The financial thriller, “Margin Call,” which opened in movie theaters on Friday, tells the story of a firm in the mold of a Bear Stearns or Lehman Brothers at the height of the financial crisis. The firm in the film is akin to real-life firms that seemingly discover too late their reliance on a culture built on growth at any cost and tainted models at the expense of risk management.
Movies are great teachers, helping everyone better understand complex situations that can be confusing even to experts. “Margin Call” does just this, by putting a spotlight on the crucial role that proactive and skeptical risk management (or lack thereof) plays, particularly in financial services. Although the Occupy Wall Street movement is still in its infancy, it demonstrates how ordinary people feel the impact of the financial industry’s actions – and mistakes. Likewise, the movie demonstrates how great an impact one firm’s actions can have on the entire financial industry, underscoring the importance of risk management in such an interconnected system.
Based on our experience as actuaries, focusing on identifying and mitigating risks, we’ve outlined what we believe are the most important lessons of both the film and financial crisis. Hopefully those who see this movie, and those who lived through the crisis, will heed them.
1. All models are wrong – communicating the pros and cons of results is right
Models come in many shapes and sizes. Mental models can be simple, like rules of thumb, or they can be incredibly complex, like those used to calculate the expected payouts of structured securities. Models, however, rarely evolve to become simpler. In financial services, for example, some models will try to reflect second order interactions, like how often savers ask for their money when interest rates rise, or how many homeowners will default or prepay their mortgages given economic circumstances. As these models become more complex, they become harder for those who did not create them to monitor. The key is learning where the shortcomings are, and not being afraid to communicate the results to decision makers.