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. 

Twitter Risk

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

 

With the title I suspect you thought I was going to blog today about the risks of having people within (and external to) your organization tweet about the organization.  I’m not – but probably will at some time in the future.

 

What I thought I would spout off on today is how Twitter is slowly changing our language patterns.  Expressing your thoughts in 140 characters or less is definitely having an effect on spelling and grammar.  However I believe the bigger effect is on how we think in terms of small, single, thought bits, rather than in more complex and nuanced ways.

 

I am obviously not the only one who thinks this.  For instance, the fact that there is a service called Longreads (www.Longreads.com) shows that others are realizing that our media (and our thoughts) are becoming more sound bites than biting.  (BTW – I highly recommend LongReads.  Great articles.)

 

Now back to my point about Twitter.  Encapsulating your thoughts in 140 characters or less is not all bad.  For one thing it forces you to be sharp and to the point.  It also forces you to cut out the unnecessary.  Struck and White would probably be big fans.  Here is the question – could you publish your risk results using Twitter?  Should you?

How do you recognise the best risk manager?

by Stephen McPhie, CA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

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.

BRIC … BTIC

by Stephen McPhie, CA

Partner, RSD Solutions Inc.,

www.RSDsolutions.com

info@RSDsolutions.com

 

 

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!

Regulation and Risk Reduction in the Shadow Banking Sector

by Don Alexander, MBA

Associate, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

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. 16^th) 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

Italy – Credibility or Fundamentals

by Don Alexander, MBA

Associate, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

Credit default swaps for Italy have surged over the last few weeks as the Italian government of Silvio Berlusconi seems to be occupied elsewhere.

In the Voxeu article Credibility is not everything, Paolo Manasse notes that many analysts have argued that the Eurozone emergency meetings could restore creditability if they came out with an all encompassing program.  However, this may not work in Italy where the problem is not credibility, but continued deterioration of the fundamentals.

For Italy, self-fulfilling prophecies may generate opposite and unpredictable outcomes for the same level of fundamentals.  This can result multiple equilibria such as a favorable debt/GDP and primary balance depending on market expectations which may suggest solvency or insolvency depending on prevailing market view. 

The favorable prospects of Italy joining the euro and reducing currency risk allowed the average cost of debt to drop from 10% to 4% in 1996 and the interest bill declined from 12% to 4% of GDP.  This allowed for a significant improvement of the budget and a strong reduction of the debt ratio.  However, this progress was squandered due to a deterioration of fundamentals since 2004.  The debt to GDP level is now back to 1996 levels and the primary balance is near negative territory.  It is only a matter of time before market rates move higher on worsening fundamentals.

The market gave too little consideration to fundamentals such as the debt/GDP ratio and primary surplus, assuming that Italy’s default and possible exit from the euro was inconceivable.  If you look at history, bond yields could return to levels last seen in 1996.  The prospect of Mr. Berlusconi resignation is necessary at this point, however, it is hardly a substitute for taking decisive action for fiscal adjustment.

Italy provides a good lesson for risk management.  Risks can return when we least expect them and the risk manager cannot get distracted from their primary job –managing risk. 

For more on this story follow the link:  http://www.voxeu.org/index.php?q=node/7187

1952

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

 

 

One of my guilty pleasures is going through old magazines – particularly old business magazines from the 50’s and 60’s.  It is a very useful exercise in that you frequently observe that the factors and practices that made companies successful 50 and 60 years ago are the same factors or practices that make them successful today.  In essence there are a set of best business practices that are timeless.

 

This raises an interesting, and perhaps troubling point.  What risk practices are timeless?  What risk practices that we currently utilize would have also been considered to be best risk practice in the 1950’s?  What risk practices from the 1950’s are still considered to be best risk practices?  What risk practices from today will be considered best risk practice in 2060?

Wordless PowerPoint

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

 

We all dislike (hate) the conference PowerPoint presentation.  Slide after slide dulling your senses and killing grey cells – forever to be forgotten 7 nanoseconds after the conclusion of the presentation.

 

To combat death by PowerPoint various new styles and formats are being promoted – and indeed I try to integrate some of the new styles into my professional and academic presentations.  One of the more common types of “enlightened” presentation is to construct a PowerPoint that has no words – only pictures.  The thinking behind this is that pictures evoke emotions (which are better remembered and understood by audience members) and pictures also force listeners to focus on the speaker (and who, as speaker, does not want the focus to be on them?)  Wordless PowerPoints are rapidly catching on, and I suspect you have been the victim (or perhaps the perpetrator) of them yourself. 

 

As a consultant I have an idea and a challenge for you.  The next time you have to give a risk presentation, can you make it mathless?  Can you give a risk presentation that has no math, no numbers, and no graphs?  Can you create a risk based presentation that evokes emotions, understanding, and keeps the focus on you – the speaker and professional?

Eurozone Leaders still don’t get it

by Don Alexander, MBA

Associate, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

Eurozone policymakers have put together another plan to save the euro.  Will it work – only time will tell?  Charles Wyplosz, in a communiqué They still don’t get it (VOXEU, 25^th Oct.) reviews recent progress.  He is not optimistic they will take the necessary steps.  He notes that by rejecting an ECB role, leaders have guaranteed that any package will fail as too little too late.  They are addressing two of the three needed steps: putting Greece on a sustainable path and backstopping banks.  The last stop still needed is to backstop all European sovereign debt to avoid contagion. 

 

The author identified three issues in an earlier VOXEU column (22^nd Aug 2011) for policymakers: a clear misunderstanding of the situation, understanding the danger ahead, and unwilling to take the necessary steps to resolve the situation.  The real danger is contagion has spread to Italy and Spain pass the point of no return and the risk of spreading to core countries.

 

The European Financial Stability Facility (EFSF) is too small to deal with the amounts involved, even under the new proposal.  The authorities must move ahead of the curve and put together policies to contain the crisis and avoid further contagion – the new proposal may not be enough.  This can be accomplished by placing a floor under public debt valuation.  This can be accomplished two ways: the ECB can act as a guarantor of public debt as maturing debt is rolled over and the second approach is to replace maturing Eurozone debt with Eurobonds. 

 

The ECB is the only institution that can deal with the amounts involved and provide breathing space to address bank recapitalization.  The continued rescue packages for banks and government are creating moral hazard problems.  Long-term, authorities must address the weakness of the Stability and Growth Pact and enact restrictive fiscal policies with monitoring.  Wyplosz notes that recapitalizing Greek banks is a temporary solution, but could undermine its purpose by increasing debt levels.  The only solution is to tap the EFSF short-term and involve the ECB to provide a backstop for public debt.

 

The worst outcome is to reject a role for the ECB.  The lack of a backstop for public debt prices will allow the crisis to fester and deepen pushing up the cost of resolution. 

 

For more on this follow the link:  http://www.voxeu.org/index.php?q=node/6845

Stupid Interview Question

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

Working with MBA students is always busy this time of year.  Students are in the final round of interviews and they are always anxious and looking for any advice they can get that will give them an edge.  To that end, I often see a fairly large number of students in my university office looking for interview tips.

 

Interviews have changed a bit since I was in the middle of looking for a job after graduation.  In my day an interview was assessing your skills and trying to ascertain if you were a likable person or not.  When I was interviewing, it was always a line manager that did the initial interviews, and they were often inconsistent in how they went about things.  Now it is human resource professionals who supposedly have much more systematic and objective interviewing techniques.  The goal now is to assess behavioural traits.  Competence and the ability to do a good job are on the list – but quite far down the list.

 

In my day interview questions were along the lines of what do you know, and what have you done.  Now that ask questions like “If you were a tree, what type of tree would you be?” I understand why they ask that type of question, but ultimately it has become such a common question (or style of question), that in my opinion it is just plain stupid.  I am not a tree, I have no immediate plans to become a tree, and if I was a tree I am quite confident that no one would want to pay me a salary.

 

That may be considered cynical however.  So just to show that I can be open minded, I will ask the question of risk professionals; “If risk management were a tree, what type of a tree would it be?”  That’s just stupid, but a hell of a lot of fun to discuss at the water-cooler!

Wanted: An Inuit Risk Manager

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

Recently while driving home from my teaching engineering students about entrepreneurship I was listening to the CBC radio program “Ideas” which had at that time a woman who studied the Inuit (the indigenous people of the Canadian arctic) language and by default its culture.  One of her more interesting discoveries is that one of the Inuit dialects has a term which best translates to X-ray eyes – in this case it is used to describe the situation a lone hunter may find themselves in when on the ice floes.  The idea is that the hunter is alone and with no form of contact with anyone and thus by necessity is forced by themselves to see through all the options that lay before them and “see” their consequences before acting. 

 

This powerful cultural characteristic would be a very desirable trait for a risk manager (and the rest of us).  Effectively what the hunter has done is eliminating the “noise”, list the options and play them out to see which has the greatest net benefit or chance of success – be that pure survival or food.  This would be a highly desirable trait for a risk manager and the metaphor of survival (no bankruptcy) or food (profitability) is rather fitting.  

IMF Fiscal Monitor – Progress on Deficit Reduction

by Don Alexander, MBA

Associate, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

According to a recent IMF report, governments are making progress in addressing fiscal policy issues, but downside risks remain elevated as 2011 growth prospects are reduced.  The rising public debt levels in advanced countries are projected to top 100 percent of GDP in 2011.  A large portion of the increase came since 2007 from a drop in GDP, lower revenues and elevated spending damaging government balance sheets.

Overall, fiscal adjustment in advanced countries has declined by over 2% of GDP since 2010.  The improvement in most cases was at or better than expectations.  Progress in fiscal adjustment is better than expected. 

For Europe, the challenge is to sustain fiscal consolidation while minimizing the growth fallout.  Europe needs to focus on crisis resolution mechanisms to help resolve the solvency issues and limit contagion.  Overall, the deficits in the euro area are expected to decline by 2% of GDP this year and 1% next year.  The speed and severity of the spread of financial pressures in the euro should serve as a lesson for the United States and Japan. 

In the United States, a focus is needed on entitlement and tax reforms as well as measures needed to raise revenues and broaden the tax base.  The U.S. deficit is projected to decline by 1% of GDP to 9.6% for 2011.  For Japan, disaster relief and reconstruction are short-term objectives, but more detailed medium-term planning is needed to focus on reducing the debt and budget deficit ratio and raising tax revenues through reforms. 

Emerging markets emerged from the crisis in relatively good shape, with continued progress expected on deficit reduction.  A few countries could be vulnerable to shift in capital inflows.  Low-income countries survived based on buffers built-up in good times, but need to address social spending and their vulnerability to rising food and commodity prices.

However, despite the IMF’s relative slightly optimistic view markets remain concerned about growth prospects.  The IMF noted two risks in the outlook: that public sector insolvency and/or that excessive fiscal tightening are not sources of instability.  The optimal policy is to reduce the deficit in a timely manner without severely impacting growth.

For more on this click on the link to the IMF site:  www.imf.org/external/pubs/ft/fm/2011/02/fmindex.htm

Cash everywhere, but what to do with it!

by Stephen McPhie, CA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

 

Many companies are hoarding cash at present.  Apple is a prime example with over $80 billion of cash.  This indicates that businesses are reluctant to go on buying sprees of targets that might seem cheap at the moment but might become cheaper in coming months.  It also indicates that they are keeping reserves in place in case the global economic situation continues to deteriorate.  These factors also make them more reluctant to return cash to shareholders in the form of dividends or share buy backs.  Normally it is considered inefficient for companies to hold large cash balances as they reduce returns to shareholders.  However, the foregoing illustrates that there are good reasons at present for companies to hoard at least a certain prudent amount of cash.

 

Of course, U.S. companies also have the problem of “stranded cash” (or “trapped cash”); that is cash held in foreign subsidiaries, which is very tax-inefficient to repatriate.

 

High cash balances in a company should beg certain questions, especially in the current climate.  In what is it invested?  What currencies is it invested in?  How liquid is it?  Is it earning the best return possible?  Even investments that were recently considered very low risk need to be focused on right now.  Is your company investing enough additional time and expertise in managing cash?  Does your Board of Directors take an interest? 

 

The risks are huge and we have certainly seen companies with growing and substantial cash balances that are not beefing up their investment strategies, risk management, controls and oversight accordingly.  Some can manage to these issues internally.  Others could use outside help for a very modest expenditure in relation to the risks and possible downsides they face.  Doing nothing more than has been done before seems particularly unwise.

We seek it here, we seek it there. Is risk everywhere?

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

Seeking risk in everything can sometimes be as debilitating as not seeking or understand risk at all.  One of my favourite blog discussion points is those dealing with individuals and organizations that spend great human and financial capital to minimize downside risk.  It can be argued that everything entails some degree of risk (which should not be equated with opportunity costs) but at times, the likelihood of occurrence of the actual cost when the risk is realized is rather trivial. 

 

 

The word of advice here is understand the risks you or your organization face and identify those with true cost (financial and in human capital) to the firm for addressing the others may set your firm back on innumerable levels.

 

Note:  A thank you to "funny times" (http://www.funnytimes.com/cartoons_tag_result.php?tag=risk) for today's risk cartoon.

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.

Engagement

by Rick Nason, PhD, CFA
Partner, RSD Solutions Inc.
www.RSDsolutions.com
info@RSDsolutions.com

At RSD we do a lot of training.  It is something that we are good at, and something that we enjoy doing.  I believe that being good at something has much less to do with skill and much more to do with passion – or even the more pedestrian “enjoying what you do”.

When we are first contacted by companies about training, they always present us with a wish list of topics that they want their people “trained” on.  In this age of efficiency, the list of topics is always much longer than the time allotted to the training.  This quest for efficiency in training is quite understandable.  However the real efficiency comes not from cramming a lot of training into a short period of time, but from cramming a lot of engagement into a short period of time.

No one likes cramming – admit it, did you really like cramming for an exam when you were in school?  No – it was a drag, a bore, and totally ineffective as you probably lost 90% of the information you crammed within three days after the exam.

What is effective in training is getting engagement of the participants.  At RSD we focus on engagement and getting people who “do things” rather than people who “know things”.  With engagement, training is fun, effective and efficient.  You learn so much better when you want to rather than when you have to.  Cramming sucks.  Engagement is a joy.

Risk Energy

Normal 0 false false false EN-CA X-NONE X-NONE

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

Oswald Gruebel, CEO of embattled UBS is quoted in the paper saying that the recent loss at the firm could not have been prevented because, “If someone acts with criminal energy, then you can’t do anything.  That will always be the case in our business.”

I understand that preventing criminal activity is extremely difficult, but criminal activity to the tune of $2.3 billion is something else.  Where was the risk energy?

Black Swan events: Sadly, global IT projects are turning the rare into the everyday

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

In 2007 Nassiam Nicholas Taleb had his book “The Black Swan – The Impact of the highly improbable” published and with it brought to the fore the term “black swan event”.  As defined by Mr. Taleb it is an event that is either never considered or considered extremely unlikely to occur, but when it does occur it is not surprising and usually easily comprehendible (we should have seen it coming).  The book goes onto explain many examples of black swan events such as 9/11 and Microsoft and events which the mass media feel are black swan events but are not – typically stock market gyrations.  This later use of the term is now being applied to large-scale global IT projects (in excess of $170 million USD) where “it found that while most projects ran less than 30% over budget, a sixth ended up costing on average three times (!!!) as much.  The study also raised concerns about the adequacy of traditional risk-modeling systems to cope with IT projects, with large-scale computer spending found to be 20 times more likely to spiral out of control than expected."  Clearly these over-runs are not a black swan event in the more pure definition.

 

This situation beckons a lot of questions surrounding risk modeling, the varied expertise that forecast costs and management seeing an anomaly and not recognizing it as the trend (fact?).  As the world settles into a new century with new paradigms and new risks, does your firm still consider (hope) that the rare is still rare and not the signs of a trend? 

 

For more on IT’s Black Swans check out this BBC news story:  http://tinyurl.com/3ruj4yf 

For more on Mr. Taleb’s excellent seminal work follow the link:  http://tinyurl.com/3h64jdl

 

Understanding the Paradigm for Risk Management: Lessons from the Crisis

by Don Alexander, MBA

Associate, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

 

A key question for risk management: do you have the correct framework to analyze risks.  This is a question that Claudio Borio & Piti Disyatat (Bank for International Settlements) ask in a recent VOXEU communiqué “Did Global Imbalances Cause the Financial Crisis?” about international policymakers?  The authors note the emphasis on current-account imbalances diverts attention away from monetary and fiscal factors that sowed the seeds of destruction leading to the underestimation and mispricing of risk.   

 

A key part in G20 and IMF discussions was the role of financial imbalances in causing the recent financial crisis.  The focus on savings-investment balances, current accounts and net capital flows may be flawed.  The authors suggest that other factors should be considered as causal factors and could provide a better understanding of the process and linkages. 

 

The authors object to two key policymaker assumptions: (1) net capital flows from current-account surplus to deficit countries helped finance credit booms; and (2) a rise in savings relative to investment in surplus countries depressed global rates.  The authors argue that global imbalances, which measure net flows, provide little evidence about global financing patterns based on the surge in gross capital flows that was largely between advanced countries.  These flows increased from 10% of world GDP in 1998 to 30% in 2007 and were driven by flows between advanced countries.  The surge in US gross capital flows involved developed areas not running a current account surplus and was private in nature.  Net capital flows do not capture the disruptions created by 2008’s collapse in cross-border lending.  Excess savings or the unwinding of global imbalances did not trigger the crisis; disruptions in the chain of global intermediation did. 

 

Their second critique is that the excess-savings view provides an incomplete explanation of low global rates.  Market interest rates reflect both monetary and financial factors: central bank policy rates, risk premia, market expectations, and supply and demand for assets.  These factors interacting with artificially low policy rates contributed to the turmoil. 

 

The authors conclude that global imbalances offered little explanation about the global intermediation process behind the credit boom or how contagion is transmitted.  The international monetary and financial system lacks a strong policy framework to prevent future credit bubbles and asset booms.  The authors suggest that without a better understanding of the analytical framework, policymakers could be prone to policy errors, faulty assumptions and flawed risk estimation.

 

Do you have the correct framework in place to understand potential risks?

 

The first author, Claudio Borio, was one of the first to note a rise in systemic risk at a presentation at Jackson Hole in 2003.

http://www.voxeu.org/index.php?q=node/6795