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One single factor distinguished the two groups: Firms that successfully navigated the crisis built a process of constructive dialogue into their decision making. When making major decisions, successful companies brought together proponents in the firm who favored a revenue-generating activity and those such as risk officers who worried about its possible disadvantages and downsides. The CEO or another senior manager encouraged a respectful exchange of views between these perspectives to gain a better understanding of the risk/reward trade-offs of the activity. These were the firms that successfully avoided exposure to unacceptable volumes of subprime mortgages and other risky products before the crisis or that shed or mitigated their exposures in a timely manner before taking major losses.

Successful firms had cultures that welcomed input from those concerned about risk. In the felicitous phrase of organizational development specialist, Jack Rosenblum, they recognized that "feedback is a gift." By encouraging constructive dialogue between those seeking increased profits and those concerned about risks, company leaders elicited information and obtained a more robust understanding of the contours of decisions than they otherwise would have had. Perhaps my favorite example comes from an official of a successful firm who told me, "The CEO often asks my opinion on major issues," and then added, "but he asks 200 other people their opinions, too." When he made a decision, that CEO had a strong sense of the risks and rewards that it entailed.

When there was still time before the financial crisis finally broke in 2008, information flow and constructive dialogue were essential to allow a firm to avoid, shed, or hedge its exposure to toxic assets (i.e., those that looked to be safe but in fact contained major embedded risk). Classic toxic assets were AAA-rated private-label mortgage securities that appeared to give financial firms both safety and higher yield than the usual safe assets. While toxic assets were risky investments for any firm, they proved fatal for highly leveraged firms that lacked the balance sheet strength to absorb the losses.[1]

  • [1] The financial crisis broke in two waves. First, firms started taking losses on assets that they had considered to be safe (especially AAA-rated private-label mortgage securities). Second, when firms realized they didn't understand the assets on their balance sheets or, by extension, on the balance sheets of their counterparties, the market panicked and withdrew liquidity from counterparties it considered potentially troubled because of too many toxic assets on the counterparties' books. It was the panic that allowed a relatively small volume of toxic assets to precipitate the financial crisis and its consequences. See Thomas H. Stanton, Why Some Firms Thrive While Others Fail: Governance and Management Lessons from the Crisis (Oxford University Press, 2012), Chapter 2, "Dynamics of the Financial Crisis."
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