Create a currency and hope for the best!

by Stephen McPhie, CA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

So the markets heaved a big sigh of relief as Germany’s parliament today (Sept. 29) approved increased powers for the European bail out fund. Armageddon postponed.  But perhaps not for long.  This is the last proposal that has now been approved by most of the 17 Eurozone members.  However, it has been recognized that it is grossly inadequate and more and greater contributions are proposed.  The trouble is that the Euro was born as a political animal and was, as we now know (if we did not realize it before), flawed.  In its early days, France and Germany flouted the stability pact rules with impunity.  After all, was Luxemburg going to insist on those two countries being fined?  Since then, Italy, Greece and others have not, to put it mildly, observed anything like prudent fiscal policies.

 

For some time now, markets have been way ahead of the politicians who are floundering around, partly in denial and partly trying to protect their own jobs and partly wondering how to recognize which is the front end of a cow.

 

Meanwhile options are becoming more and more limited.  The politicians will muddle through to a solution in the end but the real question is how long will it take to get there and how much damage will be done before they get there.

Danger Will Robinson! Think before adopting best practices.

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

In the mid-1960’s an eager young teen space traveller named Will Robinson would rush into activities he believed were for the greater good only to be warned by the Robot of the coming danger.  While the show “Lost in Space” lasted a brief 3 seasons, its lesson of think before you leap is something the business and investment world should still consider especially when the idea of “benchmarking” is discussed as a cure for department/company ills.

 

Recently the good people at the Harvard Business Review pointed out three questions one should ask before following industry or department best practices.  These being:

 

1. What are the downsides of following the leader?
2. Is a competitor’s success really linked to a particular management aspect of the corporation?
3. Are the (market and economic) conditions face by the market leader similar to yours? 

 

Of particular note is the first point which is similar to the dreaded idea of “group think”.  The financial markets most recently witnessed this when a number of Wall Street and City firms decided to follow the best practice of bundling mortgages and utilizing the same algorithm to price the package.  Yes it was profitable,… originally.

 

So before your risk department decides to follow the leader, heed the word of the Robot and take a closer look at their best practices and pick them apart to see if it really is a best practice and one that will survive the test of time.

 

Note:  A thank you to the good people at Harvard University and the HBR’s Management Tip of the Day for the idea.

IMF World Economic Outlook September 2011

by Don Alexander, MBA

Associate, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

  

The global economy has entered a dangerous new phase as the signs of an emerging recovery on 2010 have given way to a decline in confidence and the emergence of downside risk.  A number of shocks have hit the international economy from which it has not fully recovered: including the earthquake in Japan, political unrest in Arab countries, the fallout from political gridlock in Washington over deficit reduction and the unresolved sovereign debt crisis in Europe.  The structural problems facing crisis-hit advanced countries have proven more intractable than expected, but emerging markets have been the bright spot despite concerns about vulnerability to shocks.

 

The IMF World Economic Outlook (WEO) projections indicate that global growth will fall to 4% in 2011 from 5% in 2010.  In the advanced countries, growth is expected to be an anemic 1 ½% in 2011 from 2% last year.  This assumes that European policymakers can contain the sovereign debt crisis and US policymakers can reach a compromise on fiscal consolidation.  Emerging market should be able to maintain a solid pace of 6%.  The advanced countries will be paced by the US at 1.8%, Europe at 1.1% and Japan at 2.3% for 2012.  While China and India will pace emerging market countries at 9% and 7.5%, respectively. 

 

The report noted two lingering risks that could have severe negative consequences for global growth.  The first is the debt crisis in Europe spirals out of policymakers control and spills over into the global economy.  The US might be vulnerable if political gridlock remains over fiscal consolidation and the housing market remains in the doldrums from underwater mortgages.

 

The report noted that further progress was needed structural reforms for the global economy could return to a more stable growth trajectory.  First, private demand must take over from public demand.  On this issue, many countries have made progress, but the advanced countries have been the laggards.  Second, economies with large external surpluses must shift to reliance on domestic demand, while those with large deficits must do the opposite.  All countries must do more to advance rebalancing and to hedge against potential downside risks.

 

The optimism that greeted a rebound in the global economy in 2010 has given way to caution in 2011 as downside risks emerged.  The lack of prompt action by policymakers to address key issues could lead to another year of anemic economic prospects.

 

For more on the IMF’s views follow the link: www.imf.org/external/pubs/ft/survey/so/2011/RES092011A.htm

 

Extreme Financial Risks & The Eurozone

by Don Alexander, MBA

Associate, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

“An error does not become truth by reason of multiplied propagation, nor does truth become error because nobody sees it.”  (Gandhi)

 

The point is that the emphasis of Eurozone policymakers focus on a stop gap liquidity facility rather than solvency can have long-term consequences.  This is illustrated in the following communiqué (The Future of the Eurozone (VOXEU, Konrad & Zschapitz, June 10^th)) on the outlook for the Eurozone.  

 

A year has passed since the initial bailout of Greece. The Eurozone is still on life support, the authors argue, including the view that Europe’s policymakers have got their strategy desperately wrong.  The failure to modify the Stability and Growth Pact to account for macroeconomic imbalances is a move in the wrong direction.  They treat the bailout as a temporary liquidity problem and not a solvency issue, which will ultimately increase the costs of the policy error. 

 

The authors note two options, which while considered, are not deemed viable.  The first would be the reversal of the socialization of private sector debt and funding from other ECB members to finance budget deficits – a return to national fiscal responsibility.  The economic cost of restructuring would have a large economic cost to all countries.  A second alternative is the use of “financial repression.”  This is when governments adopt measures to channel funds to themselves that may go elsewhere in unregulated markets.  This method is particularly effective at liquidating excessive government debt.  However, from an economic efficiency standpoint, it makes little sense for banks to use their funds to invest in government bonds unless it is part of their shareholder mandate.

Reinhart and Sbrancia (2011) characterize financial repression as consisting of the following key elements:

1. Explicit or indirect capping or control over interest rates, such as on government debt and deposit rates (e.g., Regulation Q).
2. Government ownership or control of domestic banks and financial institutions while placing barriers to entry before other institutions seeking to enter the market.
3. Creation or maintenance of a captive domestic market for government debt achieved by requiring domestic banks to hold government debt via reserve requirements, or by prohibiting or disincentivising alternative options that institutions might otherwise prefer.
4. Government restrictions on the transfer of assets abroad through the imposition of capital controls.

The authors consider following the current option of intergovernmental transfers as a means to avoid debt default or restructuring.  However, the sums required to make this viable would not be considered acceptable to taxpayers. The most likely outcome is a breakdown of the Eurozone prior to reaching an endpoint as policymakers focus on stop gap liquidity facility rather than deal with the solvency issue.   One possible reason for this breakdown is a rise in political tensions among member countries. A second, more likely outcome is a breakdown in the Eurozone as political tensions increase and investors lose confidence in the sustainability of the Eurozone as a whole.

 

For more information on this subject, click on the link:

http://www.voxeu.org/index.php?q=node/6628

 

Note: Because of it's relevance today, this is a re-posting of a blog that originally appeared in June

 

“Let’s do it”: 3 Common (hidden) decision traps

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

Making decisions, be it on which movie to see, what new product to launch or what risk strategy to follow can be difficult.  However we tend to reduce this difficulty by unknowingly slipping into three common decision traps, these being:

 

Anchoring – Giving disproportionate weight to the first information we receive

 

Status quo – Favoring alternatives that basically keep things the same

 

Confirming evidence – Finding and following new evidence that validates your point

 

To avoid these traps, which is difficult as they appear to use common sense, the best approach is to increase the diversity of minds around the table and perhaps even go to the extent of “appointing” a contrarian.  For smaller organizations or those with large established departments, you may wish to seek the help of consultants or third parties – as paying for a second opinion sometimes has the benefit of heightening your attention to it.

IMF Global Financial Stability Report – Grappling with Crisis Legacies

by Don Alexander, MBA

Associate, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

The latest Global Financial Stability Report (GFSR) from the IMF noted financial stability risks have increased for the first time since early 2008.  The weaker growth prospects have had an adverse impact on private and public balance sheets that are coping with heavy debt burdens.  The financial system has been buffeted by market turbulence emanating from peripheral Europe, a U.S. credit downgrade with political gridlock and an adverse feedback loop between the banking system and the real economy.  The IMF estimates that the need to recapitalize European banks and insurance could eventually be as high as euro 350 billion (US$400-500 billion).  The continued political gridlock in Washington is already damaging financial market prospects.

Low policy rates are required under current conditions, but carry long-term threats to financial stability.  Some sectors of the advanced economies remain in repair-and-recovery phase of the credit cycle as balance sheet repair remains incomplete, while the search for yield is pushing some segments to become more leveraged and vulnerable.  Low rates are pushing credit creation into non-traditional sources such as the shadow banking system. 

Emerging markets provide a better story as they are in a more advanced phase of the credit cycle, but could be vulnerable to contagion, especially from advanced countries.  The combination of low rates and capital inflows leave emerging markets vulnerable to a gradual buildup of financial imbalances and potential fallout from a sharp reversal of financial flows.

The GFSR notes that risks are elevated and time is running out to tackle vulnerabilities that could affect the financial system and fragile recovery.  The IMF offered four areas for policy action: (1) reduce sovereign risk in advanced countries and prevent contagion; (2) strengthen the resilience of financial system and contain against excesses; (3) in emerging market policymakers need to guard against overheating and a buildup of financial imbalances through the use of prudent macroeconomic and financial policies; and (4) the completion of financial reform agenda implemented internationally in a consistent manner. 

 

For more on the IMF’s views click on the link: http://tinyurl.com/62hwbgn