“Risk—you must live with it, you can’t invest without it. Mike’s book does an excellent job explaining risk, and why we as investors (and real, live people!) need to understand this most basic element of our financial lives.”
“When investors are terrified, fight or flight—or freeze—are typical reactions, all of which destroy wealth! Mike Carpenter’s The Risk-Wise Investor offers a new and refreshing alternative, one investors (and their advisors!) can learn and profit from.”
“A valuable guide for navigating uncertain times that every investor should read and add to their investment library.”
“When Michael Carpenter, a savvy, seasoned, and successful investment professional talks about risk, attention must be paid! This book is not a “how to” guide to becoming wealthy, but a rich compendium of tested strategies for protecting and growing your nest egg. Investors saving for retirement, for their children’s education, or for any long term goal will profit from it”
“Financial risk has been a subject that is intimidating and not well understood, yet today has become the financial topic! Individual investors want financial risk to be defined, assessed, and managed. This book allows the investor to accomplish each of these and build a financial roadmap to calibrate their personal risk exposure.”
When you change the way you look at things, the things you look at change.
• Using a new empowering definition of risk to improve your investment success.
• Finding a time-tested way to reduce unpleasant, negative surprises.
• Reducing the severity of negative surprises, should they ever occur.
• Converting risks into “inconveniences,” and even potential opportunities.
• Improving your investment success by understanding your risk biology.
• Seeing where and how to best focus your risk management resources.
• Learning how to know which risks should you avoid, accept, or manage.
• Creating a personalized, systematic process to better identify, manage, and neutralize the risks you face.
• Managing ongoing, ever-changing, and new risks.
• Better navigating extraordinary crisis events, bear markets, frightening volatility, and extremes of the business cycle.
May you live in interesting times.
• Enormous growth in the volume, availability, and instant dissemination of investment information.
• Unprecedented expansion of the number and types of investment vehicles.
• A dramatic increase in the sheer number of investors, domestically and worldwide.
• An explosion in the total size of investment holdings.
• Huge increase in investors’ interest in, and knowledge of, investments and investing.
• The ongoing and remarkable lengthening of human life spans, raising the stakes and critical importance of investing successfully.
• The increased global interconnectedness of all investors, economies, markets, countries, and continents, and their growing interdependence on one another.
• The accelerating pace of worldwide change and all the uncertainties it generates.
• Enormously increased market volumes and at times gut-wrenching volatility.
• In today’s world almost anything is possible (both positive and negative).
• Today’s stakes have never been higher, and risk management never more important.
• Offense wins games, and defense wins championships.
• If something can happen, it typically will happen (often at the worst possible time) unless action is taken on it in advance.
• It is critical to be ready and prepared for any contingency, no matter how extreme.
• Better understand and manage risk.
• Make better, more knowledge-based investment decisions.
• Have more confidence in your risk management skills.
• Make fewer investment mis-steps and experience fewer negative surprises.
• Reduce the impact of the unpleasant surprises that do occur.
• Improve the likelihood of achieving your long-term investment goals.
• Be a happier more successful, less anxious, ready for anything “Risk-Wise” Investor.
If a man empties his purse into his head, no one can take it away from him. An investment in knowledge always pays the best interest.
1. Identify Risks. Determine, and remember for future use those things that may cause harm or interfere with your physical health, goals, or objectives.
2. Understand Risks. Learn as much as you can about each potential risk, including its likelihood of occurring and its impact should it occur.
3. Review Risk Reduction/Risk Management Strategies Available. Become familiar with any and all strategies that can be used to avoid each risk, reduce the likelihood of a risk occurring, and minimize a risk’s impact should it still occur.
4. Evaluate the Risk/Reward Tradeoff (with and without risk management). Review the rewards of an action, or inaction, and the risk reduction options available to use versus the risks (likelihood and impact) of the potential action or inaction.
5. Make Your Decision to Act or Not Act. Once you identify and understand the rewards and the risks (likelihood and impact), have evaluated the effectiveness of the risk management strategies available to use, and have a full understanding of your risk/reward trade-offs, you then make your decision to either act or not act. You can then decide to avoid the risk entirely, act and accept the risk with risk reduction initiative(s) in place (reducing the risk likelihood and/or impact) or act and accept the risk with no risk reduction.
6. Implement your decision.
7. Learn and Adapt. Continuously learn from actual experience, then use what you learn to make better risk/reward decisions in the future.
• Risk and reward are a normal part of life, of everything we do, including investing.
• Risk/reward trade-offs are integral to every decision, action, or inaction.
• Effective risk management is critical to long-term investment and life success.
• Risks can be managed, but never eliminated.
• You cannot effectively manage risk or uncertainty without understanding it.
• The more you know about risk and risk management the more effective you’ll be.
• Risk management will not work effectively if you do not understand how and why it works or have confidence in it.
• The most effective method of managing risks is to:• Directly face risks.• Become familiar with risks.• Understand risks.• Prepare for risks in advance.
1. Personal Risk Assessment• Define risk (your definition of risk is the foundation of the entire process).• Identify risks (you can’t manage a risk you haven’t identified as a risk).• Understand risks (their likelihood and their personal impact should they occur).• Determine which risks to avoid, accept, and/or manage.
2. Review risk reduction/management strategies available (their strengths and weaknesses).
3. Evaluate your risk/reward trade-offs (while avoiding common evaluation pitfalls).
4. Make your decision to act or not act—then implement it (while avoiding the common decision-making traps of many investors).
5. Effective ongoing risk monitoring and decision making (continuously being on guard for the emergence of new risks or threats and the evolving nature of known risks).
Better to be wise by the misfortune of others than by your own.
Part 1: A brief review of the ancient world through the Middle Ages.
Part 2: The pivotal role of the Renaissance
Part 3: The post-Renaissance period to the present.
• People lived at the mercy of their environment and were consumed with the basic, continuous struggles of finding enough food, providing shelter for themselves and raising their offspring.
• The seasons, weather, and the availability of food dictated peoples’ lives.
• Human life spans were considerably shorter than they are today.
• One day was very similar to the next, with little change over time.
• Decisions were driven by instinct or the necessity to follow food sources.
• Men and women were truly passive before nature.
• Oracles, witchdoctors, astrologers, and soothsayers read the stars, entrails, smoke, dreams, and animal bones in an effort to help people gain insights into their uncertain future, and/or what the gods had in store for them.
• During this period people viewed their future as a matter of random chance, luck, and/or the vagaries of the forces of nature or the gods. Humans took what was dished out to them and did the best they could to deal with the conditions that were presented.
• People invented unseen forces and ascribed divine intelligence to natural phenomenon, which they then could blame for misfortunes, praise and thank for good luck, or sacrifice to in order to gain indulgences, favors and special requests.
• Gradually, people began to see natural patterns and began to use that knowledge to their benefit. They developed mechanisms and systems to deal with what they could expect as well as the occasional surprises that could occur, even if they couldn’t predict the exact timing or form of those surprises.
• People were unable to conceive of having any real influence or control over the circumstances of their lives.
Sixth Century B.C.: The Chinese sages Confucius and Lao-tzu developed and taught their principles. Confucius emphasized self-cultivation and a preference for sound judgment, equilibrium and harmony, while Lao-tzu, the father of Taoism, was greatly influenced by nature and taught the benefit of letting events follow their natural course. This period also saw the beginnings of Greek philosophy.Fourth Century B.C: Plato asserted that all things partake of two worlds: the visible world that is always changing and the intelligible world that remains unchanged333 B.C: Alexander the Great expands the limits of what was ever thought possible, from the scope of his conquests, to demonstrating how effective out-of-the-box thinking can be in solving problems, when cleaving the Gordian knot with his sword.49 B.C: Establishing a historic example of unalterable decision making, Julius Caesar crosses from Gaul into Italy over a stream called the Rubicon, breaking a Roman law forbidding any general to lead his troops onto Italian soil.
The Dark Ages (500-800) directly following the fall of the Romans was characterized by:• Elevated political uncertainties (in the vacuum left by Rome’s fall).• A reduction in economic activity.• Successful incursions into Europe by non-Christian peoples.• The general loss of learning and literacy.• The church and clergy were the unifying cultural influence, which also maintained the arts and knowledge of writing and reading.The High and Later Middle Ages (800-1400): were characterized by:• A revival of urban and commercial life.• The development of the institutions of lordship and vassalage.• Castle and cathedral building.• Mounted warfare and the Crusades.• Growth of royal power.• The rise of commercial interests.• The great plague of the fourteenth century.800-900: The Arabic number system (originally developed by the Hindus), which includes the new invention zero, becomes accepted throughout the Arab empire, and energizes the use of mathematics due to its ease of use compared to previous systems.1066: The Norman conquest of England and the age of feudalism.Eleventh Century 1100-1200: The foundations on which algebra is developed are articulated by the Persian poet, polymath, philosopher, teacher, and mathematician Omar Khayyam• The precursors of Universities like Oxford and Cambridge were first established as scholastic enclaves by religious monks• Literacy started becoming more available to a wider class of people.1215: The Magna Carta becomes the basis of constitutional government.1291: Two hundred years of Crusading ends with the fall of Acre. While tens of thousands died in them, the Crusades led to Europeans being introduced to many new technologies, developed trade routes, and improvements in navigation. Silk, which was known to the Romans much earlier and new items such as gunpowder and navigational aids were discovered by the West, which made the great Age of Exploration possible.Twelfth and Thirteenth Centuries: A dramatic increase in the rate of new inventions and innovations began taking place. These included invention of the cannon, spectacles, and cross-cultural introduction of the compass and astrolabe.• Improvements were made to the design and construction of ships, improving seafaring.• Great numbers of translations of Greek and Arabic medical and scientific works were distributed throughout Europe.• Aristotle and his rational, logical approach became very important.
• Beliefs of more than 3000 years were openly challenged and left behind.
• Humans began to believe they could actually understand and gain control over their world and manage the risks they faced.
• Artistic expression blossomed.
• Scientific inquiry, knowledge, and interest exploded.
• Printing press is invented.
• New world is discovered.
• The incredible Age of Exploration begins.
• Commerce and trade blossomed.
• People could now earn wealth and were not limited to inheriting it.
• Superstition and tradition lost their strangleholds over people’s thinking.
• Serious study of risk and risk management began.
• A fourteenth-century English friar proposed Occam’s Razor, a rule of thumb for scientists and other trying to analyze data: The best theory is the simplest one that accounts for all the evidence.
1620: Francis Bacon, English philosopher, lawyer and politician promoted the advantages of scientific study over inductive reasoning.1630s: The Dutch issued and traded options securities virtually identical to those we use today.1641: René Descartes, French philosopher, mathematician, and scientist proposed reason as a better way of gaining knowledge and established the foundation of the scientific method we still use today. He popularized the fundamental precept of sound reasoning, that anything must be doubted until it can be demonstrated or proved.1650s:• Printing and books had ceased to be a novelty.• The Amsterdam stock exchange was flourishing.• Blaise Pascal and Pierre de Fermat developed the basic concept of calculating probabilities for chance events from gambling.1660: Pascal’s wager on the existence of God showed that the consequences of being wrong can be the most important factor to consider for a decision maker, rather than the likelihood.1687: Edward Lloyd founds Lloyd’s of London in his coffee house. He creates a risk marketplace where first ship owners, and then others seeking insurance against financial risk, could acquire that protection from a risk taker (underwriter) for a mutually agreed premium payment by the insured.1693: Edmund Halley, The astronomer famous for Halley’s comet, developed the first mortality (life expectancy) tables.1703: Gottfried von Leibniz’s comment, “Nature has established patterns originating in the return of events, but only for the most part,” to math genius Jacob Bernoulli prompts Bernoulli to invent the Law of Large Numbers and statistical sampling. Bernoulli’s work then leads to the modern activities of statistical polling, wine tasting, stock picking, and the testing of new drugs.1720: The “Bubble Year.” The South Seas Bubble in England, the Mississippi Bubble in France, and a remarkable range of other new investment ventures, many financed with borrowed money, all creating enormous speculative frenzy throughout England and Europe, finally collapsed. They financially devastated large numbers of individuals and institutions alike.1730: Abraham de Moivre first demonstrated the structure of normal distribution of random events, introducing what we know today as the bell curve.1738: Daniel Bernoulli created the basics of risk analysis by observing random events from the personal standpoint of how much an individual desires or fears each possible outcome, and he introduced the term utility to risk management. He stated that the desire of any individual for more over less is inversely proportional to the quantity of goods the individual already possesses.1763: Housing, turnpike, and canal speculation throughout Europe.1774: Dutch merchant Adriann van Ketwich creates the first investment fund, which he named Eendragt Maakt Magt or “unity creates strength,” on the principle that diversification and its resulting reduction of risk would appeal to smaller investors.1793: English canal mania hits (bubble).1797: Collapse of the French Assignat currency from hyperinflation.1822: King Wilhelm I of the Netherlands launches the first closed-end mutual fund.1825: Latin American bonds, mines, and cotton mania.1847: Railway and wheat speculative excesses in England.1848: Carl Frederick Gauss studied the blell curve, earlier described by de Moivre, and developed a structure for understanding random events that are large in number and independent of one another.• Continued railway and public land speculation.• California Gold Rush began with discovery of gold at Sutter’s Mill.1873: Railroad, homesteading, and Chicago building booms in the United States.1875: Francis Galton (the first cousin of Charles Darwin) discovered the concept of regression to the mean. That concept is based on his observation that although values in a random process can differ from the average value, in time they will move back to it. This concept will influence a number of areas, including investing, and can be recognized in everyday observations such as:• Why Pride goes before a fall and clouds tend to have silver linings.• Why we make decisions based on extremes returning to normal.1890: Silver and gold speculation leading to inflation (Sherman Silver Act in the U.S.).1893: The Panic of 1893 and repeal of the U.S. Sherman Silver Act, which reversed previous excesses.1900: Sigmund Freud’s analysis of the unconscious mind found that people’s decisions and actions can frequently be effected by factors concealed in the mind rather than by pure logic.• The great Galveston, Texas, hurricane and tidal surge killed more than 5,000 people and destroyed the city in less than 12 hours, leading to dramatic changes in the scope and nature of weather prediction in North America and the world.1906: 5:12 A.M., April 18, the Great San Francisco Earthquake began its 45-60 seconds of shaking, massive destruction, and raging fires. It led to over 2000 deaths, the demolition of the largest city in the western United States, and key lessons on the importance of managing the secondary and tertiary earthquake risks of weak building design and construction methods and poor fire preparedness.1907: Coffee and rubber booms in Brazil and the United States. The Union Pacific Railroad boom.• The Panic of 1907 A number of Wall Street brokerage firms went bankrupt, The Knickerbocker Trust and Westinghouse Electric failed, the Dow-Jones Industrial Average dropped 45 percent from its previous high, and J.P. Morgan brought together leading financiers to save the banking system and the economy.• Irving Fisher, an American economist developed the concept of net present value as a tool to help make better decisions. He proposed discounting expected future cash flow at a rate that considers an investment’s risk.1913: The U. S. Federal Reserve Bank was created to actively manage the very common boom and bust swings of the U.S economy and to act as lender of last resort to the banking system, should the need arise again.1921: Frank Knight published Risk, Uncertainty, and Profit. The book became a keystone in the library of risk management. He distinguished uncertainty, which is not measurable, from risk, which is. He celebrated the prevalence of “surprise” and cautioned against over-reliance on extrapolating past frequencies/probabilities into the future.• A Treatise on Probability by John Maynard Keynes appeared. He derided dependence on the Law of Large Numbers, emphasizing the importance of relative perception and judgment.1923: The Germany Weimer Republic experienced hyperinflation, with prices for everything doubling every two days at its peak. Banknotes had lost so much value they were used as wallpaper.1924: The first modern mutual fund (open-end investment company) was started in Boston by MFS Investment Management. Later the same year, State Street Investors Trust launched the second mutual fund.1926: John von Neumann presented his first paper on a theory of games and strategy at the University of Gottingen, suggesting he goal of not losing is superior to that of winning.1928: The first antibiotic drug, Penicillin, was accidentally discovered by Dr. Alexander Fleming, beginning the antibiotic revolution in medicine, reducing the risk of lethal infections and saving tens of millions of lives worldwide ever since. Example of logical risk management; First method to effectively reduce the common risk of death from infection.• The first no-sales charge mutual fund was launched by the investment firm of Scudder Stevens and Clark of Boston.• The first mutual fund to include both stocks and bonds, The Wellington Fund, was launched.1929: There were 19 open-end mutual funds competing with 700 closed-end funds.• In late October the stock market bubble, which had been building for over 10 years burst, dropping from a DJIA high of 381.17 on September 3 to a low of 41.22 on July 8, 1932. That drop created a total loss of 89.19 percent over that three-year period. It took until 1954, almost 22 years, to once again reach its previous 1929 high.• With the stock market crash, the highly leveraged closed-end of the time were wiped out although smaller open-end funds managed to survive.1933-1934: The Great Depression in the United States reached its deepest point.• The U.S. Securities and Exchange Commission was created to regulate the securities markets (and improve risk management).• The Securities Acts of 1933 and 1934 were enacted to safeguard and protect the interests of investors, and mutual funds were required to register with the SEC and provide disclosure in the form of a prospectus.1944: John Von Neumann (also see 1926) and Oskar Morgenstern published their paper, “The Theory of Games and Economic Behavior,” which describes a mathematical basis for making economic decisions. They embraced the view that decision makers are always rational and consistent, in general agreement with most economic thinkers before them.1945: The Atomic Age began; and the enormous rewards, risks, responsibilities, and related risk management issues raised deep concerns for all humankind.• The Nuclear Arms Race initiated between the United States and the U.S.S.R.1946: The Magic 8 Ball decision-making aid was invented by The Alabe Crafts Company of Cincinnati, Ohio. It was designed to help people make decisions under uncertain conditions.1947: Rejecting the classical notion that decision makers behave with perfect rationality, Herbert Simon argued that because of the costs of acquiring information, executives make decisions with only “bounded rationality,” and make do with good enough decisions.1952: Dr. Jonas Salk began human testing of his new (killed virus) polio vaccine, designed to neutralize the risk of polio, which at the time was everyone’s second-greatest fear after the fear of nuclear attack. Dr. Salk’s vaccine was finally declared safe and effective in April 1955. His vaccine, over time, virtually eliminated the risk of Polio, saved million of lives and untold suffering around the world.• The Journal of Finance published “Portfolio Selection,” by graduate student Harry Markowitz, who later won the Noble Prize in 1990. It explained aspects of return and variance in an investment portfolio and why diversification works, leading to many of the sophisticated quantitative measures of financial risk in use today.1956: The Harvard Business Review published Risk Management: A New Phase of Cost Control, by Russell Gallagher, then insurance manager of Philco Corporation. It highlighted the cost savings of risk management.1960s: Edmund Learned, C. Rowland Christiansen, Kenneth Andrews, and others created the SWOT (strength, weaknesses, opportunities, and threats) model of analysis, and it became widely adopted as a practical decision-making aid.1961: The term “Catch-22,” from Joseph Heller’s best-selling book, became popular for describing bureaucratic, frustrating, and illogical procedures that impede good decision making and risk management.1962: Dr. Albert Sabin saw his oral polio vaccine (live-attenuated virus) approved by the FDA. Along with the Salk vaccine, it further contributed to the virtual elimination of the risk of polio throughout the world, within 40 years.• Silent Spring by Rachel Carlson was published, challenging the public to seriously consider the risks of the degradation of our air, water, and ground from both inadvertent and deliberate pollution. This led to the creation of the U.S. Environmental Protection Agency in 1970 and the global Green movement so active today.1964: Bill Sharpe articulated his Capital Asset Pricing Model in the Journal of Finance. He also developed what becomes known as the Sharpe Ratio, and eventually is extensively used to characterize how well the return of an asset compensates the investor for the risk taken. (Sharpe subsequently received the 1990 Nobel Prize in Economics along with Harry Markowitz.)1965: The rear engine, compact car, the Corvair, manufactured by Chevrolet was exposed. Ralph Nader’s book Unsafe at Any Speed appeared and gave birth to the consumer movement in the United States, then throughout the world.1966: “Nuclear option” became a widely used new term (based on the massive impact of atomic weapons) used to indicate the most extreme option when making a decision.• The insurance Institute of America developed a set of three examinations that led to the designation Associate of Risk Management, the first such certification.1968: Decision Analysis, a book by Howard Raiffa, reviewed many decision-making techniques, including the use of decision trees and sampling to aid in decision making.1969: In a triumph of stunningly successful risk management, focused effort, and technical achievement, in just about eight years President Kennedy’s 1961 challenge to “land a man on the moon and return him safely to the earth by the end of the decade” was spectacularly achieved.1972: Dr. Kenneth Arrow and Sir John Hicks won the Nobel Prize in Economics. Arrow imagined a perfect world where every uncertainty was identified, the Law of Large Numbers worked without fail, then pointed out that our knowledge will always be incomplete and “comes trailing clouds of vagueness.”1973: Fischer Black and Myron Scholes in a breakthrough academic paper, showed for the first time how stock options can be accurately valued. Their work began a transformation in the field of investment risk management. It took until the 1987 stock market crash and then again in the 1998 financial crisis (which was punctuated by the collapse of the hedge fund Long-Term Capital Management, where Black and Scholes were partners) for the flaws in their theoretical model to be exposed by actual financial panics.• The OPEC oil embargo skyrocketed oil and gas prices, fuel rationing, high inflation, and extremely high interest rates.1974-1975: Crash in the price of stocks, REITs, office buildings, and 747 jetliners. (The Dow Jones Industrial Average dropped to 577.)1976: Fortune Magazine, with the support of the Risk and Insurance Management Society published a special article entitled “The Risk Management Revolution” articulating many ideas, which took over 20 years to be adopted.• Hayne Leland and Mark Rubinstein, fellow finance professors at U.C. Berkeley developed the revolutionary idea for a new investment concept called Portfolio Insurance, which was designed to provide the upside potential in stocks with the downside limited only to an insurance premium (see the notes under 1987 to learn how well this innovation worked).1979: Amos Tversky and Daniel Kahneman published their Prospect Theory, which established Behavioral Finance as a new academic discipline. They showed how the traditional rational model of economics incorrectly describes how people arrive at decisions when facing real-world uncertainties.• The cover story “The Death of Equities” in Business Week magazine’s August 13 issue became a famous example of a contrary indicator, since within a few years the stock market began a 20-year bull run, increasing over 1000 percent by the end of 1999.1980: The Society of Risk Analysis formed in Washington, D.C., to represent public policy, academic, and environmental risk management advocates.• Through the SRA’s efforts the terms risk assessment and risk management became more familiar in North America and Europe.• Monte Carlo simulations became popular in the theories of random walk, asset pricing, and finance, as a way of exploring a range of possibilities.1983: William Ruckelshaus, the former director of the Environmental Protection Agency, delivered his speech on “Science, Risk, and Public Policy” to the National Academy of Sciences, launching the risk management idea in public policy.• Risk management reached the national political agenda.1984: The horror in Bhopal— 40 tons of poisonous methyl isocyanate gas were accidentally released from a Union Carbide chemical plant in Bhopal, India, killing 3,800 people and injuring 11,000 people. The accident served as a bellwether to the entire chemical industry and a catalyst for increased focus on risk management and safety reforms.1986: Meltdown at Chernobyl: The Soviet nuclear power plant experienced a core reactor explosion as the result of a planned experiment that went bad. It sent a huge radioactive cloud into the atmosphere, immediately killing 31 people from radiation poisoning, forcing the evacuation of 130,000 people, and spreading radiation over most of Europe.• Space Shuttle Challenger exploded just after liftoff on January 28, killing all crewmembers on board, setting the shuttle program back over two years, and becoming a horrific example of how even small errors in managing risk in complex systems can have catastrophic consequences.• The Institute of Risk Management began in London establishing the first continuing education program in all facets of risk management.1987: “Black Monday,” October 19, 1987, hit the U.S. stock market. Its global shock waves reminded all investors of the risk and volatility in the markets.• The Dow Jones Industrial Average (DJIA) dropped 508 points, to 1739 on record volume. The 22.5 percent one-day DJIA drop was the largest one-day percentage decline in stock market history and also set off record declines in stock markets around the world.• The flaws of portfolio insurance, invented in 1976 (based on the quantitative Black/Scholes options pricing model) and then broadly used by institutional investors to reduce risk were widely exposed by the market crash. The inability to implement its strategies in a market route and the cost of portfolio insurance turned out to be much higher than the paper calculations had predicted, which invalidated the model. With the concept failing to prevent large losses, it totally fell out of favor and has not been used the same way since. As Michael Lewis said in the introduction of his book, Panic, The Story of Modern Financial Insanity, copyright 2009, and published by W.W. Norton & Company, “The very theory underlying all insurance against financial panic fell apart in the face of an actual panic.”• Important assumptions concerning human rationality, the efficient market hypothesis, and economic equilibrium were brought into question by the event.• Debate as to the cause of the crash of 1987 still continues many years after the event, with no firm conclusions reached.1989: The Exxon Valdez super tanker ran aground on a reef in Alaska’s Prince William Sound and punctured eight of its cargo holds, spilling over 11 million barrels of crude oil into one of the world’s most pristine natural areas. The severity of the spill and the ineffective response to it created an economic and environmental disaster, leading to subsequent improvements in the design and construction of oil tankers and oil spill response preparation around the world.• United Airlines Flight 232, while flying en route to Denver from Chicago, experienced an engine explosion, which expelled debris that severed all three hydraulic systems on the aircraft, leaving the pilot without any control of his DC-10. Through very unconventional methods, courageous effort, skill of the cockpit crew, and a highly coordinated emergency response, the plane was able to make a crash landing at the Sioux City, Iowa, airport. Due to outstanding risk management practices, both in the air and on the ground, of the 296 passengers and crew onboard, 184 people survived the crash. This event reaffirmed the importance of risk management planning and preparation.1991: The spectacular bull market in Japanese stocks, The Nikkei Bubble ended, beginning a 14-year bear market.1993: The title of Chief Risk Officer is first used by James Lam, of GE Capital, to describe the function of managing “all aspects of risk.” Today there are hundreds of CROs, globally responsible for the multiple risk management functions of their organizations.1995: Rogue trader Nick Leeson, in Singapore, found he was disastrously overextended and managed to topple Barings Bank (known as the Queen’s Bank) within a couple of days, becoming a glaring example of insufficient financial risk management. Founded in 1762, the bank had financed the Napoleonic Wars, the Louisiana Purchase by the U.S. government, and the Erie Canal. At its demise, Barings was the oldest merchant bank in London.1996: Risk and risk management made the best-seller book lists in North America and Europe with the publication of Peter Bernstein’s Against the Gods: The Remarkable Story of Risk. Now in paperback and translated into multiple languages, this single book, more than any preceding papers, speeches, books, or ideas popularized the understanding of risk and the attempts over the centuries to manage it.• The Global Association of Risk Professionals (GARP) representing credit, currency, interest rate, and investment risk managers, began in New York and London. By 2002, with over 5,000 members and 17,000 associate members it had become the world’s largest risk management association.• In the March-April issue of the Harvard Business Review, Peter Bernstein warned in his piece “The New Religion of Risk Management,” about the replacement of “old world superstitions” with a “dangerous reliance on numbers.”• At the December meeting of the American Enterprise Institute, in discussing the strong stock market, Federal Reserve Bank Chairman Alan Greenspan said, “But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?”1997: The Asian Financial Crisis (Asian Contagion) gripped much of Asia beginning in July, and raised fear of a worldwide economic meltdown (financial contagion). The IMF stepped in with a $40 billion program to stabilize the region. It resulted in President Suharto of Indonesia stepping down after 30 years in power, widespread rioting, dramatic price increases, and weakened economic conditions that lasted well into 1999.1998: Long-Term Capital Management/Russian Crisis.• The investment dream team of John Meriwether, former head of bond trading at Solomon Bros., Myron Scholes, and Robert C. Merton, who shared the 1997 Nobel Prize in Economics and David W. Mullins Jr., former Federal Reserve Vice-Chairman, saw the highly leveraged hedge fund they formed in 1994, Long-Term Capital Management, lose $4.6 billion in a few months.• Despite being based on sophisticated quantitative financial models and overseen by Nobel laureates, with annualized returns of over 40 percent, before fees, in its first years, it still failed.• In order to avoid heavy losses to its lenders and a wider collapse in the financial markets, the Federal Reserve Bank of New York organized a bailout of $3.625 billion by the fund’s major creditors.• After the creditors recovered their bailout investments, the fund was liquidated.• In a far-sighted observation, some industry officials said that the Federal Reserve Bank of New York’s involvement in the rescue, however benign, would encourage large financial institutions to assume more risk, in the belief that the Federal Reserve would intervene on their behalf too, in the event of trouble.1999: The dot.com and Internet boom reached a true feeding frenzy, even though some observers were calling it a classic bubble. To their future great regret, many investors disdained any need for risk management because “this time it’s different,” “the sky is the limit,” and “we are in a brand new era of mankind.”2000: In a great success for risk management, the widely anticipated Y2K bug failed to materialize, mainly due to the billions spent to update software systems worldwide.