Sunday, August 18, 2013

Life after CDS

One of my closest friends and colleagues in the Netherlands wrote to me this week reminding me of a conversation we had years ago.  Jan J.Ph.M. de Dood, Director at Rabobank Noord-Holland Noord has been advocating for fundamental transformation of the banking system not as an isolated industry endeavor but as a critical utility serving all human enterprises.  Together with his colleague Marieke de Vrij, he published The Future of a Truly Sustainable Economic Order  in which they lay out an accessible assessment of where society is at the moment and where we might consider transforming our behaviors and systems if we wish to establish a more sustainable economy.  As many of Marieke’s and Jan’s analyses and suggestions are plainly articulated in their piece, I will simply commend its reading to you.  Take some time, follow the hyperlink and take in their insights.

The conversation we had in Amsterdam a few years ago had to do with organizational behavior that arises from the explicit and implicit expectations we manifest by virtue of the titles and roles we use.  At the time, Jan served as Chief Risk Officer at Schretlen & Co, an investment bank and wealth management unit of Rabobank Group.  In our conversation, we were discussing what would happen if financial institutions had a Chief Synergy Officer at a role equivalent to (or above) the Risk mandate. 

“What if,” I suggested, “a bank would be as concerned with the economic and credit success of their borrowers are they are forced to be about the risk of credit failure?”

What would a Chief Synergy Officer do?  This question opened up a wide-ranging conversation about the ecosystem of banking.  Imagine a situation in which a bank would lend money to a farmer growing wheat, to a miller who grinds grain into flour, and to a baker (a nice example if you know Rabobank’s roots).  Each of these actors has economic utility requirements that are fundamentally shaped by factors that are beyond their direct control and that happen in variable durations. Wheat is harvested in its entirety once each year.  The farmer’s “wealth” is an annual pulse.  The miller receives the abundant harvest and has the role of processing and storing the grain and flour for distribution to users of flour.  Unlike the farmer, the miller has some sequencing control over when grain is ground into flour and when the supply is expanded or contracted.  The baker sells bread each morning and purchases flour from the miller once each week. 

A Chief Synergy Officer at a bank would do a few vital functions.  Realizing that “credit quality” is a function of the healthy flow of currency in systems of exchange, the CSO would identify the entire value chain and seek exposure to, and the health of, all units within that exchange.  By participating in the farmer’s business, the CSO would understand that “risk” and “abundance” is a commodity function tied to weather, for example.  By participating in the miller’s business, the CSO would understand that the “risk” and “abundance” has to do with the price controls possible in setting the price of staples.  By participating in the baker’s business, the CSO would understand that “risk” and “abundance” is linked to the daily annuity of multiple individual transactions which perpetuate the flow of value exchange within the system. 

But in addition to the closed loop system of the wheat to bread cycle, the CSO would keep a watchful eye on: 
  • new irrigation or crop management technologies which could benefit the farmer and limit the “risk” of climate related production failure; 
  • better energy systems to improve the efficiency of the mill or climate control the warehouse of flour; and,
  • better property locations to improve the baker’s store front placement (or oven venting for the scent temptation effect) to increase traffic to the bakery.  

Rather than proprietary trading against clients – a practice that is routinely done by today’s leverage optimized banks – a CSO would actually trade into the benefit of borrowers to increase their collective chances for sustainable success.  In this world, there would be no Credit Default Swap (CDS) but rather a Productivity Enhancement Option (PEO).  Returns could be improved by virtue of market vigilance for enterprise enhancement rather than hedging the risk of failure. 

To be clear, the present system has its Paleolithic version of this system in the most inefficient and crude fashion.  The opportunistic association between private equity and banking achieves a fungal version of this model with one notable deficiency.  In the present system, the system most often serves the rentier (banker) and his constituents at the expense of the farmer, the miller, and the baker and the bread-eaters.  The bread-eaters receive the crumbs from this system after the feast is consumed through their meager, manipulated pensions.

Jan de Dood and his colleagues are showing the world the pathway in banking that Robert Kendall demonstrated in Cole Publishing.  By serving an industry ecosystem in which the goal is to build the success of actors within that ecosystem, the potential for wealth and health within that system goes up.  Those who subscribe to the “profit at all costs” model fail using their own metrics (unless they corrupt the system by covert accommodation from elected political benefactors).  The model suggested by Jan and deployed by Bob don’t require bailouts – they have celebrations of success.  As Marieke and Jan observe, this more constructive approach is as close as our capacity to think differently. 

Think differently.

1 comment:

  1. Excellent insights, David. Much of today’s highly leveraged risk-based trading is focused on what can go wrong and how to minimize the downside exposure of large financial institutions. But excessive leverage has actually made the system weaker and more vulnerable.

    We should flip the whole bloody thing by creating, as you suggest, a new role of Chief Synergy Officer. The aim would be to focus on what can go right and how to build strength into the weaker links of the chain, thereby creating a more stable market. Something to consider in today’s complex, massively interconnected world…


Thank you for your comment. I look forward to considering this in the expanding dialogue. Dave