Rick and TED(x)

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

It is with great pride that RSD Solutions wishes to announce that Rick Nason (Partner) will be speaking at the TEDx event in Halifax on March 11^th.  Rick will be providing the audience with insights he gained from his experiences as a trained physicist working on Wall Street.  This mash-up of science and business allowed for him to develop a unique perspective on risk and risk management which has become the foundation for his soon to be released book “It’s Not Complicated: The Art and Science of Complexity in Business”.  Interestingly, in all the years of TED talks, this will be the first in risk and risk management.  For this to we are also proud of Rick for pushing the barriers of risk management acceptance.

 

For more on TEDx in Halifax, NS and a background to Rick please follow the link: http://tedxhalifax.ca/

Throwing Out PowerPoint 1

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

This seems to be a week of creating presentations.  I like presenting, but creating presentations is not really my favorite activity.  All of my best presentations are bespoke and are designed to zig when the audience wants to (or needs to) zig, and to zag when that is what the situation calls for.  PowerPoint is a wonderful tool, but it locks you down into a linear path when sometimes the situation calls for more flexibility.

 

To that end I have gone in search of new presentation software.  One that will allow for a more non-linear approach.  I found one that I liked Prezi (www.Prezi.com), and will be testing it out in front of a live audience later this week.

 

Prezi is quite easy to use, but there is still a nagging worry in the back of my mind.  The point is that I know PowerPoint.  My audience knows PowerPoint and what to expect with PowerPoint.  I am not sure how they will react to a whole new presentation style?  How will I react to a whole new presentation style?  What if I make a mistake with the new presentation format? Will people laugh at me?  No one I know has used this software, and I have only seen the presentations with it on the internet – and we all know that they were probably edited a thousand times to make sure they ran smoothly.  Oh my, I can come up with a thousand different things that might go wrong.  Well, actually I can only come up with four or five things that might go wrong, but I am sure that there are at least a thousand things that might go wrong ….

 

Does the above paragraph of whining and useless worry sound like you and your risk team when it comes to trying something new?  I bet it does.  Times change, things change, people change, and organizations change.  You and your risk department also need to change.  Now – where is that Word Perfect file that I just downloaded from my Tandy computer?

 

Throwing Out PowerPoint 1

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

This seems to be a week of creating presentations.  I like presenting, but creating presentations is not really my favorite activity.  All of my best presentations are bespoke and are designed to zig when the audience wants to (or needs to) zig, and to zag when that is what the situation calls for.  PowerPoint is a wonderful tool, but it locks you down into a linear path when sometimes the situation calls for more flexibility.

 

To that end I have gone in search of new presentation software.  One that will allow for a more non-linear approach.  I found one that I liked Prezi (www.Prezi.com), and will be testing it out in front of a live audience later this week.

 

Prezi is quite easy to use, but there is still a nagging worry in the back of my mind.  The point is that I know PowerPoint.  My audience knows PowerPoint and what to expect with PowerPoint.  I am not sure how they will react to a whole new presentation style?  How will I react to a whole new presentation style?  What if I make a mistake with the new presentation format? Will people laugh at me?  No one I know has used this software, and I have only seen the presentations with it on the internet – and we all know that they were probably edited a thousand times to make sure they ran smoothly.  Oh my, I can come up with a thousand different things that might go wrong.  Well, actually I can only come up with four or five things that might go wrong, but I am sure that there are at least a thousand things that might go wrong ….

 

Does the above paragraph of whining and useless worry sound like you and your risk team when it comes to trying something new?  I bet it does.  Times change, things change, people change, and organizations change.  You and your risk department also need to change.  Now – where is that Word Perfect file that I just downloaded from my Tandy computer?

 

Reassessment of Euro Risk

by Don Alexander, MBA

Associate, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

 

The Euro rebound is stronger than anticipated as investors and central banks show an increased appetite for euro denominated paper as signs of a Greek debt crisis start to fade.  The rise in oil prices and surge in central bank reserves has triggered the demand for currency diversification. The euro is one of the few safe currencies that can absorb the growth of reserves.  As we have noted in our blogs of Feb. 26^th and Feb. 15^th, USD or Canadian dollar based investors may want to hedge potential euro exposure.

 

Analysts expect the demand for euro denominated assets to persist temporarily as oil prices remain elevated and central banks, especially in emerging markets, continue to diversify reserves.  This temporary demand for euro denominated may receive temporary support from political tensions in the Middle East and the false sense that problems in the euro peripheral countries have been resolved.  Longer-term, the risks to the euro remain to the downside as the sovereign debt crisis has evolved into a banking crisis and projected economic stagnation in Europe relative to the rest of the world.

 

Spreads on sovereign debt declined since the proposed settlement for Greece was reached.  There is a link between the decline in bond spreads and the ECB announcement the creation of the long-term refinancing operations (LTROs).  There is concern that banks will borrow from the ECB at low rates and buy sovereign bonds whose yields are higher, especially where banks are subject to local political pressure.  Policymakers realize that one of the necessary conditions to stabilize financial markets was the need for an explicit guarantee (such as the ECB) for sovereign debt.    

 

However, this move along with the other temporary financing facilities falls short of what is needed.  Greece and Portugal will not be able to grow with their existing debt burdens.  This could result in contagion spreading to Italy and elsewhere.  European growth is projected to be flat to negative for 2012 and only a modest in 2013, especially with significant budget cuts.

 

The temporary financing could make things more dangerous.  Any wave of sovereign defaults would create problems for the ECB as nearly euro one trillion in sovereign debt is due for rollover in the next 12 months.  The sale of overseas assets by European financial institutions to bolster capital and continued reduction of sovereign exposure by private investors could add to euro pressure.  European politicians have failed to address any of the underlying long-term structural issues facing euro such as monitoring and implementing policies deficit reduction among member states.

Matthew 25

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

Matthew Chapter 25 in the New Testament of the Bible contains the well known story of the master who went on an extended trip leaving three different servants in charge of three different sums of money. 

 

To one servant the master left a large sum of money and the servant managed to double the amount through prudent investment by the time the master returned from his trip. 

 

The second servant who was given a medium amount of money was also able to double the amount for his master through making wise investments. 

 

The third servant was given a small sum of money to manage.  This servant was afraid of losing any money for his master, so he went and buried the money in a safe place until the master returned.  Upon return the master was furious with this servant for his misguided uber-conservatism.

 

While I do not believe that Jesus had risk managers in mind when he told this story, but he might have.  The question is what kind of a servant are you?  Another good question to ask is what kind of a risk master do you serve? 

 

 

Untitled

by Don Alexander, MBA

Associate, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

Charles Wyplosz in a recent communique discusses the shift in risk from various European countries to a “de facto” implied guarantee by the ECB  (The ECB’s Trillion Euro Bet, VOXEU, Feb. 13^th.).  The amounts could be staggering as the ECB is taking enormous risk.  Currently, the ECB is holding over euro 200 billion in sovereign bonds from recent intervention and will face nearly euro 1 trillion rollover of European sovereign debt in 2012.  

 

Eurozone sovereign spreads have recently declined with the exception of Greece.  Charles Wyplosz argues that a good part of the drop in spreads is due to the perception that the ECB is “de facto” acting as the guarantor for Eurozone government debts.  The ECB leadership suggests that the decline in sovereign spreads is the result of country reforms. 

 

There is a link between bond spread contraction and the ECB’s long-term refinancing operations (LTROs).  The LTRO bought euro zone leaders time to get their act together.  Fiscal deficits are slowly declining as the sovereign debt overhang persists, the EU banking system remains undercapitalized (current estimates of euro 100 – 200 billion), and a euro-wide recapitalization facility for banks is missing.  Analysts suggest one method for crisis resolution is through the explicit guarantee of government debt. 

 

Previously, ECB officials argued this was not their mandate; it created moral hazard, exposed the system to increased financial risk and reduced politician’s incentive to make the necessary cuts.  The new ECB regime made the LTRO available to commercial banks, but does not do enough to resolve the crisis such as providing a long-term growth strategy.  Greece and Portugal will be unable to grow with their existing debt burden and this may also be the case risk for Italy and other countries as contagion takes hold.  

 

LTROs could make things more dangerous, especially if banks use LTRO cash to acquire more sovereign bonds.  Banks could borrow money from the ECB at very low rates (about 1%) and buy bonds whose yields are much higher.  A wave of sovereign default could turn these bonds into toxic assets and a trillion-euro problem.  The more the banks accumulate these bonds the riskier the situation becomes.  The problem is compounded by the fact that banks are regulated by national authorities and under pressure to increase their domestic bond holdings.

 

The ECB seems to be making a bet that the market is swayed by its recent action and provides a stable equilibrium.  Holding sovereign debt will be seen as safe and the ECB has saved the euro at a minimal cost.  However, the reversion to a stable equilibrium is not guaranteed.  Should markets conclude crucial policy actions are missing, the debt defaults will spread and Eurozone banks might fail imposing a massive cost to taxpayers and leading to further euro problems.

 

The ECB has bought time for authorities and has involved taking on enormous risks.  The lack action on long-term restructuring of the underlying euro treaty and the promotion of a long-term growth strategy could negate their action.

 

For more information on this follow the link:  http://www.voxeu.org/index.php?q=node/7617

 

Risk Washing

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

Going through the week’s mail I received the one of the few annual reports that I elect to receive from one of the companies that I invest in.  Yes – I am one of those old fogeys that still occasionally looks at them in hard copy form. 

 

As I tell my students, the only sections that I look at are the MD&A and the notes.  I found the notes were particularly interesting in this one annual report I received this week.  They are interesting in that there is an incredible amount of detail on the company’s risk management policies.  It explains all of the risk management strategies they have in place – stopping just short of describing the risk management practices in place for when the “C” level officers clip their toe-nails.  It is truly overkill.

 

It got me to thinking about what the objective of all this risk reporting is.  While it is great that companies are taking risk reporting seriously, there is also the possibility of too much of a good thing.  You can refer back to my article “Is Your Risk System Too Good?” in the RMA Journal (http://www.rsdsolutions.com/quotis-your-risk-system-too-goodquot-article-rick-nason-published-rma-journal).

 

The only reasonable rationale that I could come up with for so much risk reporting was “risk-washing”.  With all of the emphasis on risk awareness and risk preparedness, I can only assume that this company wants to be seen as a leader in risk management.  However just as companies that try too hard to be seen as being environmentally friendly get accused of “green-washing”, it may be the case that we will start to see companies “risk-washing”.

 

Venture Capital

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

As part of my preparation to teach a seminar on advanced investment techniques, I have been reading up on what the latest is in the field of venture capital.  In going through old interviews and notes I had compiled the one thing that struck me about venture capitalists that being their desire to have someone leading the company who is flexible.  Every venture capitalist hates to have someone who is overly passionate about an idea.  An overzealous entrepreneur is likely someone who will not be willing to change course when things inevitably do not go as planned.  It is considered far better from the VC’s point of view to have someone who has a general idea, rather than a fully articulated plan that they are determined to stick with through thick and thin.

 

I believe there is a lesson here for risk managers.  As a profession we tend to be like over-planned overzealous entrepreneurs who demand to have every detail thought out in advance.  While planning is obviously a necessity, it is possible to over-plan.  It is also possible to be overly committed to a plan.  That goes for a business plan or for a risk plan.  Things will happen.  Things will change.  Assumptions will prove to be incorrect.  Economic shifts will happen.  When the inevitable happens, commitment to a plan can be just as costly as not having had any kind of plan at all in place.  Just like a venture capitalist, you need to learn to know when and how to be flexible.

 

Now if we could only get regulators to understand that point. 

Dangerism

By Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

Just finished reading the very interesting TED book “Beware Dangerism” by Gever Tulley.  http://tinyurl.com/6me2gww

 

A lot of interesting ideas in this very short book.  The central thesis is that kids need to be protected from overprotective parents so they can learn how to deal with risk.  Perhaps there is a corporate analogy to Dangerism, in that companies need to be protected from overzealous regulators and risk management systems so they can learn to deal with risk!

Spray and Pray

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

 

This week I had my photo shoot for a speaker series that I am participating in.  Each professional photographer has a different style – each of which seems to be more annoying than the previous one.  The photographer this week however was different.  He came into my office, sat himself down and talked to me.  No rushing to get lights set up – no running around the room with a light meter – no assistant with a make-up kit.  Yes – he did set up lights, yes he did check light levels, no he did not apply make-up to my ugly mug (probably should have).  But he did talk.  He engaged me in a conversation.  Occasionally while talking he would take a photo or two.  But the number of photos was minimal.  Then after about 20 minutes of conversation and about a dozen photos he thank me for my time and said he was done!  I was shocked!  What?!  Only a dozen photos or so.  I was expecting at least 5 times as many shots. 

 

As he was leaving I asked him why so few photos.  His response was very telling.  He said, “I believe in understanding my subjects.  When I do that I only need a few photos to get a great shot.  I don’t need to spray and pray like other photographers”.

 

Interesting.  He actually tries to understand his subjects as people so he can take better photos. 

 

What about risk managers?  Do we “spray and pray” with our vast amounts of modeling and analysis and data collection, or do we try to understand the people in our organizations and thus need only a fraction of the data that we normally collect and analyze?

TED

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

Some of you – hopefully all of you - may be familiar with TED talks.  If not, go to www.TED.com right now.  You are in for a treat.  TED talks are of course are a series of talks by interesting people on interesting subjects.  They are short, they are impactful and they are to the point. 

 

TED stands for technology, entertainment and design.  The theme of non-profit TED is “ideas worth spreading”.  There are hundreds (if not over a thousand) TED talks that are available for free at TED.com.  All the talks are short (20 minutes or less), and cover a fascinating range of topics.  A great way to spend some quality time with your computer.

 

I recently searched for “risk” and “risk management” on the TED site.  Came up with nothing.  It appears that risk managers are either just not dynamic enough or interesting enough or into technology, entertainment or design.  Although it is a TEDx talk, (emphasis on the “x”), I hope to change that.  www.tedxhalifax.ca  

Benevolent governments let us keep some of our earnings!

by Stephen McPhie, CA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

Over the weekend, I heard the UK government minister who is number 2 in the treasury, argue that a certain tax deduction for pension contributions should be limited as this would save the government significant expenditure.  This is the first time I have heard a tax increase effectively described, not as a tax increase, but as a reduction in government spending.  The logical extension of this is that any tax rate below 100% is government expenditure.  In other words, the government is entitled to everything you earn and is incurring an expense in giving some if this back to you.  How generous of them!

 

At the same time, while there used to be a clear distinction between tax avoidance (legal) and tax evasion (illegal), politicians are now describing the former as being part of the latter; at least morally.  (Somehow I got the words “politicians” and “morally” in the same sentence!)  We keep getting told how many billions in tax large companies and rich people are stealing from us.  Of course there is no explanation of the nature of the amount of tax avoided, or whether or not such deductions are desirable.  Is it deductions for capital expenditure for example?  Or R&D?  Or is it all more about votes with little regard for substance or truth?

 

Is political spin spinning dangerously out of control?  More importantly, are you examining your tax risk?  Cash strapped governments may be keen to trumpet lower or stable headline rates out one side of their mouths, but what they giveth with the right hand ……

Faces

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

Faces are complex.  Recognizing a face is a very difficult task for a computer – much more difficult than recognizing your retina.  Faces convey a ton of information.  They convey emotions.  They also convey understanding or lack of understanding.  Faces are complex (not complicated) and thus are not easily codified.  That is why a computer cannot easily deal with them.

 

Scientific studies have shown that we pay up to 8 times more attention to faces than to objects.  I think that is interesting in a world where faceless social media is so prevalent. 

 

Now, here is a question – do risk managers pay more attention to faces or to data?  Ha!  There is not a single risk management Master’s program anywhere that talks about the importance of faces (or the importance of people for that matter).  A long time ago in this blog series, I blogged about risk management by walking around (RMBWA).  We need more risk managers to manage by reading and understanding faces.  Let the computers take care of the data – let the humans take care of the humans.

Is it time to reassess your hedging practices?

by Stephen McPhie, CA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

Do you have Euro exposures?  Are you worried about the Euro exchange rates?  Are you concerned that volatility will also affect other currencies, perhaps through flight to quality? 

 

As a result, are you scrambling around looking for additional hedges?  If you are, then you should consider if what you are doing is more speculation than hedging.  You should also consider a thorough review of your hedging policies and practices.  A well-conceived hedging policy should be designed precisely for volatile situations such as this and to allow time for longer term adjustments to be implemented. 

 

That is not to say it shouldn’t be constantly reviewed and updated.  It should be.  However, it should not be prone to significant, sudden and little considered changes in times of volatility.

Fiscal Adjustment: Too Much of a Good Thing – Lessons for Risk Management

by Don Alexander, MBA

Associate, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

 

The purpose of models is not to fit the data, but sharpen the questions.

                                                        (Samuel Karlin)

 

Carlo Cottarelli, in a VOXEU communique “Fiscal Adjustment: Too Much of a Good Thing” dated Feb. 8^th notes that a sharp reduction in budget deficits in certain circumstances can actually increase risk.  This raises a question when we attempt to mitigate risks: Does a rapid adjustment actually increase risk? 

 

Almost everyone agrees that the fiscal accounts of several advanced economies are in bad shape and need to be strengthened.  But how fast should the adjustment be in the present circumstances.  At time over the last couple of years, the IMF has called on countries to step up the pace of adjustment when they were perceived as moving too slowly.  The IMF has argued that countries should reduce public-debt ratios through a gradual and steady process.  However in the current environment, some countries are moving too fast. 

 

The IMF Fiscal Monitor (Jan. 2012) indicates deficits are projected to fall by 2% of GDP in 2011-12 in the advanced economies, 3% in Eurozone countries.  Adjustment is reasonable in a good growth environment, but in a weaker macroeconomic environment bringing down this quickly can increase risk to the economic recovery.  IMF research suggests fiscal adjustment that lower debt ratios and deficits can reduce government bond spreads when the impact on growth is limited.  Conversely, when tightening fiscal policy reduces growth, bond spreads can widen, especially with weak growth and fiscal tightening is large.

 

In advanced countries with limited financial options, deficit reduction is the best alternative.  Structural reforms to boost competitiveness and growth along with deficit reduction are critical, but take time to work.  It is important for countries to adjust at an appropriate pace and have adequate financing to boost confidence as market perceptions adjust (such as through the European Financial Stability Facility and the European Stability Mechanism).  Markets eventually respond to better fundamentals with stronger growth and reduced deficits, but this can take a while. 

 

If growth slows, countries should avoid further fiscal tightening.  Countries with flexibility, such as some Eurozone members with lower interest rates, can slow the pace of deficit reduction.   The projected 2% reduction in the U.S. deficit in 2012, the largest in forty years, is excessive.  It is more important for countries, such as the United States, to formulate credible medium-term adjustment plans and gradually reduce the deficit.  The adoption of credible medium-term adjustment plans, which is missing in many advanced countries, would reduce uncertainty.  The cost of policy uncertainty is high, especially if growth starts to slow.

 

Can we learn anything for risk management?

 

For more on this follow the link:  www.voxeu.org/index.php?q=node/7604

 

 

 

Tom Coughlin

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

I am writing this blog before the Super Bowl starts – in fact a couple of days before the Super Bowl starts.  Thus by the time you read this blog it may be totally out of date.  But I will take that risk as I suspect you are tired already of figure skating and already longing for next football season to start.

 

As with every Super Bowl there is no end to the media buildup.  The articles really become quite stupid, and just like reality TV, the more stupid the reporting becomes the more interesting it becomes to look at.

 

Killing time this week while I should be doing something else (although I am writing this blog so that should count for something) I read an article by Joe Posnanski on cnnsi.com.  The article was on “Why Tom Coughlin has become such a good coach”. 

 

One of the players interviewed for the article (Giants linebacker Michael Boley) came out with this gem; “… one of the things that Coach Coughlin always talks about is adjust and mystery.” (Italics added for emphasis.)

 

“Adjust and mystery”.  What a great way for a risk manager to be labeled a good coach.

As Downside Risks Rise, Fiscal Policy Has To Walk a Narrow Path

by Don Alexander, MBA

Assocate, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

The IMF noted in its latest Fiscal Monitor (24^th Jan.) that countries continue to make progress on deficit reduction. 

Fiscal deficits in many advanced economies fell significantly during 2011, and most plan substantial adjustment this year. The pace of fiscal consolidation may slow as too rapid consolidation could exacerbate risks.  Continued adjustment is necessary for medium-term debt sustainability, but should ideally occur at a pace that supports adequate growth in output and employment.   Conversely, too rapid a consolidation in a slowing growth scenario could exacerbate risks.

 

Given the large adjustment already in train this year, governments should avoid responding to any unexpected downturn in growth by further tightening policies, and should instead allow the automatic stabilizers to operate, as long as financing is available and sustainability concerns permit. When economic conditions deteriorate they can cushion the impact on demand.

 

Countries with enough fiscal space (the room in a government's budget that allows it to provide resources for a desired purpose without damaging the sustainability of its financial position or the stability of the economy), including some in the euro area, should reconsider the pace of near-term adjustment. At the same time, some countries—notably, the United States and Japan—need to clarify their medium-term debt-reduction strategies. Adjustment should be supported by the availability of adequate nonmarket financing when, as in the euro area, market confidence is slow to respond to reforms. 

 

Some emerging economies with low debt and deficits and declining inflationary pressure have room to make policy more supportive of economic activity. Others have little space for more than the operation of automatic stabilizers if growth slows.  Emerging economies highly dependent on commodity revenues and external capital inflows also need to consider the risk of a large and protracted decline in these flows.

 

Corporations, like governments, should have contingency plans for meeting funding requirements as part of their risk management plans.

For more on this follow the link: www.imf.org/external/pubs/ft/fm/2012/​update/01/pdf/0112.pdf

 

 

 

 

 

Hippocratic Oath

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

While doing research for my forthcoming book on complexity I came across this modern translation of the Hippocratic Oath.  This of course is the famous oath that medical doctors take when they start their practice.  I thought it was interesting for this risk blog.  Before I explain why, simply read through the oath that I have clipped verbatim from the Wikipedia page on Hippocratic Oath.

A widely used modern version of the traditional oath was penned in 1964 by Dr. Louis Lasagna, former Principal of the Sackler School of Graduate Biomedical Sciences and Academic Dean of the School of Medicine at Tufts University:^[8] 

I swear to fulfill, to the best of my ability and judgment, this covenant:

I will respect the hard-won scientific gains of those physicians in whose steps I walk, and gladly share such knowledge as is mine with those who are to follow.

I will apply, for the benefit of the sick, all measures [that] are required, avoiding those twin traps of overtreatment and therapeutic nihilism.

I will remember that there is art to medicine as well as science, and that warmth, sympathy, and understanding may outweigh the surgeon's knife or the chemist's drug.

I will not be ashamed to say "I know not", nor will I fail to call in my colleagues when the skills of another are needed for a patient's recovery.

I will respect the privacy of my patients, for their problems are not disclosed to me that the world may know. Most especially must I tread with care in matters of life and death. If it is given to me to save a life, all thanks. But it may also be within my power to take a life; this awesome responsibility must be faced with great humbleness and awareness of my own frailty. Above all, I must not play at God.

I will remember that I do not treat a fever chart, a cancerous growth, but a sick human being, whose illness may affect the person's family and economic stability. My responsibility includes these related problems, if I am to care adequately for the sick.

I will prevent disease whenever I can, for prevention is preferable to cure.

I will remember that I remain a member of society with special obligations to all my fellow human beings, those sound of mind and body as well as the infirm.

If I do not violate this oath, may I enjoy life and art, respected while I live and remembered with affection thereafter. May I always act so as to preserve the finest 

 

Capital Budgeting

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

I do a lot of work on capital budgeting.  I teach several classes that focus on it, and of course it plays a major role in several of the training courses that we conduct for various organizations. 

 

I stress that organizations should use a lot of different techniques for capital budgeting including real option analysis, Monte Carlo Simulation, and decision analysis whenever possible.  Successful capital budgeting often is the determining point between whether a company is thriving or dying five years down the road. 

 

The capital budgeting task is filled with risk and uncertainty.  Given that, it is rare that the risk department is a fully integrated team into the capital budgeting process.  There are a variety of reasons for this; the silofication of treasury and finance functions, ignorance of capital budgeting techniques by risk managers, ignorance of risk management by the capital budgeting team, as well as a host of others.

 

I believe that if there is one area that risk managers could make a positive and significance difference it is early in the capital budgeting process.  Sad that this rarely happens.

Untitled

by Don Alexander, MBA

Associate, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

The increased strains from the euro area debt crisis continue to weigh on global economic prospects and caused the IMF to sharply cut its forecast for global growth this year, have dimmed prospects and financial stability risks have increased noted in the latest market update (IMF Global Market Stability Report “GMSR” Market Update, Jan. 2012).

 

Since the last GMSR, the risks for stability have increased, despite various policy steps to contain the euro area debt crisis and banking crisis.  European policymakers have outlined significant policy measures to address the medium-term issues contributing to the crisis, and some of these have helped improve market sentiment, but sovereign financing remains challenging and downside risks remain. 

 

If funding challenges result in a round of de-leveraging by banks, this could ignite an adverse feedback loop to euro area economies.  The US and other advanced countries have homegrown challenges in the removal of financial tail risks, including overcoming obstacles to achieving an appropriate pace of fiscal consolidation.  Developments in the euro area also threaten emerging Europe and may spillover elsewhere. 

 

Further policy actions are needed to restore market confidence.  This effort will require building larger backstops for sovereign financing, assuring adequate bank funding and capital, and maintaining a sufficient flow of credit to the economy possibly establishing a “gatekeeper” charged with prevent a disorderly bank deleveraging. 

 

Emerging markets, outside of Europe, and Asian countries are exposed to downside risks as weaker macroeconomic prospects make them vulnerable to spillovers from the European debt crisis.  Authorities in advanced countries will need to address banking issues, make necessary adjustments without a large impact on growth prospects.  Policymakers in other areas may need to address issues relating to funding and credit strains, especially if global growth continues to stall

For more information on this follow the link: www.imf.org/external/pubs/ft/fmu/eng/​2012/01/index.htm

Filter

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

I was at a meeting last week and someone tried to insult me by saying “there you go, talking without your filter again”.  They may have meant it as an insult, but I take it as a compliment.  They implied that I was being politically uncouth by saying what I thought and believed, rather than by saying what everyone wanted to hear. 

 

How effective are filters in your risk department?  How often do they get changed?  How clogged are they?  Do you need them?  Do you want them?  Do they actually help?  Do they actually help in the long term?

Mispricing of Sovereign Risk & Policy Errors

by Don Alexander, MBA

Associate, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

The recent surge in the peripheral European country bond spreads has been a major source of concern to financial markets, as investors try to estimate whether it is a change in fundamentals or shifting market sentiment.   It is similar to risk management where we have to understand the source of risk.  Paul de Grauwe and Yuemei Ji attempt to address this issue in a Jan. 2012 VOXEU communique called Mispricing of Sovereign Risk and Multiple Equilibria in the Eurozone.

 

De Grauwe & Li note that markets were wrong in placing the same risk premium on Greek bonds as on German bonds from 2001-08.    Since the start of the sovereign debt crisis, financial markets are making errors in the other direction – they overestimate risks...  Now they are wrong in overestimating the risk that the peripheral countries will default. 

           

The surge in peripheral country spreads since 2010 is disconnected from fundamentals such as debt-to-GDP ratios and current-account positions, and is more attributable to negative market sentiment.  De Grauwe & Li note that after investors long ignored high debt-to-GDP ratios, the resulting surge in negative sentiment caused a rise in spreads.  However, standalone countries with high debt ratios were immune to these liquidity crises and did not experience an increase in spreads.  This was consistent with earlier research that found government bond markets in a monetary union are more fragile and susceptible to self-fulfilling liquidity crises. 

The Eurozone crisis is also a story of systemic mispricing of sovereign debt, which in turn led to macroeconomic instability and multiple equilibria.  The underpricing of sovereign risk in 2001-2008 in the peripheral countries led to unsustainable booms in consumption and real estate.  The overpricing of sovereign risk since 2010 led to a self-fulfilling downward spiral into bad equilibria characterized by solvency crises and deep recessions. 

The lesson for policymakers is that when spreads are tightly linked to underlying fundamentals such as the debt-to-GDP, the best option for spread reduction is to improve debt fundamentals. In contrast, any disconnect between spreads and fundamentals, a policy of exclusive focus on debt reduction will not be sufficient and force countries into a bad equilibrium.  This can be achieved by active ECB liquidity policies that prevent a liquidity crisis in government bond markets turning to a self-fulfilling solvency crisis.

The lesson is that any policy aimed at improving fundamentals through fiscal austerity and a policy of liquidity provision from the central bank are not substitutes, but complements.  In contrast, any country that is a member of a monetary union hit by a liquidity crisis that leads to a disconnect between spreads and fundamentals, will require both policies.  These policies should not be seen as “either/or” options.

The systematic mispricing of sovereign risk in the Eurozone intensifies macroeconomic instability, leading to bubbles in good years and excessive austerity in bad years.  The failure to address these issues has increased the duration and the cost of crisis resolution.  Perhaps, we can learn some lessons for risk management.

For more on this follow the link:  www.voxeu.org/index.php?q=node/7553

 

 

System D Economics

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.,

www.RSDsolutions.com

info@RSDsolutions.com

 

 

Spending a yucky Saturday afternoon catching up on last month’s Wired (just got this month’s issue in the mail so I need to clear out last month’s).  Wired is one of my favorite magazines and I always seem to find something useful in it.

 

In the January 2012 issue however I was initially ticked off by one article titled Slumdog Economist, which highlights some of the work of economist Robert Neuwirth who studies the underground economy.  I reason I was ticked off is that I always wanted to study the marketing habits of street vendors.  He stole my idea!  How dare he!?

 

Kidding aside, it is a great article that looks at the underground economy of street vendors or those that work under the table.  Neuwirth calls this the System D economy.  Some fascinating ideas and facts in the article and I highly recommend that you take a moment to take a glance at it.

 

One of the surprising facts that comes up in the article is that currently 50% of workers globally are part of System D and that is projected to rise to 2/3rds by 2020.  Take that you global multinationals!

 

Neuwirth explains many of the reasons for this surprisingly rapid rise of System D, but the most telling response to why the rapid growth is in this statement; “Because it’s based purely on unfettered entrepreneurialism.  Law-abiding companies in the developing world often have to work through all sorts of red tape and corruption.  The System D enterprises avoid all that.”

 

In my work as a consultant with many corporations what I see is a lot of red tape and corruption.  True, the corruption may be slightly different than the type of corruption that Neuwirth is implying, but in my scheme of things, political interference is still corruption, and red tape is red tape.

 

Risk departments (all departments) should be allowed to do their work in the absence of red tape and corruption.  That may be an obvious statement.  What might not be so obvious is that risk departments should also work on a principle of pure unfettered entrepreneurialism.  Is yours?