Dissecting the Credit Crunch

In assigning blame for what they are now calling "the credit crunch," the news media have been pointing vaguely in the direction of risk assessment and the models produced by Monte Carlo simulation.  But with the exception of Joe Nocera’s excellent piece focusing on value-at-risk in the New York Times, I had not seen a clear explanation of the factors feeding into the exponential decline of the credit markets until I came across a policy paper from the Association of Chartered Certified Accountants, "Climbing out of the Credit Crunch."

This paper provides an excellent, plain-English account of the interplay of the many factors that brought the current turmoil in the financial sector–a number of these factors the ACCA identifies are psychological and attitudinal.  Its discussion of risk identification and management focuses not on risk analysis models but on the underlying assumptions–a common "garbage in, garbage out" observation–and a passive, unquestioning reliance on these models.  This leads the ACCA to one of what it identifies as a major risk management failure: "a very clear disconnect between incentives to senior staff" and [highly sophisticated] risk management functions."

The point is that risk management is so crucial to financial performance that executives who keep a close, critical eye on the tools and techniques they are using to assess risk should be rewarded for that vigilance. 

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