By Don Alexander, MBA
Associate, RSD Solutions Inc.
Guillermo de la Dehasa wrote an interesting paper for Voxeu called “Eurozone Design and Management Failures” (May 2011). The paper provides an interesting perspective on the role of risk management in a large, complex organization. The risk management failures include: taking into account and ignoring known risks, monitoring and managing risk, and using the appropriate risk metrics.
Europe’s sovereign-debt crisis is a defining moment for the Eurozone in that it exposed the weakness of the monetary union’s design, governance and management. Academics pointed out three basic initial design flaws overlooked by policy makers in their haste to create the euro: the lack of price and wage flexibility, a monetary policy where one size fits all and the lack of monitoring of individual countries’ fiscal policy.
The Eurozone sovereign-debt crisis uncovered more serious flaws: the Eurozone policymakers (IMF was) were not equipped to deal with a solvency crisis; the European Financial Stability Fund (EFSF) only provided a short-term liquidity facility. A liquidity facility may delay the day of reckoning and raise the cost and lastly there was no provision in various Eurozone agreements for resolving a solvency crisis. The present system, at best, contributes to the creation of a debt overhang increasing the cost of crisis resolution.
The three current bailouts were triggered by policymaker management failure to address the solvency issue. The failure to incorporate risk analysis into Eurozone policymaker culture and strategic thinking could prove extremely costly for investors and painful for Eurozone citizens.
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