by Stephen McPhie, CA
Partner, RSD Solutions Inc.
Is the best risk manager the one who has the best solutions? Is it the one with the most experience, the best grasp of technical fundamentals, the one with the best solutions? Is the best risk manager the one who understands the optimum risk appetite for his or her organization? I would contend that it’s none of these. The best risk manager is the one who asks the best questions.
By Stephen McPhie, CA
RSD Solutions Inc.,
The American and British cure for many of our current ills has been printing money. Quantitative easing as those who practice it are concerned. Germans, especially the head of the Bundesbank are dead set against it. They view it as a way to let some countries off the hook. They also believe it will lead sooner or late rot inflation – a logical view.
Perhaps like many, for or against it, you just desperately hope for the best and that it will work somehow and lead to strong growth. However, if you are a financial executive in the US or UK, do you also countenance the inflation possibility? A medium term view is important and the consequences of inflation should be considered in risk management. In spite of a benign rate environment, caused partly by flight to quality), consequences include higher interest rates.
by Don Alexander, MBA
Associate, RSD Solutions Inc.
The waning confidence in US political leadership threatens global financial markets as the super committee has failed to reach a plan for deficit reduction. This failure is leading investors to wonder how long the debt overhang will impact the struggling economy. There is concern that an impasse could last until the November 2012 election as politicians haggle over mandatory spending cuts.
The political gridlock in Washington has a cost and that is the focus of this communique. There are two lessons for risk management: decision paralysis has a cost and an adverse incentive system can lead to gridlock. This outcome would not be tolerated in the private sector.
In a recent column, we reviewed the cost of policy uncertainty. Policy uncertainty and the stalled recovery (Scott Baker, Nicholas Bloom & Steve Davis, VOXEU, October 22nd). The authors distinguish between economic uncertainty and economic policy uncertainty, constructing an index to measure policy-related uncertainty and argue that reducing policy uncertainty would raise output and add dramatically to job creation.
Prior to the financial crisis of 2008, stock markets moved in response to economic numbers such as GDP or employment and corporate earnings. But today, it is politicians and government regulators making comments about bailouts, budgets and regulatory reforms that are driving the markets. As a result of diverse comments from politicians and government officials, have generated massive economic uncertainty. This policy uncertainty is a key factor in stalling the recovery and contributing to the risk of a double dip.
Baker et al constructed a new index of US policy uncertainty by combining three types of information: frequency of articles that reference economic uncertainty and policy, references to expiration of various federal tax code provisions and disparity among forecasts about inflation and government purchases of goods and services. In addition, the authors are able to separate an indicator of economic uncertainty from that of policy uncertainty. They note the key drivers of policy uncertainty are dominated by monetary and tax issues. When businesses and investors are uncertain about taxes, health care costs, budget prospects and regulatory initiatives, they adopt a cautious stance. They find it costly to make a hiring or investment mistake, waiting for calmer times to expand or consider riskier investments.
As a result, the recovery never takes off as business remains cautious on making investments in capital goods, research and worker training – key determinants for long-run sustainable growth. Investors remain on the sidelines in “safe” investments avoiding risk. The authors noted that if their index for policy uncertainty was restored to 2006 levels, it could result in a rise of industrial production by 4% and the creation of 2.5 million jobs over 18 months. This may not be enough to create a booming economy, but it is a step in the right direction.
The lesson for the continued political fiasco is that it comes at a cost. The lesson for risk management is that inaction on risk mitigation also has a cost.
For more on this follow the link: www.voxeu.org/index.php?q=node/7137
by Stephen McPhie, CA
Partner, RSD Solutions Inc.,
Something does not feel quite right with BRIC. The "R" in fact. This represents a country that has shunned the opportunity for reform that could have been afforded while high oil and gas revenues have been flowing in. One where corruption is rife, the rule of law inadequate at best, the demographics are unfavourable and floods of people are getting out or getting their money out or both. One where an increasingly oppressive regime seems destined to continue for many years to come. Why is it part of BRIC?
Perhaps the "R" should be removed and replaced with "T". Of course, many countries in the developing world have great promise and improving conditions for growth so BRIC represents the large powerhouses among them. T is for Turkey, which looks in a very good position to grow and prosper over the coming decades and which has good looking demographics. Only problem is that BTIC does not flow so easily off the tongue.
What does this mean at the company level for risk managers? Perhaps little but perhaps a lot, depending on sales, supply and investment flows and potential currency movements. Such things should at least be considered in an ERM context.
It would be interesting to hear any comments about my "R" for "T" substitution, especially among any ex-pat Turks!
by Don Alexander, MBA
Associate, RSD Solutions Inc.
The shadow banking system is vast and plays an important role in financial intermediation. Analysts suggest that it played a small role in the early 1990s and now accounts for over 60% of US financial intermediation. A question is why did it arise and become so important? Some view it as regulatory arbitrage and others suggest it as the market fulfilling investors demand for “riskless” assets. A recent communique by Zoltan Pozsar; Can Shadow Banking Be Addressed Without the Balance Sheet of the Sovereign (Voxeu, Nov. 16th) explains some of the issues and potential policy options.
Shadow banking system is the name given to the financial infrastructure that exists outside the regulator’s remit. There are two ways to understand shadow banking: one a supply-side approach where banks use securitization-based credit intermediation process through various vehicles, funds and subsidiaries that are globally interlinked and two, the demand side which focuses on cash investors that provide banks with wholesale market funding rather than via traditional deposits. The volume of institutional cash pools increased from $100 billion in the early 1990s to over $3.5 trillion today.
The intersection of the two approaches indicates that shadow banking is a significant part of the risk-intermediation process, and for that reason the Financial Stability Board (FSB) has issued a set of recommendations to monitor its activities. Investors manage large cash pools, which replaced institutional deposits, in the form of repos and asset-backed commercial paper. These instruments are considered safer since they have layers of protection compared to unsecured deposits.
The privately guaranteed money involves risk stripping into credit, maturity and liquidity transformation components and came about due to the shortage of government-guaranteed instruments. The sovereign balance sheet plays into the emergence of shadow banking and the money claims against it. The first priority is safety as mortgage pools are securitized and placed into tranches. The tranches are put into a levered maturity transformation and funded with short-term instruments and quasi-liquidity guarantees. Short-term money market instruments are put into vehicles such as money market funds vulnerable to changing market conditions.
The FSB reform idea is to adopt measures that shorten the financial intermediation process, allowing governments to issue short-dated instruments to absorb the cash pools. Recently, the US Treasury Borrowing Advisory Committee produced the issuance of floating- rate notes to serve a similar as the issuance of t-bills as money for institutional cash pools. Regulatory approaches to design a smaller and less run-prone banking system are a key step. A more hands-on approach is required to engineer a migration of cash pools away from wholesale funding markets and toward short-term sovereign claims.
For more on this click on the link to the Voxeu article: http://www.voxeu.org/index.php?q=node/7278
