Tuesday, June 2, 2015

Are some consulting companies, e.g. McKinsey & Co. Too-Big-To-Think?

A book, “No ordinary Disruption”, which I paid for, arrived with my mail today. The authors are Richard Dobbs, James Manyika, Jonathan Woetzel all belong to McKinsey Global Institute, the economics and business research arm of the management-consulting firm McKinsey & Co

From its introduction “An intuition reset” I quote:

“Dramatic changes come from nowhere, and then from everywhere… The fortunes of industries, companies, products, technologies, and eve countries and cities rise and fall overnight and in completely unpredictable ways.”

That is true but it makes me ask: Where was McKinsey & Co when bank regulators decided that their capital [equity) requirements for banks, those that are expected to cover for unexpected losses, were to be based on the predictable expected losses derived from the ex ante perceived credit risks?

Why on earth should banks need capital against perceived credit risks, when what is perceived cannot really be what is that dangerous? 

Or is it that McKinsey does not understand the difference between risk and uncertainty?

And the McKinsey authors identifying their “Four great disruptive forces” list: (1) the locus of economic dynamism shifting to emerging markets like China; (2) the impact of technology; (3) demographics; (4) “The final disruptive force is the degree to which the world is much more connected through trade and through movements in capital, people, and information. 

But they leave out that monstrous source of disruptive force that can emanate at any moment from sheer regulatory stupidities with global reach. Why? 

And I ask this because I am convinced that McKinsey & Co., somewhere deep in its bowels, must have known that: allowing banks to hold so little equity against some assets, only because these were perceived as safe, had to end in tears; and that allowing for different capital requirements for different assets, based on perceived credit risk already cleared for, had to dangerously distort the allocation of bank credit to the real economy.

The authors present us with the management imperative for the coming decade, namely: “To realize that much of what we thought we knew about the how the world works is wrong.”... 

Wrong! That’s no excuse, McKinsey & Co. involved in so many areas should have known that when regulating banks you must do two things: First define what’s the purpose of banks, something which was not done; and second analyze what caused bank crises in the past… and it sure was not what was perceived as risky but always what was ex ante perceived as safe but that ex-pots turned out risky.

So if there is a management imperative for the next decade that should be: To realize why so much we think about how the world should work could turn out to be so fundamentally wrong; and how to avoid to become a silly mutual admiration club prone to groupthink.

When a consulting group is no longer able to freely question what’s going on, to freely be able to call the bluff of what’s dumb, then it will have grown too big. It will be weighed down by too many conflicts of interests of all nature; which hinders it from speaking or even thinking the truth… and finally, very sadly, it will end up as a highly paid endorser of stupidities.

When a consulting group with global reach reaches a point of too much importance, then it also becomes a dangerous source of systemic risks.

So do we now need capital requirements for banks based on the size of the consultant group they use? J