What, exactly, happened on the day whistleblower Paul Moore lost his job as head of risk at HBOS Plc? A clear explanation might help avert another financial meltdown, judging from Tim Harford’s brainy new book, “Adapt.”
The year was 2004, long before the U.K. lender sank under bad loans, posted a loss of 7.5 billion pounds ($12.3 billion) for 2008 and merged into Lloyds TSB Group Plc.
As Moore describes it, HBOS Chief Executive James Crosby swatted away his concerns about the bank’s “over-eager sales culture” and sacked him. Crosby says Moore’s allegations were fully investigated and had no merit. Harford offers a subtler explanation: Crosby was in denial, he says.
“It seems to be the hardest thing in the world to admit that we have made a mistake and to try to put it right,” he writes in this pleasing fugue on the theme that “success always starts with failure.”
Note the adverb “always.” We all struggle to accept our failures, cut our losses and move on, be it at the poker table, on the battlefield or in that lime-green Edsel bought on a whim. Yet admitting our mistakes holds a key to solving the planet’s most intractable problems, says Harford, author of “The Undercover Economist” and “The Logic of Life.”
Wherever you look, success emerges from trial and error. You know the drill: Try variations on what you already have, filter out the flops and copy the hits. It’s called evolution.
“Often summarized as survival of the fittest, evolution is a process driven by the failure of the less fit,” Harford says.
The computer industry offers a fine example. Microsoft Corp. (MSFT) defeated International Business Machines Corp. (IBM) and Apple Inc. (AAPL) in PCs. Then Microsoft lost the search-engine war to Google Inc. (GOOG) Google itself embraces evolution: It lets its engineers spend 20 percent of their time on pet projects, spawning both hits and misses; think AdSense and SearchMash. Like Thomas Edison, the Googleplex gang understands that breakthroughs come from dogged experimentation.
“If I find 10,000 ways something won’t work, I haven’t failed,” the Wizard of Menlo Park is quoted as saying. “I am not discouraged, because every wrong attempt discarded is just one more step forward.”
Breezing along in declarative sentences, Harford examines variation and selection in endeavors as different as waging war and curbing climate change. He draws, graciously, on ideas developed by historians, psychologists and economists including Paul Ormerod, author of “Why Most Things Fail.”
Iraq and Spitfires
Harford has a knack for making complicated ideas sound simple. He nudges the reader along with bite-sized biographical sketches and case studies. He introduces us to rebellious U.S. colonels who changed the course of the war in Iraq; the engineer who designed the Spitfire fighter; and a group of young researchers who are upending ideas about foreign aid in Africa.
In most human endeavors, failure is necessary, useful and must be tolerated, Harford argues. One big exception, he says, is in banking.
His chapter on financial meltdowns opens, curiously, with the grim evening in 1988 when the Piper Alpha oil and gas rig exploded in a deadly inferno on the North Sea. To a banker, this might sound irrelevant. Yet the connection is obvious to people who study industrial disasters such as the Bhopal toxic gas leak, Harford says.
Accidents are inevitable in certain kinds of systems, as Yale Professor Emeritus Charles Perrow explained in his 1984 classic, “Normal Accidents.” That’s because they’re both “tightly coupled” -- like a domino-toppling display -- and complex. Once trouble starts at a nuclear power plant or in the banking system, unintended consequences pile up so fast that it’s nigh impossible to halt the chain reaction.
How can we limit the damage when a megabank implodes? The answer, Harford says, is to decouple some links, to keep failures isolated. Domino topplers have learned to use safety gates to contain accidents. For bankers, Harford says, such gates might include higher capital requirements, bankruptcy contingency plans, and the judicious use of contingent convertible bonds, which turn into equity when a banks crashes.
Another possibility: Consider giving whistleblowers financial incentives to speak out, he says. That sounds reasonable until you realize that the U.S. Securities and Exchange Commission introduced tipster rewards two decades ago and rarely handed them out. This was, after all, the agency that missed Bernard Madoff’s fraud even when Harry Markopolos served it up on a platter.
SEC staffers were in denial, just like James Crosby in Harford’s description of HBOS. Seduced by Madoff’s polished reputation, they couldn’t perceive him as a crook. They must have suffered cognitive dissonance, the tension caused by holding two conflicting ideas simultaneously.
Reading this book won’t rewire anyone’s brain. Yet it might help bankers and regulators get over the hump of denial and, just possibly, avoid another $2 trillion meltdown.
“Adapt: Why Success Always Starts With Failure” is from Farrar, Straus and Giroux in the U.S. and from Little, Brown in the U.K. (309 pages, $27, 20 pounds). To buy this book in North America, click here.
(James Pressley is a book critic for Muse, the arts and leisure section of Bloomberg News. The opinions expressed are his own.)
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