Could IT have prevented the Financial Meltdown?

As things for better or worse continue to unfold in the Financial Crisis, the feds and surviving financial institutions are working diligently to unravel the loans, MBSs, CDOs and other toxic investments that have come to surface over the past year. Which makes us wonder: Does the technology exist to do that? If it does, then wouldn’t this technology have been helpful in giving us some indicators that could have helped prevent the financial meltdown we are now seeing in world markets? As this article points out, things may not be that simple. The fact of the matter is that even with regulations such as SarbOx, there are currently very few regulations on the origination of loans and how they are broken up, resold and resold again.

Some Background

Though it may seem rudimentary, one of the fundamental factors leading to this crisis was debt discipline. The finance industry has an accepted principle that home seekers should provide a 20% down payment on their desired house and finance the additional 80%. When banks began taking the misstep of offering the customers 100-percent-plus variable mortgages without any security, they were abandoning that discipline which is a pillar of the credit system. However lending firms were not solely to blame here, the Financial institutions of this country, most of which have gone under or been bought out, took this ignorance of debt discipline to another level.

Though the buying and selling of pooled loans called Mortgage Backed Securities is nothing new, Fannie Mae was established in 1938 for this purpose, the complex financial assets that were being created by world financial institutions were of a kind which we have never seen before. Financial firms were cutting these loans into 5, 10 or in some cases 20 slices and reselling them to 5 or 10 different organizations, making it extremely difficult to track who was involved and who was taking on the risk. Again the slow movement away from debt discipline is evident.

In theory these financial institutions knew the risk they were taking on with each loan and had a way to gauge if they had enough liquidity to support then if they went south. But as indicated by this article, most firms geared their analytic scenarios to favor positive outcomes in order to justify keeping less money in reserves. Josh Greenbaum, principal at Enterprise Applications Consulting, is quoted in the article saying, "A large number of buyers of these kinds of instruments really didn't care about the value. They just wanted to flip it. A lot of people just didn't want to know."

Even in this oversimplified version of how the world landed in this financial crisis, the ignorance of debt discipline is everywhere. Don’t get me wrong, borrowing money is good. Highly leveraged firms have higher rates of return compared to those firms that chose a more conservation route. However it is expected of these financial institutions, which are trusted with so much of our economy’s money, that debt is taken on in a responsible manner. This means that every measure possible is taken to assess the risk of that debt and the possibility of default. This also means that these institutions should acquire debt that is for the long-term benefit of the company and that the it can be paid off if needed.

Back to the real Question

So now that we see where things went wrong, we come back to the question: Could we have used IT to prevent this financial meltdown? The answer is: Prevent the meltdown? No, but IT could have given us some bright red warning signs of what was to come. Had these financial service agencies drawn out a few matrices giving the ratios of their cash reserves vs. their debt, some telling answers would have be found. As stated in the article, this process generally goes slow and ends with numbers having to be manually entered into Excel.

There are however some other options, particularly Complex Event Processing (CEP) and Operational Business Information (BI). These systems can analyze massive amounts of transactions as the article explains, “100,000 messages per second with millisecond response time, triggering remedial actions by other systems. But they can also be slowed down and used by analysts as a decision support tool. Tools such as Aleri's Liquidity Management System already exist to help treasurers in global banks gauge their liquidity position in real time” So yes there is technology out there that could have helped our preparedness for crisis that was coming.

Where do we go from here? Better late than never!

One of the major concerns now, is that there is another bunch of mortgages that are coming up in 2010 and 2011. Though these mortgages are primarily not “sub-prime”, we cannot be sure how they will effect our financial institutions or the global economy. What should we be doing then? Companies now, having seen the devastation, should be using CEP and Operational BI to help predict how these mortgages will alter the global economic scene. They should be using their advanced IT capabilities to develop more complex and fine tuned models specifically for this cause.

As we move on from here, it is assured that the Government will impose an array of restrictions on the financial markets and institutions. There is no doubt that these will entail quite of bit of regulation designed to keep debt discipline in line. With a new set of rules to play the game by and some new technology to help us avoid repercussions from past mistakes, global market will being the long process of rebuilding the world economy.

"How IT could have prevented the financial meltdown." TMCNet.com 24 Sept. 2008. http://www.tmcnet.com/usubmit/2008/09/24/3669282.html