I’m obsessed with the financial crisis, love reading about it, love learning from it. Humans have a huge bias towards positive outcomes and learning more about how crises happen, has helped me counter that bias. Additionally, learning from other’s failures make our lives a bit more bulletproof!
My latest read has been Hedge Hogs: The Cowboy Traders Behind Wall Street’s Largest Hedge Fund Disaster. Billed as a deathmatch between two natural gas traders John Arnold and Brian Hunter, classic young gun vs old steady hand tale. Arnold being the veteran Enron trader and Hunter the new kid on the block trying to unseat the king. In addition to the crisis stuff, I learned a lot of how energy markets evolved and how de-regulation came to being and made this sleepy corner of the market into a speculative and explosive disaster.
Onto the learnings
Risk management is crucial
Hunter’s fund Amaranth advisors blew up because they utterly failed at risk management. The vision sold to investors was that they were a well-diversified fund, but in reality, they were super concentrated in speculative natural gas futures contracts. As product person in a software business – understand what decisions can be reversed easily and what cannot. For example in the fintech space, an example of an easily reversible decision is any sort of application journey – you can change it quickly and easily. Making a mistake here isn’t going to kill you. However, anything dealing with credit scoring and money management which have strong regulatory oversight and outsized negative impact on your user need to be done very carefully. These are not easily reversed decisions. Figure out your reversible/not-reversible decision matrix and then you can follow the move fast and break things or move slow and it always works approach.
Since Hunter was making so much money, albeit all on paper, the bosses and the risk management folks looked the other way. Their bonus depended on Hunter making money and thus they had zero incentive to curb his risk-taking behavior. In every organization or really whenever there is more than one human involved, incentives can explain everything. Product management 101 is all about influence through others and doing the right thing for the user and the company, simultaneously. Understand the incentives that drive internal groups, understand the incentives that drive your users – and you will be super successful. Also be very cognizant about the dark side of incentives. To juice short-term numbers there is a strong incentive to do shady things to your users. As product leaders pay attention when this happens and it is your job to change this behavior.
Watch out for “too good to be true” effect
Blackrock pulled their investments in Amaranth once they saw outsize returns. They caught on that risk management was screwed up. If it’s too good to be true, it probably is false. Blackrock correctly realized that amaranth was going to blow up because of outsized risk-taking. This is an interesting one that doesn’t get highlighted enough in product circles. Whenever an idea promises outsized benefit relative to ideas that were considered in the past, be suspicious. More importantly when the initial results come in from an experiment or product launch and are extremely higher than expected, much higher than previous trendiness – get very very suspicious. In my experience, you need to really start digging deep into the weeds when this happens. Most of the time the results were wrong as somewhere in the calculation chain there was either a wrong assumption or just bad data. The normal tendency is to start celebrating early and go full tilt on the experiment – watch out for the too good to be true effect.
Sweat the details
The book abounds with examples where investors and regulators did not understand the risks involved. Everybody did a cursory due diligence and were happy with a superficial understanding of how things worked. Does risk management exist, check – but how does it really work? Nobody dug in deeper to understand the risk, monitor the risk and thus paid the price at the end. You have to sweat the details, you have to create playbooks from scratch (link here) and understand how every step in the process works. There are huge dividends to this – you will understand your users the best, you will understand the assumptions the best, since you know the mechanics in detail you will know what to tweak and when. Great product folks sweat the details.
Hunter was braggadocio about beating Arnold, he told everybody in the business that he wanted to be top dog and beat Arnold. As a result, everybody knew his trading positions and took a bet on the other side. In addition, he was so blinded by his desire to beat Arnold that he kept taking bigger and bigger risks which ultimately led to his blowout. Again, this is product 101. Anybody in this profession needs to be super humble. Realize that you are not the one ultimately doing the work, you are helping the team, are in service of the team but you are absolutely not the boss. Don’t go around saying “mini-CEO”, you are just going to annoy people. Humility also increases the tolerance for mistakes. We all make mistakes, but when we are humble, the people around you as well as your users empathize and understand that. They give you a break. Humility, in the long run, is your competitive advantage!