Saturday, July 16, 2011
Friday, July 15, 2011
Feelings
by Rick Nason, PhD, CFA
Partner, RSD Solutions Inc.
If you opened this blog thinking it was going to be about the old 70’s (1974) song by the same name then you are mistaken. I thought that song sucked – even when it was parodied. Instead I want to tell you a short story about when I was a graduate student. I spent a summer writing business school cases for Dr. Shaw – who was an awesome Finance Professor. Although it has been many years since I graduated, I had the honour of meeting up with Dr. Shaw this past spring. He reminded me of this story.
There was one case that I was working on and I used the phrase, “… the financial manager felt that it would be best to …”. In a few other paragraphs I also used a similar phrase that included some tense of the word “feel”. The draft came back to me with a big red “X” through it. I went to see Dr. Shaw to ask him what was wrong and he said, “ a financial manager may conjecture, may believe, may calculate, may speculate …etc., but a financial manager never feels!” I got the message.
It raises an interesting question though – does a risk manager “feel”, or does a risk manager always have to calculate, conjecture, speculate etc.? While I may agree that a financial manager may not feel, I believe due to the nature of the risk manager’s role that indeed they do have to feel. Unfortunately risk management is not an unambiguous science – and nor is it ever likely to be.
Thursday, July 14, 2011
The Thirteenth Tale
by Rick Nason, PhD, CFA
Partner, RSD Solutions Inc.
“Human lives are not pieces of string that can be separated out from a knot of others and laid out straight. Families are webs. Impossible to touch one part of it without setting the rest vibrating. Impossible to understand one part without having a sense of the whole.[1]
The above is a quote from the novel “The Thirteenth Tale”. In my opinion a fascinating story that is extremely well written. In this blog I do not want to expound any more on the book (although I will encourage everyone to read it), but instead I would like to focus on the passage written above. This passage seems to be a perfectly obvious statement. We all know how relationships can be, and more so how family relationships can be. I think everyone can relate to the above passage in one way or another.
An additional moment’s thought however and one can also realize that the above passage applies to companies. Companies – like families – are webs. Furthermore it is impossible to understand one part of a company without having a sense of the whole.
But take an additional moment to ponder whether or not industries – like families – are webs, and the answer will almost assuredly come back “yes”. Going a little further down the wormhole we can ask ourselves whether or not economies are webs of industries, and then whether or not the global economy is a web of economies.
This is the basis of the science of complexity. It is a subject that I am very interested in and a subject that I believe needs to be understood and appreciated for a new and more powerful paradigm in risk management (and indeed in business as a whole) to come about. With all due respect and apologies to Diane Setterfield;
Risk issues are not pieces of string that can be separated out from a knot of other corporate issues and laid out straight. Corporations are webs. Impossible to touch one part of it (i.e. risk) without setting the rest of the issues vibrating.
Wednesday, July 13, 2011
Events dear boy, events!
by Stephen McPhie, CA
Partner, RSD Solutions Inc.
“Events dear boy, events” is a quote attributed to former British Prime Minister Harold MacMillan when a journalist asked him what politicians fear. Doing a Google search I find that all sorts of bloggers have recently used this quote in talking about the current crisis. I did think of it myself before searching, but the fact that it is coming to mind so commonly suggests a lot of people share my view that events often tend to run away in the opposite direction from the best (and sometimes most expensive) plans.
While politicians desperately try to save the Euro and limit the crisis to Greece, events seem to by pushing in the opposite direction: an angry German electorate, angry Greek citizens, worried bankers, rating agencies trying to prove their mettle. Moody’s recently cut Portugal’s debt rating to junk status opining that a second bail out will be required. Along with background chatter about Spain and Italy, containment seems more hope than reality.
How many times have we heard politicians (and some economists) use the term “soft landing” in the late stages of an economic boom? How many times has it actually happened? Never in my experience. Psychology and herd instinct take over and recessions generally come fast and hard. (Usually the climb back out of recession comes strongly too although this time it doesn’t seem like it – more like bumping along the bottom hoping that it’s not a false bottom.)
So do you as an individual or company executive place your hopes and confidence in the politicians or do you prepare, and hedge for, the possibility of a deepening Euro crisis with the attendant currency, commodity price and economic disruptions?
Tuesday, July 12, 2011
The Risk of Contagion in Europe – Evidence from Credit Default Swap Spreads
by Don Alexander, MBA
Associate, RSD Solutions Inc.
The majority of analysts suggest that Greece is insolvent. The issue for investors and risk managers is whether Greece’s troubles are contagious. The authors lay out a framework to test whether Greece’s troubles can cause contagion.
Investors and policymakers are split into two views on dealing with Greece: the bail-in-ers want a coercive (but soft) restructuring of Greek debt while bail-out-ers favor procrastination with continued EU-IMF lending to Greece. There is no disagreement about whether Greece is broke. The argument among in-ers and out-ers hinges on the fear of contagion or spill over into other markets. There is concern that investors could over-react and flee Spanish and Italian debt forcing a European sovereign debt and banking crisis. This could force the choice between a full-blown monetization and/or a break-up of the euro.
The first test the authors perform is to look at the volatility of five-year European peripheral country Credit Default Swaps (CDS) spreads breaking it into a euro-wide and country wide spread component. The euro-wide spread component has been declining for most of 2011 indicating a lower degree of “EU-bundling” of sovereign risk. A second test looks at the factor weight of Greek CDS spread in a Euro-wide component. The factor weighting has declined significantly in the Euro-wide spread this year. The last test shows that the correlation between Italian and Greek CDS spreads has declined steadily since late 2010.
The evidence suggests that contagion has become less likely today than the past couple of years. Markets bundled EU sovereign risks together for a long-time, but recently financial markets are starting to discriminate more. There are two potential conclusions: the orderly restructuring of Greek debt should not produce an investor panic out of EU debt and second the fate of other problematic countries such as Italy rest in their own hands. Risk managers need to be cautious, but the research suggests that fear of contagion may be overdone.
For more on this issue, click on the link to VOX :The fear of contagion in Europe”, Manesse & Trigilia: http://tinyurl.com/6ep63ha
Monday, July 11, 2011
Banking and Politicians
By Stephen McPhie, CA
Partner, RSD Solutions Inc.
Politicians in Britain are constantly targeting banks for, in their words, massive unwarranted bonuses, getting us into the mess we’re in, failure to lend and generally anything else that has gone wrong. Investment banking is often referred to as “casino banking” and derivatives are referred to in terms that suggest they are the root of all evil.
As usual, when politicians become involved, there is a massive amount of misleading information being bandied about. It generally comes from one or more of ignorance, pandering to the crowd, living in some sort of dreamland and, their speciality, deflecting attention from their own shortcomings.
Most politicians probably don’t know what a derivative is, and certainly wouldn’t be able to distinguish between an FX future and a long-term synthetic structure. Do any of them really think that if across the board bonuses had been half or even a quarter the level they actually were in recent years, other conditions being the same, that bank behaviour would have been any different? And while ranting on about reckless lending in the past, they call for a return to the same levels of lending! “We’ve got to get the banks lending again” is a familiar refrain. It seems that if only that would happen we would return to a land of wine and roses.
Of course, along with consultants, banks are easy and perennially favourite targets for politicians. Objectivity and accuracy seem irrelevant. To be fair, the banking industry has brought many of the problems upon itself.
The level of some of the bonuses seems obscene to many, including me in some cases. However, it misses the point. What is the point? I’ll get to that anther time, but would welcome comments on that topic in the meantime.
Sunday, July 10, 2011
Preparing For Failure
by Rick Nason, PhD, CFA
Partner, RSD Solutions Inc.
If one asks for success and prepares for failure, he will get the situation he has prepared for.
Florence Shiner
As risk managers, and as risk management departments how do we ask for success? That might sound like a really stupid question, but when I ask risk managers what success is I either get a dumbfounded look, or the answer along the lines of “absence of failure”.
What is success for a risk manager? How many risk departments can answer this in a strong way that shows vision, passion, and a value added component. I believe that the risk department should add to the value of the organization. I believe that the risk department should not be the “Department of No!”, but instead be an integral part of allowing the strategic vision and more importantly the strategic opportunities to come to fruition.
However risk is often framed incorrectly. Regrettably the risk objective is often framed in the negative (albeit a perverse form of a double negative, as in “we don’t want this bad thing to happen”). Framing in the negative often means that you get the negative – as the above quote implies. It is way past due that risk managers start to think in terms of the positive possibilities, rather than in terms of the negative possibilities. It is time that risk managers defined success more positively and prepared for success more positively.