Innovation, Regulation, Stagnation, Strangulation?

Is this title a possible description of what the past few years have brought and what will happen in the future? Financial managers need to make sure that they and regulators do not fall victim to the oldest trick in the book – excess in one direction followed by an equal and opposite excess, in the other.

The last three economic cycles in the US have been spurred by a high level of innovation in financial products and services ranging from junk bonds and leveraged buyouts in the 80s, to derivatives aim the 90s and “exotic” products in the first decade of the 21st century. In each case the innovation led to huge excesses, followed by a collapse, ensuing regulation which did not solve the problem, and then a repeat of the cycle.

This time around the scale of the collapse has been so huge and dramatic that we can expect much more regulation than the last times around. Much of this regulation will be good and necessary. However it is probably inevitable that there will be over-regulation which will lead to a stifling of financial innovation, particularly in the US. This will lead to less competitions and a lower rate of economic growth for the US over the longer-term and indeed for any other country that over-regulates.

Financial Managers need to be Risk Judges not Just Risk Technocrats

What is the role of the financial manager in the street in all of this?

Financial managers have been faced with an ever-widening array of bewildering financial products most of which are hard for any person to understand. The temptation will be to dismiss all or most of these.

This temptation will be fostered by a much-more stringent and less tolerant regulatory and corporate environment in which CEOs, boards and shareholders will be attempting to avoid any whiff of risk or innovation. Financial managers have to see above the ruck to sort out what is good and what is bad.

If they can make the right determinations, and they correctly stick with innovations that will have sustained and longer-term impacts, they will provide a source of competitive advantage to their own firms, not to mention their own careers. Just look at how Porsche just beat the hedge funds at their own game by using innovation creatively.

If they do not, their own firms will suffer and so will their careers because there will be some financial managers who get it right and will therefore be promoted faster than their more conservative brethren. That is, if the too-conservative financial managers even survive. Just remember, the economic future is unpredictable and it could turn around to the positive long before anyone would have thought possible.

The role of the financial manager will be a hard one since complex judgments need to be made about the competing priorities of safety and innovation within a new and much less tolerant environment for risk. But the financial managers who get it right will be establishing the corporate financial; platforms that will end up ahead competitively.

Unlearning, Financially

Financial technocrats got us into this mess (although we all aided and abetted their beguiling visions). To get ahead, financial managers must now demonstrate their capability to make judgments on financial techniques that are based on common sense and business acumen, not just on quantitative techniques dreamed up by PhDs and Nobel laureates.

In their career development, financial managers must now strive to develop several capabilities:

Business acumenHigh-level judgmentCommon senseThe ability to psychically disinvest in financial techniques they have already learned and believe in.
To get to mid-level managerial positions, occupants must have been able to demonstrate their ability to learn. So learning is old news. Ultimately it is the ability of a manager to unlearn that is more important to reaching a top leadership role.

Next Steps

A few hints and recommendations

If you have not done so already, attend course on exotic financial instrumentsThen make your own determination as to their level of risk and suitabilityDon’t listen too much to the experts, as you can see they usually get it wrongDon’t get too bowled over by compliance and avoid hyper-compliance (it didn’t stop the problems last time, did it?)Don’t regard yourself as a technocrat– get involved in the behavioral aspects of financial decisions, both by your own people and by othersGet involved in senior hiring decisions in other areas, because the behaviors of these people can be the biggest source of financial risk that you will face