WILTON, CT – MARCH 21: Protesters stand in front of the Financial Products Headquarters of American … [+]
In March 2009 Gerry Pasciucco was finally beginning a long-delayed vacation when he got news that his employer was under siege. Pasciucco had been brought in as head of AIG Financial Products (AIGFP) five months ago with the mandate to unwind it after its failed trades had inflicted such enormous losses on AIG that the federal government had had to rescue it with a $182 billion bailout. The day before he had left, AIGFP had paid out $165 million in retention bonuses. The bonuses triggered an unprecedented storm of public outrage. Pasciucco rushed back from vacation and to a headquarters surrounded by protesters and armed guards. Now he was faced with a second crisis inside the larger one.
Pasciucco was one of the best leaders in the financial industry but he had never thought the payments might cause a problem, even though the Treasury Department had warned AIG against making them. Why not? Both his story and the larger one reveal a key insight into the origin of crises: that the most dangerous ones spring from long-held assumptions about the world that are suddenly proven false. In this post and the next two I’ll explore how crises happen, why they spread so widely that the mistake of someone you’ve never heard of can throw your company into chaos, and why these crises are happening more and more often.
Unquestioned shared assumptions are uniquely dangerous
The world is mired in an unprecedented crisis – a pandemic combined with the worst economic downturn since the Great Depression. But this is just the latest in a series of “Black Swan” or “once in a lifetime” crises, ranging from 9/11 to the 2008 financial crisis. Some of these crises are systemic – triggered by factors external to any individual company. Others are the product of internal mistakes my a single company, ranging from Volkswagen’s diesel emissions scandal to Boeing’s disastrous safety failures with the 737 MAX. Even if you’re an entrepreneur or leading a small business, you need to be prepared, because these events can transform your company’s fate.
The Global Financial Crisis had a variety of causes, ranging from the increased leverage of major American financial institutions to the incredible complexity of modern financial instruments. At root, however, its proximate cause was the fact that the financial models used to price and assess mortgage backed securities all assumed that no nationwide decline in housing prices was possible, because no such decline was recorded in their historical datasets.
How about Pasciucco? He, and everyone he worked with at AIG, had spent their entire careers in a financial sector that had gone for generations without facing significant public scrutiny about its compensation practices. As with most organizations, the people of AIG had a shared culture and basic assumptions that were a product of their history. This homogeneity created the possibility that AIG’s senior executives were in a bubble and prone to “Groupthink” – a tendency to come to shared conclusions that people outside the bubble would reject.
For AIGFP, the shared conclusion was that people should be paid according to the logic of efficiency, which said they should be paid since the bonuses were trivial compared to what would be saved by keeping the people who understood AIGFP’s portfolio best on hand. Most people, however, are governed by the logic of fairness, which says that people should be punished for doing harm, even if inflicting that punishment is costly. Rightly or wrongly, most Americans perceived the people who worked at AIGFP as at fault and were enraged to see them rewarded.
Both the financial crisis and Pasciucco’s dilemma, then, had the same root cause: an unquestioned assumption that was suddenly exposed. Volkswagen believed that its engineers could work miracles and that their “solutions” to the difficulties of controlling diesel pollution would not be examined too closely by the EPA. Boeing thought that the established safety record of the 737 would carry over to the 737 MAX despite substantial changes in its design. This is the hallmark of the most dangerous crises.
Unquestioned shared assumptions are uniquely dangerous. The thought of them failing may never even have occurred to you or to anyone on your team, so everything you do might depend on them, and it’s likely that no one has prepared for what might happen when they turn out not to be true. Preparing for a crisis means asking what you know that might not be so and then acting on the answer to that question. In future posts I’ll look at leaders who did exactly that and how they did it.
In my next one, however, I’ll explore why, more and more, it’s not just your assumptions that might cause a crisis for your business, but more and more, those of people from everywhere on earth.