Failure Mode & Effects Analysis-Planning for and Mitigating Risk

 

Like everyone else, I’m wondering how such huge financial risks were taken by so many leading financial institutions.  What could have been done and what can be done?

Perhaps if any number of people had used one of Six Sigma’s most powerful tools, Failure Mode Effect Analysis or FMEA; we might not be in the mess we are in, or at least, we would have recognized the huge risks being taken.

FMEA was created by NASA early in the Apollo program to balance two opposing goals and mottos. The first, “failure is not an option,” meant successfully completing the mission and returning the crew safely. The second, “perfect is the enemy of the good,” meant failure of at least some components was inevitable. The job was to predict them, prevent them when possible, plan for them, and build in the capability into the systems to overcome them.

The diagram below shows quite clearly the methodology. I believe, if applied, many of the problems which we are wrestling with now could have been predicted, planned for and either prevented or minimized.

fmea-diagram-25

 

 

Another key Six Sigma tool is Root Cause Analysis. In essence, it is finding the root causes of errors and variances to processes.

Looking at the current financial crisis through these lenses helps us see more clearly and perhaps what needs to be done. 

I do not claim to be an expert in any sense on the financial crisis we are all facing. For those interested in exploring this further, I’ve provided some links below, which may provide some explanation.

The use and application of FMEA could have helped mitigate the risks being taken.

1. The products and services were never clearly described. A new vocabulary was created, with sophisticated sounding names like; mark to market accounting, credit default swaps, derivatives and mortgage backed securities. I think the vocabulary fostered a sense that the “financial experts” knew best and our common sense was lost.

fmea-disgram-31

For those interested in trying to understand this further, I’ve included some links below, which I think are helpful.

2. The potential failures were never clearly identified. Not only was the risk to the individuals never fully explained to them, the collective matrix of risk was never really comprehended. I do think that plenty of people just stepped in and made lots of money, when it was available to them. Obviously, many individuals took risks beyond what was prudent as well. The incentives were to participate and the so called “regulators” did not fully grasp or articulate the collective risk involved.

fmea-disgram-4

  3. The effects of failure were never really described. Without having a sense of the scope of the problem, nor how the complex factors interacted, how could anyone predict failure? You can’t prevent what you cannot describe, see and acknowledge. If they were described, no effective corrective action was taken.

fmea-diagram2

 

 

 4. I believe the application of FMEA could have helped find the Root Causes and thus plans to predict, prevent or mitigate failures could have been developed. Even now, how to effectively regulate our complex financial systems is being considered. I believe Six Sigma and in particular, FMEA can play a role in this process.

More information on the vocabulary of the financial crisis.

http://topics.nytimes.com/topics/reference/timestopics/subjects/c/credit_default_swaps/index.html

http://en.wikipedia.org/wiki/Credit_default_swap

http://en.wikipedia.org/wiki/Credit_derivative

http://en.wikipedia.org/wiki/Mark_to_market

http://en.wikipedia.org/wiki/Mortgage_backed_securities

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