Old Favourites

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

 

I am writing this blog late on a Sunday night as I wait for a connecting flight to get home from an international trip.  I am tired, exasperated with the hassles of travel, and hungry yet not wanting to face another airport meal.  Those of you that travel a lot know the drill all too well.  (The flip side is that I have a really cool job as a consultant, and I get to meet a lot on interesting people who give me great ideas and inspire me.)

 

While I sit in the airport lounge and think of all the things I have to do, I am reminded for some strange reason of my university days.  It must be the Sunday night fatigue, and combined with the time of year of the semester end with all of its stresses with exams and term projects coming due.  In any case, I am tired, but have a long layover, and thus I need to get myself to some level of reasonable work efficiency.

 

Thinking of my university days, I thought I would pick out an old album that I used to listen to while I did my university work.  In my university days I always had energy (youth is an amazing thing) and somehow I always got things done. Perhaps instead of the youth it was the music?!  At this stage it can’t hurt I thought.  I cued up an old university album on my iPad and you know what – the music did revive me, and I am now starting to have a productive evening again.

 

Listening to an old album inspires old feelings – most of which were good feelings.  Indeed the music is inspiring me and I am being quite productive.  However it got me wondering if as risk managers we too go back to the old tried and true when creativity and energy for new solutions is lacking.  Old favorites are great for a short spurt, but do we want to constantly and consistently live in the past?  Or is the old music and the old way of doing things invigorating because it was great and continues to be great?  An interesting double sided coin.

Why

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

 

As a kid I was a royal pain (some – maybe most – of the people who know me now might say that not a lot has changed).  I was always asking my parents why this and why that.  Everything was one big question to me.  Fortunately my parents were patient and answered my questions and then when fatigue set in they would send me to the bookstore.  My addiction with questions is probably what led me into studying science at school.

 

Kids in general tend to be very curious.  They ask lots of questions, and they ask lots of layers of questions. Kids think their parents are smart, as their parents (and teachers) have answers.  It is fun being a kid – ask a question and get an answer.  Now as a parent I realize that sometimes the answers were not quite as accurate and true as I originally thought. 

 

Do we as risk mangers ask lots of questions – or do we try to play the role of grownups in always having an answer (no matter how flimsy or inaccurate)?  Count how many times today you ask why, and how many times you give an answer to someone else’s question (implied or explicit).  What is your question to answer ratio?  Are you a parent or a kid?  Which should you be as a risk manager?

“Bad Recipe” for Risk Management – The Agency Problem

by Don Alexander, MBA

Associate, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

The Wall Street Journal of November 23, 2011, focusing on the demise of MF Financial, noted flaws in their risk management – the lack of accountability for decisions.  The article noted that decisions made by MF Financial CEO Jon Corzine, on his European sovereign debt trades of $6.3 billion, lacked proper supervision.  The typical trader would have position limits and require approvals from the head trader, the risk manager, chief risk officer, the CEO and eventual approval by the Board of Directors.  In the case of Mr. Corzine, it was only the Board of Directors, and most likely, reviewed well after the positions were established or sometimes called the agency problem (conflict on incentives).  The failure to implement an effective risk management system resulted in the demise of MF Financial.

 

The US bi-partisan Super Committee on deficit reduction failed to reach an agreement by the November 23, 2011 deadline imposed by Congress.  The lack of a clear outcome and responsibility by politicians pose a special problem for risk management – the agency problem.  The agency problem, or sometimes referred to the agency dilemma, attempts to address difficulties that may occur under periods of incomplete or asymmetric information when a principal (voter) hires an agent (congressmen), to address a problem of moral hazard (weak economy) with a potential conflict of interest.  The problem is when the agent (congressmen) acts for their own self-interest rather than that of the principal’s interest (restoring economic growth).  A recent example is the no-tax pledge made by Congressmen to Grover Norquist, of the lobbying group “Taxpayer Protection Pledge”.  Mr. Norquist does not have any accountability to voters on the economy.     

 

As a result, a number of automatic spending cuts are supposed to kick-in 2013.  The nastiness of the cuts and their potential implications were expected to encourage lawmakers to strike a deal.  It now appears that Congressional leaders will be unable to reach a compromise as special interest groups try to limit/offset the impact of mandatory spending cuts implemented in 2013.  The question becomes how long will this impasse persist?  It could last until the election looming in November of 2012.

 

Under the current incentive system, US Congressmen have little incentive to reach a compromise to tackle the debt problem and adopt policies to restore economic growth.  It was noted in an earlier column in VOXEU on November 23, 2011 that the surge in political uncertainty comes at a cost. A recent note Policy uncertainty and the stalled recovery (Scott Baker, Nicholas Bloom & Steve Davis, VOXEU, October 22nd) address these issues.  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.  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 lack of clear accountability of Congress (agent) to the voter (principal) will likely result in a stagnant economy through 2012.  The failure to implement an effective risk management system for politicians has a cost for the US economy.  Politicians need to learn the lessons on risk management from MF Financial.

 

A reference for the Baker, Bloom & Davis paper.

www.voxeu.org/index.php?q=node/7137