics come up as a result of talking about technology, innovation and risk. It’s been underway for several days now, and will continue until October 31st.

So far much of the conversation has been focused on deliberative processes for assessing risk, and we are just starting to wade into deeper waters with talk of the precautionary principle and whether or not Hillary could manage to re-start the Office of Technology Assessment without wrecking it with politics.

You don’t have to be a WELL member to read the conversation, but if you aren’t a member and want to start prodding me with some questions, just send an email to <inkwell@well.com> to have them added to the thread.

The host of the conversation is the redoubtable Jon Lebkowsky, a Texan who I’ve known for many years from the technology world who now writes a regular column for Worldchanging.com.

Hybrid Vigor’s co-founder Diana Rhoten has just published an op-ed in the journal Inside Higher Ed that should be of interest to anyone who is trying to understand how interdisciplinary research works in the real world.

An excerpt from the article, which you can read in its entirety here:

… As researchers interested in interdisciplinarity as an object of study, we have both been asked repeatedly about gender as predictor of participation in or success with interdisciplinary practices. We have also been confronted by scientists telling us that we should not encourage junior women to conduct interdisciplinary research because “women have a hard enough time as it is, you need to keep them focused on rigorous science or they’ll never be taken seriously.” After a growing store of anecdotal data to the point, we started to ask ourselves why we weren’t looking at gender and began listening to our peers and readers. …

Rhoten and the co-author of the article, Stephanie Pfirman, are co-chairs of a workshop at Columbia University next month on Women, Minorities, and Interdisciplinarity: Transforming the Research Enterprise.

Hybrid Vigor’s co-founder, Diana Rhoten, program director at Social Science Research Council, recently sent me a copy of a fascinating paper that she and Stephanie Pfirman (of Barnard College) published in the journal Research Policy, called “Women in Interdisciplinary Science: Exploring Preferences and Consequences.”

I am still so cranky at the recent story in Nature about how for-profit journal publishers like Elsevier and Wiley want to kill open-source journals like Public Library of Science that I’m tempted to ignore copyright restrictions and post the PDF here out of spite, but she asked me not to.

And I can’t find a @#$% link to it online, so if you aren’t already a subscriber, write Elsevier and complain ask them nicely how you can get a copy. The reference is Research Policy 36 (2007) 56–75.

Here’s the abstract:

For at least a decade, U.S. funding agencies and university campuses have promoted the expansion of interdisciplinary research. At the same time, federal and local programs have sought to increase the participation of women and minorities in science, mathematics, and engineering. Research has focused on each of these trends independently, but very few studies have considered their interaction by asking how intellectual preferences for and professional consequences of interdisciplinary science might be influenced by gender, race, and/or ethnicity. Focused specifically on gender, this paper considers the expectation that women will be more drawn to interdisciplinary research, and explores the learning styles, work preferences, and career behaviors that might anticipate and/or explicate gender differences in interdisciplinary science. Principal mechanisms by which researchers engage in interdisciplinarity – cross-fertilization, team-collaboration, field-creation, and problem-orientation – are tested for evidence of gendering using preliminary empirical data from three studies. The results of this exploratory analysis offer clues about possible tendencies and raise questions about the potential costs and benefits for those who adopt them.

At the moment, Diana is on sabbatical from SSRC, where she’s the director of the Knowledge Institutions program. Apparently her idea of taking a break is to move to WDC for a year; she was invited to help start and direct a new program in the National Science Foundation’s Office of Cyberinfrastructure.

… a.k.a. “what else I was doing while I wrote Intervention.”

Based on some ideas that I started exploring with Baruch Fischhoff of Carnegie Mellon shortly after I wrote my first paper on risk and genomics, in early 2004 we got funding from the National Science Foundation to see if we could get started on designing a new methodology for assessing emerging bio-risks.

The project was called “Understanding Genomics Risks: An Integrated Scenario and Analytic Approach,” and it was funded through NSF’s Decision, Risk, and Management Sciences program.

Our primary focus was on the risks that might result from growing and harvesting transgenic pig organs for transplants, a.k.a. xenotransplantation. (The pigs in question have been genetically altered so their biochemistry doesn’t trigger a rejection reaction in humans. This isn’t theoretical.)

The centerpiece of the xeno project was a day-long meeting at UC Berkeley, hosted by Steve Weber, director of the Institute of International Studies. We brought together a panel of experts that included an agricultural ecologist, an economist, an MBA/MD, a medical anthropologist, a political scientist, and a zoologist and vet who’d been a senior executive at USDA, and got them talking about the problem.

What they came up with is at the core of Chapter 11 in Intervention, “Putting Pigs to the Test.” Most people who’ve read it — as well as the panelists who attended the meeting — have said that it makes a pretty compelling case for why we need to change how we conduct risk assessments for new biotechnologies.

The entire story of how we got to that meeting in Berkeley didn’t make it into the book, but I wish it had. It’s a terrific object lesson in collaborative problem-solving and decision making. I’ll either post it here at some point when it makes sense, or maybe I’ll see if I can publish it in a magazine or a journal somewhere.

In any case, the project was quite successful. As a result, we got:
a) a tremendously promising start on this new methodology for emerging risks;
b) a paper in the Journal of Risk and Uncertainty; and
c) a chance to use the work in a different and even more critical setting: evaluating the risks of avian flu.

In regards to (c), and to make a long story short, in the fall of 2005, one of the xeno panelists recommended me to a group of people (specifically, Global Business Network and Larry Brilliant) who were designing a meeting on avian flu called Pandefense 1.0.

Pandefense 1.0 was an interdisciplinary “think tank” and exercise in emergency preparedness for a possible avian flu pandemic. It brought the world’s top flu and vaccine experts, epidemiologists, bird specialists, animal pathologists, and public health professionals together with leading thinkers from philanthropy, academia, business, scenario planning, decision theory, risk communication, and the investment community.

Its goal was to explore the wide range of consequences — public health, economic, political and cultural — of an avian flu pandemic, and most importantly, to identify and alert decision makers and the public to the interventions that could be taken immediately to avoid or mitigate a disaster.

Hybrid Vigor’s participation in Pandefense led to an invitation to co-edit a special Forethought section, called ‘Preparing for a Pandemic,’ in the May 1, 2006, edition of Harvard Business Review. Here’s the editor’s letter introducing the section.

Of course, I dragged Baruch Fischhoff into participating as well, and this led to the publication of yet another paper, in a new journal called Global Public Health.

The upshot of all of this activity for me, personally, was a growing belief that the risk assessment methods I’d been studying and working on with Baruch had the potential to have a tremendous positive impact on getting out in front of emerging infectious diseases, in addition to the benefit it could bring to the assessment of commercial biotech products.

I’m now working on raising the money to fund a couple of new projects in this area with several of the people I met at, and through, my involvement with Pandefense.

Wish us luck: this kind of work is of critical importance, and it is ludicrous how difficult it is to get funding for prevention and preparedness, unless it directly provides cash to a specific industry.