In the wake of JP Morgan’s $2 billion derivatives loss, many people have been talking about the failure of risk models and the flawed nature of modern financial theory. Ditto to all that. But I see a deeper problem here, and it goes for financial institutions of all stripes:
Too much of the mathematical and technological genius in finance has been wasted building models that sharpen the “tip of the sword” – trying to make risk and trading algorithms and models sharper and more lethal – at the expense of the base of the sword – the basic data reconciliation, aggregation and normalization processes that guide the strategic path of the organization. (Which is perhaps why the “base” has been known to fall off every once and a while, which may be what just happened at JP Morgan.) It seems to me that most of the processing power – the intellectual horsepower – in the financial world has been focused on taxing the system’s inefficiencies – e.g., high frequency trading – instead of helping investors actually do a better job at investing.
And this annoys me.
Here’s what I think: It may not be sexy to build awesome data management systems. It may not offer the promise of ‘free money’ that comes with algorithmic trading. But the ability to automate routine data management tasks (to remove human errors), normalize and reconcile different data sources, improve portfolio visibility and transparency, while maintaining flexibility and innovative capabilities is crucial. In my view, this is where real value can be added.
What we should be working toward are data management systems that can get timely, pertinent and reliable information into the hands of key decision makers.
But that’s not really happening today. Most organizations are operating with inflexible, legacy systems that barely get the job done. We need a dramatic change.
And this will require a cultural change on Wall Street. The financial industry needs to prioritize long-term value creation (e.g., investing) instead of short-term “deals” (e.g., trades). The latter dominate the culture of Wall Street, but it is the former that offers a sustainable model for financial institutions.
And all of this is tied to the reward systems that are in place. But that's for another post...
