Supply Chain

When the Numbers That Make Sense Don't

June 8, 2012

A staple of business practice is making certain that the numbers work and are justifiable.

But, there are moments when- despite the positive ways things might look on the balance sheet and in quarterly reports- the numbers don't make sense.

A good friend of mine worked for AIG's Financial Products operation in London. These were the guys who sold the credit default swaps on so many of the innovative mortgage-backed derivatives that Wall Street was creating in the early 2000's.

He told me that during the run-up to the 2008 collapse, salespeople in his office were regularly earning more than $100,000 a month in commissions; and, the only thing that kept them from earning more was the need to sleep.

I asked him if anyone ever wondered what would happen to AIG if they had to pay on the swaps.

He told me that no one asked because "the numbers made sense".

That, so long as the value of U.S. real estate continued to rise, there was no need to question what they were doing.

He went on to say that the company- and its employees- believed they were selling "pig iron underwater": a phrase I learned that insurance folks use when they believe there is almost no chance whatsoever that they will ever have to pay a premium.

(Pig iron melts at around 1200 degrees C. If underwater, it would be almost impossible to melt. So, writing a fire insurance policy on "pig iron underwater" means there is virtually no likelihood a claim would be made.)

Had anyone raised doubts about AIG's exposure, my friend assured me they would have been labeled a fool, or worse; because they were swimming against the tide of numbers that made sense.

Of course, the numbers ultimately didn't make sense and we know the rest of the story.

I wonder if somewhere within today's derivatives market of $250 trillion ($1/4 quadrillion), there are other numbers that seemingly make sense but really don't.

And, if they aren't the next weapons of mass destruction to be unleashed as Warren Buffett accurately called them.

About the Author

Andrew R. Thomas Blog | Associate Professor of Marketing and International Business

Andrew R. Thomas, Ph.D., is associate professor of marketing and international business at the University of Akron; and, a member of the core faculty at the International School of Management in Paris, France.

He is a bestselling business author/editor, whose 23 books include, most recently, American Shale Energy and the Global Economy: Business and Geopolitical Implications of the Fracking Revolution, The Customer Trap: How to Avoid the Biggest Mistake in Business, Global Supply Chain Security, The Final Journey of the Saturn V, and Soft Landing: Airline Industry Strategy, Service and Safety.

His book The Distribution Trap was awarded the Berry-American Marketing Association Prize for the Best Marketing Book of 2010. Another work, Direct Marketing in Action, was a finalist for the same award in 2008.

Andrew is founding editor-in-chief of the Journal of Transportation Security and a regularly featured analyst for media outlets around the world.

He has traveled to and conducted business in 120 countries on all seven continents.