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Last year Margaret Heffernan, author of the book ‘Wilful Blindness: Why We Ignore the Obvious at Our Peril’, visited Bradford to give a talk in the School of Management’s guest lecture series which are open to local businesses. The theme of the talk was that managers and businesses fail sometimes to see the most obvious things and it is often those things that sow the seeds of their destruction. Amongst examples Margaret provided at the time were the Catholic Church, the subprime mortgage lenders and BP’s safety record. The latest example of wilful blindness is Rupert Murdoch’s failure to recognise the issue of phone hacking in his organisation.What can Bradford companies do to avoid this trap? How can organisations ensure that they can differentiate between doing things right to grow the business and doing the right thing by employees and society for a sustainable business? I would suggest some of the following:
The theme of wilful blindness belongs to the wider debate on building sustainable businesses that contribute to society and protect our environment. It is critical for businesses to generate profits for reinvestment and growth, but we need new business models for the future that change the focus from profit alone, to a triple bottom line – economic, social and environmental.
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Andrew Johnson is Operations Director, Worldwide IT at (External) JWT in New York, one of the world’s largest advertising agencies. He graduated from Bradford University School of Management’s Distance Learning MBA in 2010.I started out doing a Business Information Systems degree and went on to work as a software developer. After eight years, I was in a management role and felt the need for a more rounded understanding of business in order to take the next step in my career.
Not a typical IT professional
Despite my ‘tech’ background, I had always been interested in different aspects of business and found that I was more confident talking outside of technology than some of my IT colleagues. Many IT professionals want to stay behind closed doors, whereas I liked being client-facing and engaging with others from various different areas of the business.
I decided to embark on an MBA to keep my career options open and ensure that I didn’t get boxed into a specific role in a specific industry.
Virtual MBA study for international travellers
After relocating to the US with a small UK company I was doing a lot of international travel. I didn’t know where I was going to be based in the longer term and couldn’t commit to being in one place. I looked at a number of different options and came to the conclusion that distance learning was the best path for me, particularly because of its interface with technology. However, I still wanted the kudos of getting the qualification from a prestigious university – something that’s particularly important in the US market.
Working remotely with international MBA colleagues
I chose Bradford University School of Management because it offered incredibly good value for money for a globally recognised, highly rated programme. I was particularly attracted to the support system in place for distance learning students, which includes the opportunity to work remotely with people from around the world.
From IT specialist to international project manager
Half way through doing the MBA, I moved to a role at JWT in New York – one of the longest-running advertising agencies in the world – as Operations Director of Worldwide IT. I was attracted to the role because of the mix of technology, creative and business elements. Despite not having completed my MBA, I felt I was able to make this move because I’d been able to re-market myself as more of an all-rounder with a strategic overview, rather than an IT person. I had to demonstrate that I could fit my technical skills into the business context of a global company.
What the MBA has given me is the confidence to sit in a room with people from across the business and understand how everything fits together and translate business problems into effective IT solutions. Every business needs people who understand the capabilities of technology and how to apply them in order to achieve business goals. Without that, it is impossible to innovate.
I also benefited from the international perspective that Bradford’s MBA gave me. My current role is truly international and I work with people from around the world on a daily basis.
Choose your Distance Learning MBA Business School carefully
My advice to those thinking of embarking on a distance learning MBA is to get some experience and network before starting. It can be a lonely process and you need to know that you can be proactive and motivate yourself. Despite distance learning being a very independent study mode, your choice of business school and modules is really important. You need to ensure that the programme is designed for distance learning and it is not just an afterthought. The opportunity to listen to/watch lectures makes it much easier to engage with the subject matter. It is also really important that you keep up with modules so that you can take advantage of engaging in conversation with others about them.
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Hajime Sudo is a Japanese student on Bradford University School of Management’s full time MBA in Italy based at the University of Perugia. He is on the (External) FT’s (External) MBA blogging panel where he regularly shares his experiences as an MBA student.Hajime’s most recent blogs have been about how he is now beginning to put the MBA theory he is learning into practice. On a visit to an eco-sustainable Italian company with his fellow MBA classmates he learnt how creative thinking is crucial for increasing productivity and effectiveness, which he believes will help him to support Japan’s recovery from the recent earthquake when he goes back to his home country.
Over the Easter vacation, a visit from an old friend from home who is a professional manager gave him the opportunity to discuss what he was learning about business strategy with someone who is putting it into practice on a daily basis.
Hajime is now preparing to finish the last few modules of the MBA programme before embarking on an internship with an Italian company, which he will base his management project on. He will be working in a finance role and plans to explore new ways of bringing the principles of sustainability to accounting. He is now starting to think about his career in an innovative way.
Track Hajime’s progress throughout his MBA through his blogs at (External) http://blogs.ft.com/mba-blog/author/hajimesudo/#axzz1f0t0QPoQ
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Peter Popena is currently on Bradford University School of Management’s Accelerated MBA . He has come to the UK from Papua New Guinea on a scholarship programme and will return to his environment management role to undertake his MBA project in the summer, just eight months after starting the programme.I am from Papua New Guinea, which is a developing country in the South Pacific with a population of 7.5m. My employer, (External) Steamships Trading Company , is part of an international company called Swire and I was lucky enough to be selected for a scholarship to do an MBA in the UK, jointly funded by the company and the British Council.
I have got 19 years experience specialising in environmental management in the petroleum, palm oil, gold mining and other industries. I joined Steamships Trading Company as Group Health, Safety, Security and Environment Manager a year ago and am responsible for auditing, coordinating with and advising the various different divisions of the company. We work in the road transport, IT, shipping, food manufacturing, real estate and hotel industries and are a major player in Papua New Guinea’s economy.
An MBA for social good
I wanted to do an MBA to help me develop my overall understanding of business strategy with a view to moving into an executive management role. I also want to be able to contribute meaningfully to the development of Papua New Guinea and help formulate policy that will ensure that environmental protection is a priority.
An MBA that makes a difference quickly
When I researched MBA programmes in the UK, I was attracted to Bradford University School of Management for a number of reasons. Firstly, I was impressed by the School’s reputation and ranking in the UK and internationally. The facilities also looked fantastic. The Accelerated MBA was ideal for me because my employer had agreed to sponsor and pay me during my time studying in the UK and it meant I could get back to work in Papua New Guinea within 10 months.
An MBA with sustainability and sustainable development at its heart
However, my main reason for choosing the Bradford MBA over the others that I looked at in the UK was the School’s focus on sustainability in its research and teaching. Sustainability used to just be about environmental management – now it is relevant to every aspect of business and society – and I strongly believe that economic development and environmental protection should go hand in hand. Doing the Bradford MBA is a fantastic opportunity for both me and my home country to build stronger international links and gain greater understanding of sustainable development.
An MBA that gets you back into learning
After 19 years out of the classroom, the first few weeks of a full time MBA were tough, especially moving to a different country. However, the staff and my fellow classmates have been very welcoming and I have received a lot of support. As the weeks go by, I am becoming much more comfortable with learning again and am getting a lot out of the experience that I look forward to taking back to my home country.
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by Dr Charlie Shepherd, who runs business improvement consultancy Charles Shepherd Consulting. Co-author of Innovation Management, he was recently a guest speaker at the School’s Innovation Club.Earlier this month I was invited to join a group of business leaders at Bradford University School of Management’s Innovation Club.
I co-authored a book, (External) Innovation Management , with Prof Pervaiz Ahmed, and I was asked to talk about new approaches to product development that we have been involved in at NCR, Raytheon and other companies.
Here is a snapshot of some of the areas we covered
1. How do you drive more profit from the business?
Businesses need to find ways of deciding which, of many potential new products and services to invest in. The key to this is aligning the R&D interface with marketing. Marketing should understand the customer and their needs and market trends. They should be able to work in partnership with R&D development and challenge the relevance of new ideas and the value they will have for the customer.
The closer these two work together, the less wasted effort in the business, the more profit.
2. Customers don’t have a clue what they want
The caveat of what I said above is that if you give a customer what they said they wanted – there is a high chance they don’t sufficiently value what they said and more importantly, are not prepared to pay the cost of it.
Over the years I have seen customers delaying signing off projects because every time you start coming up with what they thought they wanted, the target has moved.
Market research can cost a fortune – and most of the time only tells you what you knew.
The way over all this is to build relationships in order to understand the customer better – to become trusted advisers to your customers. The closer you get to a customer, the more you can both understand what will really add value – and what is worth paying for.
We needed to develop our skills in understanding the exact customer need and how we could satisfy that. And the customer had to really understand what we were developing and put value on the cost.
Perhaps the most innovative part of our approach was that we shared the gains from a project – if we could deliver £20m more savings on a project, we would return 50% of that to the customer. That incentivised them to become involved and ‘own’ the project – and us to make sure we were listening and feeding back to the customer.
Below is the model we developed for aligning marketing with technology.
3. Partnering can speed up R&D – at a profit
One of the processes we have previously developed was to identify the competencies of all the various businesses we had acquired or units we had set up, such as knowledge labs.
Sometimes the competencies were not immediately obvious. I remember one where the skills were in managing services, as in an eBay-type approach.
I was interested in the School’s Innovation Club – and have made my own suggestion to them that we should put business problems on the table at future events and do peer problem solving.
What are the best things that you have done to speed up innovation?
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Tim Yeardley graduated from Bradford University School of Management’s Part-time Executive MBA in 2008. He was sponsored by his employer at the time, HBOS, where he was Communications and Finance Manager. Since completing his MBA, Tim has published research into management training in the UK and set up his own company, (External) Mnemoysne Training . He recently returned to the School of Management to give a guest lecture.My interest in management training started when I realised the UK’s productivity figures were pretty poor compared to other countries. After years spent on a farm in Lincolnshire during my teens, I wasn’t really up for flogging myself for hours for little reward. Yet that’s what we basically do in the UK; work the longest hours, for the least reward, in Europe.
I always thought – why are managers making us work so long for so little? After all, they are in charge.
I wanted to get to the bottom of the problem. It took 25 years’ experience in UK, American and Australian management, but I realised that a key problem is that managers are poorly trained in the basic competencies (or soft skills) for management.
Learning to be a manager ‘on the job’
I didn’t get any management training before being a manager (like 80% of all managers). The training I did receive I couldn’t remember; it was pitched too high, with too many unrealistic models, was reactive in nature and more about problem colleagues, rather than problem managers. It was assumed that I knew the basic soft skills needed to manage people and could only really develop them through ‘on the job’ experience.
This ‘sink or swim’ attitude towards manager training means that courses on conflict management, assertiveness training and time management are usually only attended after issues are identified at work.
The link between poor management training and poor performance
In order to prove what was to me the obvious link between poor management training and poor performance, I did some research into what training (those lucky enough to get it!) is given to new managers.
The research paper I produced, which I received international recognition for alongside notable academics and best selling authors via an Emerald Literati Excellence Award, confirmed that managers are not taught basic managerial core competencies, even at entry level. I looked, for example, at the mention of the core management competency of ‘communication’ in new manager courses. A third made no mention of it! In tough economic times such as these with redundancies and restructures, communication ought to be a key skill for any new manager.
Leadership training only for leaders
The separation of management from leadership has been widely documented and argued in management literature for many years. The issue this has caused is that it is assumed that new managers do not need leadership training. I found that over half of new manager courses do not cover any leadership discussion at all. The new economy, though, demands all managers be leaders and vice versa. Why would businesses limit the capabilities of new managers by denying them access to leadership values? Research in the US found just 10% of new managers get leadership training as all the leadership training goes to… the leaders! In the UK the position is equally poor.
Management training for Generation ‘I’
What I found most astonishing about all my findings was that the new manager training courses I looked at didn’t take into account the new challenges and competencies needed by the next generation of managers. I use the term Generation ‘I’ rather than Generation ‘Y’ – meaning ‘internet’ and ‘I’ myself. Just 2% of courses actually considered the impact of today’s culture on the new managers of tomorrow.
This is relevant because the managers of tomorrow have grown up in a completely different world to their predecessors. How will those who do most of their interaction online cope in a managerial position? The management training available to them just assumes they will adapt.
And what about the perception of business young people are gaining through programmes such as Dragons Den and The Apprentice? Evidence suggests these programmes leave our younger audiences cold to the aggressiveness and harsh reality of being in business. We really are not doing ourselves any favours in encouraging aspiring youngsters into the world of work. It is easy to see why the UK only comes 18 th out of 31 in the OECD league table of lower and intermediate management skills.
From my own experience and research, I believe manager training has not progressed for the past 20-25 years and needs to catch up with the core competencies needed by new managers of today. It is still a tick box exercise and not fit for purpose.
The next generation of management training
There clearly needs to be a rethink towards management training and the tools new managers need to get the job done. It must start with the basics – such as awareness and setting standards – and we must stop assuming that the excellent technocrat can move straight into a managerial position. Management training should be a pre-requisite of being a manager – and it should be integrated into the ‘day job’, not a one-off, reactive event.
I set up Mnemosyne Training to assist all managers with innovative and unique core competency learning – based on six ‘soft skills’ which are inter-linked to make them simple to understand and remember
Are you confident that your new managers have all these skills?
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The latest module on the Bradford University School of Management MBA in Perugia, Italy, is Strategic Management. As part of it, the module leader Deborah Allcock, asked us to discuss the question ‘Is marriage strategic?’ It seemed an odd question at first but it really got us thinking about management strategies and how the concept of marriage translates in business.Some of my fellow students, including managers from Italian public companies, said that marriage should be all about natural love, whereas others insisted that marriage should be a strategic decision. Those who argued the latter believed that considerations such as future career and the possibility of divorce should be taken into account before entering in to marriage.
I sat between the two opinions – I think marriage per se should be based on love but that love can collaborate strategically with life planning.
We looked at Italy’s successful sector during the module of Manufacturing Systems and Supply-Chain Design by Flavio Tonelli. Italy’s ‘Golden Triangle’ of Northern cities (Milan, Turin and Genoa) is home to many headquarters and factories of famous global companies such as Ferrari. This was one of the reasons that I chose Bradford’s MBA in Perugia because it gave me the opportunity to gain management expertise whilst being able to see its application in the Italian manufacturing industry, which is similar to that of my home country of Japan.
I attended a lecture by Flavio Tonelli, a Professor from the University of Genoa, who explained the different manufacturing systems among different countries and cultures. Toyota’s system focuses on being effective whilst not producing much waste, which enables them to maintain equivalent productivity with fewer employees. In Japan, the 5S practice contributes to significantly reducing production time, whilst the practice of Kaizen continuously improves and maintains a sophisticated production system that makes reliable products.
In India, a large number of global companies explore and outsource important roles with regard to manufacturing processes. Currently their economic growth is outstanding. Almost all US companies are superior to planning and control before they launch the operation. Furthermore, German firms are proud of stable assembly lines based on reliable machines and materials.
Flavio Tonelli investigated not only different types of manufacturing systems design but also their background and global cultural difference. In Italy, they have a unique manufacturing system design based on their culture. From my own viewpoint, the Italian manufacturing system may not be able to exist without considering coffee and tea. They believe that they can enhance effectiveness by communicating more effectively over a café espresso or cappuccino during break times. Many Italian people also spend much of their leisure time in coffee shops, relaxing with others. It can be said that productivity in Italian companies could be rising by switching between work and refreshing.
While it has not been proven that this ‘coffee culture’ motivates Italian employees to work more productively, I am convinced that the country’s manufacturing system cannot be accomplished without this typical Italian culture.
This brings me back to the question ‘Is marriage strategic?’ Like the Italian manufacturing sector, successful business is half based on the love of what you do and half based on the strategy behind it. One cannot exist without the other – businesses based solely on passion cannot be successful just as those based solely on strategy cannot.
Keep up to date with Hajime’s experiences on our MBA in Italy on the FT’s MBA blog here (External) http://blogs.ft.com/mba-blog/author/hajimesudo
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Heather McGregor, headhunter, FT columnist under the name Mrs Moneypenny and Bradford University School of Management alumnus, has published a book called Careers Advice for Ambitious Women. Here are her top tips to help more women become boardroom directors.Get qualifications to stand out
Mrs Moneypenny recommends getting an MBA from a leading business school and a financial qualification as well as learning a language to increase your confidence.
Don’t try and ‘have it all’
She believes it is a myth that women can ‘have it all’ and that successful females will sometimes have to make tough choices and ‘outsource’ family and home support. She also believes it is never too late, whether to become qualified, make a career change or take up new pursuits. McGregor herself achieved her private pilot’s licence in her 40s.
Learn how to say ‘No’
There is a whole chapter in the book on saying ‘No’. McGregor says: “Saying no is a life skill and women are notoriously bad at it when it counts. It may seem odd to mention this, but when saying no, do please remember to include the actual word ‘No’. Don’t use some other word that you hope does the job. It usually doesn’t.”
Network in the right circles
Other advice includes the need for women to network and promote themselves as well as taking on voluntary roles to broaden experience and become a ‘more interesting person’. McGregor says women generally have to work harder at maintaining their networks than men and this is where ‘thought leadership’ becomes important – involvement with industry associations which allows a woman’s thoughts to be heard while building her profile.
Learn how to control your finances
In the book, McGregor says: “On your way to achieving your goals, you may need to take a career break, or retrain, or obtain experience of a particular industry to add to your CV. Some or all of this may require you to earn less money – and sometimes you may have to work for no money at all. People with low financial literacy are more likely to be in debt, and are less likely to participate in the stock market, accumulate and manage wealth effectively and plan for retirement.”
Sarah Dixon, dean of Bradford University School of Management, said about the book: “Heather does not focus on barriers or see glass ceilings, but recognises the world as it is and sets out very practical advice. Our students are ambitious – whether undergraduates, Masters or MBAs – and most see themselves becoming a director in their career. Following the advice in this book will add value to your qualifications to help you achieve your ambitions.”
(External)
Careers Advice for Ambitious Women by Mrs Moneypenny with Heather McGregor
, is published by Penguin £16.99
Heather is also the author of (External) Mrs Moneypenny: Survival in the City (2003) , and (External) Mrs Moneypenny: Email from Tokyo , (2006) . Her column appears every week in the FT Weekend Magazine.
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Delroy Beverley, Director of Propertysolutions at Bradford-based housing association Incommunities Group, recently joined Bradford University School of Management’s Advisory Board. He holds a number of board level positions, advises many businesses on diversity and inclusion and was a trustee of one of the world’s largest and most influential charities. He is also a Fellow of the Chartered Management Institute and recently sat on the judging panel for the British Libraries in association with Chartered Management Institute management book of the year. In 2010, Delroy was elected to the National Apprenticeship Ambassadors Task Force in recognition of his contribution to addressing worklessness through diversity. He is also an Ambassador for Constructionskills the Sector Skills Council and Industry Training Board for the construction industry.I would be the first to acknowledge that have I been incredibly fortunate and humbled to have met and worked with some of the UK’s brightest business leaders. I am also privileged to have studied at some of the world’s best universities and business schools. I have done so because I believe passionately in knowledge and the wisdom of “knowledge empowerment”. Stepping out of the workplace into a learning environment provides a rare opportunity for reflection, which is hugely valuable in business and in life.
But what about those that aren’t fortunate enough to be able to study at world class business schools? How can we create “social entrepreneurs” in hard to reach communities to those less fortunate? How can we ensure that the business leaders of tomorrow and the work they do helps boost social mobility for the many and not just economic mobility for the few?
Through my work within Incommunities, we try to create an environment that fosters those types of successes. Five years ago, I took a personal decision which was endorsed through Incommunities executive team that it would make societal sense to forge closer links with Bradford University School of Management – a world class business school with an international reputation right on our doorstep. It is a place that creates leaders and inspires people, which is what we need in many communities throughout the country.
Here are some ways that I think business schools can ‘share their knowledge wealth’ with local communities.
Make business education have a real life impact
Business school students need to have the opportunity to have a real life impact through their studies if they are going to have a real life impact when they graduate.
Over the past five years, Incommunities have offered a number of projects to the School of Management’s MBA students. The projects, which are formally advertised and recruited for, are real pieces of work that are critical to the business – things that we would have had commissioned such as a strategic marketing review, performance management framework and a customer relationships strategy. The students are given office space and become part of the organisation during their time with us. They have routine one-on-one time with me, attend senior management team meetings and make real business decisions. We don’t pay them in cash terms but what we give them in life terms is priceless – the chance to put their MBA skills into practice and have a real impact. They experience what it is like to part of a business team that makes a difference on the ground and get to see the results of their work.
Use business skills to facilitate long term social change
Business schools and their graduates are perfectly placed to facilitate long term social change because they are all about thinking outside the box.
As Director of Incommunities, Propertysolutions one of the UK’s largest social housing providers, I see it as my role not just to provide leadership to a fantastic team, but to help Incommunities create legacies within the communities in which we work – not just to deliver short term construction solutions. We ensure that we have a much wider influence on our estates than just housing.
A key part of this is helping people to get back in to work and then they become role models and ambassadors in their communities who inspire future generations.
Young people on our award winning apprenticeship scheme now get additional recognition for doing social good. More importantly, they are representative of the people in our communities. As we sit here today we can proudly say that over 30% of our apprentices are women, 25% are black astonishing when you consider the challenges within construction. In addition, Incommunities 2 years ago recruited the first ever Asian female apprentice gas plumber, again a remarkable achievement all round.
The real impact of all this may not be seen for a generation but we are in the business of not just creating sustainable communities but creating a better future for our grandchildren. I am clear in my mind that business schools can become a fostering ground for community business leaders for the future. It’s a mindset thing!
Give business school students greater ‘life experience’
Many people that go to and teach at business schools are already privileged and in most cases well educated. This means that the business school experience may lack a ‘real life’ perspective. Take for example my personal life experiences, which mean that I am well placed to say what the solutions are for supporting and mobilising deprived communities. I am passionate about social mobility and social engineering because I have lived it. I used education to lift me out of poverty – and now I am helping others do the same through our apprenticeship scheme.
Business school students need to have the opportunity to step out of the classroom and see what is happening on the ground and hear from those who have ‘lived’ what they are learning about.
I am excited about joining Bradford University School of Management’s Advisory Board. From the first meeting, I can see that there is a real enthusiasm amongst the group and they will be a fantastic bunch of people to work with. I hope to bring my life experience and professional experience to bring both some quick wins and long term impact for the school, its staff and more importantly the local community stakeholder’s.
Inspirations that drive me forward
It would be difficult not to share with you and acknowledge the people who have influenced my life. They are the creator (known by many names) for blessing me with a loving and supportive family, inspirational friends/colleagues and positive community and global role models, my ancestors whose courage, strength and survival under extremely difficult, in some cases oppressive situations and environments, enabled my existence. To the inspirational leaders, authors and visionary leaders whose work I have read and who shine the torch for humanity, justice and equality for all. Fortunately, during the most difficult times in my life, their words, actions and example, has inspired and empowered me to believe in myself and my ability to value life in all it‘s physical forms and manifestations.
Martin Luther King said — “You cannot teach people anything, you can only help them discover it within themselves”
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Chris Bentley graduated from his MBA at Bradford University School of Management in 2006 and joined Holidaybreak plc, where he is now Head of Corporate Development. He has supported the company’s strategic development, leading the Group’s merger and acquisition activities. He also chairs the company’s Adventure Travel Division, and works with business units on the evolution and redesign of their business models. Here, he shares his views on a recent guest lecture by fellow alumnus Terry Carroll.I’ve started to make a point of attending the Guest Lecture series at Bradford University School of Management whenever my schedule permits. The latest, Terry Caroll’s ‘ 2007: How did it happen? ’ was a brilliant and relentless exposition of the myriad factors that combined to make the ‘credit crunch’ such a perfect financial storm: the housing market factors, the financial market factors, the regulatory factors, and so on. There was one issue though which Terry hinted at and then veered away from. Understandably, as we’ll get to in a minute. But, to me at least, it’s a point which may be at the heart not just of why there was a crash, but of why it came so close to annihilating the global financial system altogether. It offers hope, but it also points to some unpalatable questions about the future of capital markets.
At the end of Terry’s lecture, Dr Peter Prowse made the point that we seemed not to have learned from a long history of bubbles and crashes. And he was right. Bubbles will always be with us as long as there are feedback loops. Heck, all it really takes to stoke a property bubble is a plentiful mortgage market and a bit of exuberance. But bubbles have burst before without causing anything like this amount of mayhem. As one audience member asked, what was it that was different this time?
By way of answer, Terry pointed to the massive growth in derivatives, dubbed ‘financial weapons of mass destruction’ by Warren Buffet. True, I think, but specifically why?
Another audience member asked whether there were any ‘red flags’ that could have warned us in advance. Terry pointed to several, including the now famous economist Nouriel Robini, ‘Dr Doom’, who was predicting a housing market crash and global recession as early as 2005.
There was another prophet though. And his red flag was in the air almost half a century ago.
How much is that doggy in the window…
The gasoline that fuelled the crisis combined global financial imbalances, lax monetary policy, the bubble in the US sub-prime property/mortgage markets and, what was it…? Oh yes, of course, ‘greed’. But the spark that ignited it was buried in the derivative securities into which mortgages were bundled and sliced into tranches. Each tranche was designed to exhibit a specific profile of risk. Putting a price on a tranche was basically about pricing that risk.
…the one with the waggly tail?
Which is tricky. What is the most likely level of loss within a given tranche, and what is the ‘tail risk’ that losses may be significantly higher than this?
It turns out that everyone was pricing risk in the same way, using a statistical model with origins in the actuarial sector, called a Gauss copula. The model attempts to take account of simple correlations between variables, but at heart it is still a ‘normal’ distribution, a bell curve, with events clustered fairly tightly around an average and tail risk falling away sharply either side of the mean.
In 1962, a deeply eccentric mathematician called Benoit Mandelbrot showed that fluctuations in the cotton market were anything but normally distributed. His ideas caused some excitement through the 1960’s, but had fallen out of fashion by the seventies. In 2004 he published an exposition of his earlier and more recent work and a summary of research by others, including Fama, Schoutens and De Vries, all of which pointed to massively higher tail risk than would be implied by Gaussian models, in markets as diverse as blue-chip US stocks, the S&P 500, the sterling-gilder exchange rate from 1609 to 2000, 19th Century railroad shares, US Treasury bills, call money (interest rates on loans from banks to brokers), gold prices and foreign exchange. To put these waggly tails into context: one study by Citigroup in 2002 found gyrations in dollar-yen rates as high as almost eleven ‘standard deviations’ – something that should not have happened even once if they’d traded dollars and yen every day since the Big Bang [1] .
The Gauss copula models being used by everyone, including the credit rating agencies, were massively underestimating the degree of systemic risk in the sub-prime property market. In one of life’s great ironies, the Gauss copula model itself, and especially its universal adoption, was probably no small contributor to the systemic risk that invalidated it. The sub-prime dogs would turn out to have very fat tails indeed.
As the sub-prime market started to come off, even the ‘safe’, AAA-rated tranches began to take losses, a near impossibility according to the financial models. And because everyone was using the same model, which clearly didn’t work, no one had a clue anymore how much their portfolios were worth or, more to the point, how much trouble other people’s portfolios might be in. And in conditions of such near blindness, banks simply stopped lending to each other. The vital interbank funding market, the beating heart of the global financial system, ceased to function overnight. And civilisation found itself staring into the abyss.
I suppose that it’s too much to ask of our politicians that they try to understand and explain this stuff. It’s hard to imagine even David Cameron’s oratorical skills stretching to a passionate advocacy of the Lévy stable distribution as the solution to our ills. But the alternative is that banking reform is sold to us without a complete understanding of what went wrong in the first place. Worse, as an expedient substitute for a proper explanation, an entire class of people (not just culpable individuals) has been vilified.
Why didn’t the rocket scientists in the middle of all this realise what was going on? There were competing theories, and there were some exceptions to Mandelbrot’s findings. The financial economics of asset and derivative pricing wasn’t (and still isn’t) black and white. And then there is the funny thing about risk – being prudent can be very costly. If you’d taken the Mandelbrot view in 2002, while everyone else was going gangbusters, your shareholders would have fired you for incompetence by 2007, as your investment returns trailed in the dust.
Benoit Mandelbrot died on the 14th of October 2010, aged 85. His views offer hope – it is hard to see that puppies will be quite so mispriced in future. But they also raise big questions – not least that of how capital should be allocated in a world where tail risk dominates.
[1] The (Mis)Behaviour of Markets: a Fractal View of Risk, Ruin and Reward , Benoit B. Mandelbrot (2004)
select this link to view a video of Terry Carroll’s recent guest lecture on ‘ 2007: How did it happen? ’
select this link to read Terry Carroll’s blog on careers advice for ambitious undergraduates
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