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.

Foxes vs. Hedgehogs

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

A fox knows many things.  A hedgehog knows only one thing, but knows it well.  Is your risk management unit a fox or a hedgehog?  There are arguments for both strategies (for example the well known  book Good to Great argues that hedgehog firms perform best, while most will agree that having a portfolio of ideas is preferable).  What is not acceptable however is not knowing which category the firm falls into. 

 

A firm that thinks it is a fox, when it is in reality a hedgehog is as stupid, weak and exposed as a firm that thinks it is a hedgehog when in reality it is a fox.  So what is it?  Is your risk management unit a fox or a hedgehog?

 

“…, This century is different”: A quote right on cue

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

 

Predicting the future is fun for you are never wrong until it happens:  one of my past times is looking back at future predictions and comparing them to the current reality.  Great insight can be gained from this – usually it is that trends don’t continue indefinitely because some other reality appears like higher energy prices or some form of political (in) stability.  My favourite forecaster of the social and economic reality of the 21^st century is William Draves (left in above photo) and his book “Nine Shift” which looks at the nine shifts in human behavior that will come about this century.  His book is interesting for it not only makes the predictions but also provides the time line for them to occur.  Published in 2004 this little read book is spot on on innumerable levels.

 

The above quote is from a recent Bloomberg article on US employment - the realization about this century being different is right on cue with Mr. Draves's forecast.  In his book, Draves believed it would be around 2012 that the world would begin to realize that we are living in a very different economic and social environment – and this for a trend that started at the birth of World Wide Web. 

 

Does this story sound familiar to your business – are you in a state of denial that we are now living within a new paradigm and that 20^th century business practices and risk management techniques will get you through the new (?) century?  Definitely food for thought and I would recommend to you to have a read of Mr. Draves’s book to perhaps learn about the “Shifts” that are taking place or check out his website for current confirmations. 

 

(A special thank you to Jeff Roach (http://jeffroach.ca) (of Sociallogical (http://sociallogical.com) for introducing me to Nine Shift)

 

For more on William Draves, follow the link:  http://www.nineshift.com/

 

For more on what is different, click on the link to the Vivien Lou Chen’s article in Bloomberg: http://tinyurl.com/3dbyp2k

 

Experience Precedes

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

What do the books “The Inner Game of Tennis” (by Timothy Gallway) and “Managers Not MBAs” (by Henry Mintzberg) have in common?  The answer is that both argue in their own way that “Experience precedes technical knowledge”.

 

“Experience precedes technical knowledge” is a direct quote from the Inner Game – the best selling tennis book that was originally published in the 1970’s.  The argument is basically that you do not know much about playing tennis until you have picked up a racquet and hit some tennis balls.  Technical expertise is meaningless unless you have experience.  Mintzberg argues much the same thing when he essentially argues that MBA programs have limited effectiveness due to the limited experience of the students in business school.

 

This brings us to risk management.  The demands of quantitative regulation (regulation by means of quantitative measures) and the prominence of quantitative techniques for best practice in risk management has led to an emphasis on technical knowledge over experience.  In my opinion this puts the cart before the horse, and is as useful as hiring a PhD in tennis as your tennis coach, even though the person has never picked up a tennis racquet.

Watches

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

I have noticed with interest the rise in popularity of luxury watches.  The exorbitant prices (sometimes into six figures) charged for these watches are justified in large part by their ”complications”.  The thinking goes that the more “complicated” a watch is in its manufacture, the more that collectors are willing to pay.  On one level this makes a lot of sense.  A more complicated watch should in theory perform better, and the craftsman who took the extra time and effort to create the complicated watch should be compensated for their skill and their efforts.

 

Paying a $100,000 or more for a watch however begs the question of what exactly a watch is supposed to do.  A watch of course is supposed to tell time.  Does a $100,000 watch tell time better than a $50 Timex (a watch that “takes a licking and keeps on ticking”)?  The answer of course is no – a Timex tells time just as accurately and with much less required maintenance than a “complicated” watch costing more than a 1,000 times more.

 

Now I do not intend to start blogging on horology, so you may be wondering what this has to do with risk management.  Simple.  The more firms that I work with, the more I have come to realize that firms are putting their faith into having a “complicated” risk management system, rather than a simple one that works.  In other words, companies believe a “complicated” timepiece will help them tell time better than a “Timex”.  “Complicated” does not mean better.  Functional is better.  Is your risk management emphasis on functional or complicated?

Top 50 Risk Management Blogs + 1

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

RSD Solutions has been blogging about risk and the topics surrounding it for a few years now and more recently stepped it up to a regular blog.  While RSD tends to look at finance, the "art" of risk management and a few daily quirks we see in the field or on the net, there are innumerable other areas of risk we do not reach into.  For the benefit of those who work in areas outside of finance or strategic risk management, we at RSD thought you might like to see what other risk blogs are out there.  So,… click on the link (http://www.pmpcertificationtraining.org/risk-management) for the top 50 blogs, as chosen by the good people who bring you the Project Management Professional designation.  It is an interesting list of risk blogs on subjects such as workers' compensation, IT security, and injury prevention plus many more. 

 

Of course, we at RSD do hope you continue to follow us and "subscribe" to our blog.  We endeavor to bring you a variety of contributors who write about risk management issues in both a general and targeted way and sometimes with a touch of humour. And who knows, maybe one day RSD will gain a spot on that list and you will be able to point out how you were an early adopter/follower and trend setter.

The Real Effect of Debt – Rising Systemic Risk

by Don Alexander, MBA

Associate, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

The Real Effect of Debt (Federal Reserve of Kansas City Jackson Hole Economic Policy Symposium, Stephen G Cecchetti, M S Mohanty and Fabrizio Zampolli, Aug. 2011) Cecchetti et al, in a recent paper referenced below, looked at the debt levels and saw in moderate levels, it can improve welfare and enhance growth.  However, high levels can have damaging effects. 

The authors extend the work of Reinhart & Rogoff (2009) on government debt by including non-corporate and household debt.  Based on estimations that include government, corporate and household debt from 1980 to 2010, the authors find that excessive debt levels can have a damaging impact on economic activity.  The safe level for government debt is in a range of 80-100% of GDP.  This was consistent with earlier studies, but the study was limited to advance countries and looked at data from the last 30 years. 

The implication is that countries with high government debt levels must act quickly to address fiscal problems.  Otherwise, these countries can experience a sustained period of stagnation.  Long-term, a fiscal cushion is needed as a buffer for extraordinary events. 

Similarly, the authors find that moderate levels of corporate and household debt can enhance economic prospects.  The results suggest the threshold level for corporate debt is 90% of GDP and the level for household debt is 85% of GDP, although the result is less robust.  Total debt levels in all three sectors have increased from 165% of GDP to 310% of GDP over the last 30 years.  The most striking implication is that advanced countries are in worse shape than previously thought. 

The problem is compounded by future promises made to the people, an aging workforce and slower population growth, and lower long-term economic growth prospects.  As a result, debt rises faster, reinforcing its downward impact while raising the return demanded by investors.  The authors, economists at the Bank for International Settlements, conclude that advanced countries need to act decisively to address fiscal problems before the adjustment costs become prohibitive.

Systemic risk will be elevated for the immediate future until the debt overhang is addressed.  

 

For more information on this, follow the link:  http://tinyurl.com/3lwhww2  

 

Omniscient

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

If you were omniscient, what would you do differently as a risk manager?  What information would you need to know to consider yourself to be omniscient?  Aren’t they interesting questions?

Robustness

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

Simply put robustness is how much of a hit, or abnormality a system can take until it breaks down.  Risk management of course is used to ensure that a company’s operation remain robust.  Various risk measures are taken to calculate the potential exposure, and risk mitigants are utilized to ensure that the company’s operations remain sound and profitable.  All good, simple common sense. 

 

Flipping the concept around – does it make sense to ask how robust is your risk system?  In other words, how much of a change from normal assumptions or conditions can your risk measurements take before your models and metrics breakdown?  Instead of constantly performing risk checks on the company operations, perhaps the company should periodically perform a risk check on its risk system.  A risk system cannot keep a company robust if the risk system itself is not robust!

Three Body Problem

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

The three body problem is a classic problem of physics.  Simply stated, the three body problem of physics states that if your have three particles (think of the classic billiard balls) coming together at once, then prediction of the subsequent path of the three particles is impossible.  The insolvability exists for any number of particles three or greater coming together simultaneously.  Two particles coming together is a problem that virtually all freshmen physics classes explore at length.  A two-particle problem is a piece of cake to solve – three particles is a no-go.

 

Is your organization operating in a world where it will only collide with one other issue at a time (a classic two body problem), or does your organization operate in a world where more than two issues are affecting it at any time (a classic three – or n-body problem)?  Does your organization assume two-body solutions?   See the problem?

 

 

When logical,... isn’t

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

 

 

Risk managmenet algorithms are designed to give you an answer but not the solution.  When devising a solution does your risk team call upon diverse sets of experience, common sense and third party views?  For it is possible that if you followed the obvious logical route you may end up getting wet.

 

A nod to the people at ProductDecisions.org for the cartoon:  http://tinyurl.com/3stu3oe

 

When group think predicts the future: A lesson for risk management

by Michael Arbow

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

Health experts in the US have warned that unless a trend is broken, half the US population will be obese by 2030 (about 164 million people): their solution is to get governments to resolve the problem through increased education and taxation on fattening foods.  This analysis and the resulting solution outline a few issues experienced in risk management; namely group/clone think and the need for a “man made” solution to natural phenomena.  By broading their health research and consulting with economist, agriculturalist and global population experts they would have learnt that the trend can’t continue because the growth in world population and wealth, the transfer of food from mouths to fuel tanks and the falling rate of increases in food growing productivity (amount of food grown per hectare) are all leading to higher real food prices.  As prices rise there will be demand destruction (Americans consume on average 12 times more food than they need to survive, Japan 7) and consumption of food will move to more historical levels.  Thus the trend will not continue as it will be ended through natural economic conditions of supply and demand.

 

So you can see from this example how group think when applied to risk management can lead to a possible false conclusion which the groups then feels obliged to mitigate.  So the question is:  How does your risk team go about reducing the chance of group think – do they bring in other departments, seek guidance from the cloud, or bring in independent third party views? 

 

For more on this article from the UK’s Daily Mail online service follow the link: http://tinyurl.com/3w43889

Measuring earthquakes: A lesson for measuring risk

 

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

Last week, areas on the Eastern U.S. seaboard and parts of central and eastern Canada experienced a rare earthquake which emanated from Mineral, Virginia.  Damage was minimal.  As measured by the traditional Richter magnitude scale, the quake was recorded as 5.8.  The Richter scale has been the bench mark for measuring earthquakes since 1935 but the 1997 work of Rachel Davidson advocates use of an Earthquake Disaster Risk Index.  Ms. Davidson believes that what is more important isn’t the magnitude of the quake but rather the damage.  Case in point: Haiti recorded a magnitude 7.0 earthquake which led to the loss of 230,000 lives while Japan’s recent 9.0 led to 16,000 deaths (an earthquake 1000 times stronger).  Haiti’s high death toll is attributed to poor construction and rescue operations.  So how does this map onto enterprise risk management?

 

First, traditional benchmarks or test of risk exposure may have outlived their usefulness.  Second and more importantly when looking at risk, one may wish to take a more granular look at the impact of an economic quake in each department or product rather than the company as a whole.  At a high level (Richter scale) the economic quake maybe neutralized but at a more granular level products and/or divisions maybe wiped out.  Identifying and realizing this can focus corporate resources to areas in need so to better mitigate their risk.

 

For more about Stanford's Rachel Davidson’s work click on the link:  http://tinyurl.com/4ymv83u

 

 

How do we incorporate bullying in risk management assessment?

by Stephen McPhie, CA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

 

Most of us have seen them, either in our own organization or in that of an acquaintance.  Some of them are visionary and some are just plain wrong some or most of the time.  What many of them share is an absolute belief in themselves and an absolute intolerance of being questioned by those below them.  Others are just covering up their own inferiorities.  They are senior management bullies.  And when the bully is the top guy, disaster could lurk.  No normal risk management system can offset or effectively mitigate such a situation. 

 

By all accounts the former CEO of Royal Bank of Scotland ruled his domain by fear until the bank required a huge government bail out and he acquired the dubious distinction of becoming the most hated person in Britain according to some opinion polls.  Accounts by people who worked under him suggest that everyone lived in terror of the guy.  And this was a person who was aggressively trying to make his institution into the largest bank in the world.  He nearly succeeded - on paper – until the whole thing came crashing down in sea of bad assets.  Nobody in the bank dared stand up to him.  And he probably steamrollered the board.  (I’ve seen smart aggressive CEO’s steamroller boards many times before.  Most board members barely understand their company’s business let alone have the knowledge to sustain an effective argument against such a CEO.)

 

I’ve seen his breed of CEO a number of times.  Of course, you want a CEO who believes in himself and his strategy.  However, you don’t want a person to be an absolute power unto himself (or herself) and able to run amok with shareholders’ creditors and other stakeholders’ livelihoods.

 

So if you are analysing a business, do you include the CEO’s personality type in your assessment?  If so, how?  Is your own business in this situation?  If so, what can be done about it, if anything?

 

Risk: Created and negated by you and nobody else but you

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

Recently I went on a vacation to Acadia National Park near Bar Harbor, Maine to do some “mountain” hiking.  Over three days I hiked several trails in levels of difficulty from easy to strenuous or difficult.  One particular trail – The Precipice – is rather popular and considered not suitable for the faint of heart and my hiking partner declined to join me for she considered the trail too risky and believed I should consider it the same.  During our discussion, I recalled a conversation between a CBC radio interviewer and an experienced mountaineer who had scaled Mt. Everest a few times.  The interviewer asked: “,… but isn’t climbing Mt. Everest very risky?” upon which the talk show guest replied “If it was risky, I won’t do it.”

 

 

What the interviewee then explained was that given his intense and detailed preparation, confidence in choice of mountain equipment and his physical and mental fitness; what seems as a risk to many was not a risk to him.  This reinforced for me that risk is subjective or alternatively that what we originally perceive as risk can be reduced to a near non-risk situation with proper planning and thought.  Organizations face risk daily, however more successful ones routinely enter seemingly dubbed “risky” areas because they have identified the risks and put in place risk mitigation tools or procedures that provide them with the confidence of moving forward.  This begs the question: Are there risks your organization/department has identified that may be holding you back unnecessarily which, if you took the effort to mitigate could increase profitability and opportunities?   

 

Note:  A special thanks to LB for the pic.  One of the summits we shared - Dorr Mountain with Cadillac Mt. in the background.

 

Unthinking and inflexible risk management = ineffective risk management

by Stephen McPhie, CA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

  

I have just returned from a few days at Wimbledon watching my daughter play in a junior tennis tournament.  It’s been a great week and a wonderful experience for the kids being able to play on the hallowed turf (but not on Centre Court unfortunately).  Although not detracting too much, it has also been an example of how unthinking and inflexibly applied risk management and bureaucracy can serve to create little more than frustration and irritation and probable do nothing to lessen risk.  

 

The organizers and security staff have their instructions and work their seemingly interminable way of enforcing all the rules to the letter, no matter how unnecessary they seem.  Clearly with a large number of kids around, they are very concerned about avoiding injuries or something going wrong and this is a laudable objective. 

 

A couple of examples follow – perhaps relatively inconsequential in themselves but intended to illustrate a point.

 

Security staff do a good job but are mainly people who probably don’t have a lot of power in other aspects of their lives.  Some of them seem happy to wield their temporary power inflexibly.  One in particular kept chasing after people to stop them taking a direct route beside Court 1 to get from the competition pavilion to the shop.  He made them exit from one gate, walk along the road and re-enter another gate, a much longer route.  This reduced the risk that people could get a free peek at Court 1 without paying for a tour of the grounds (actually futile as competitors and parents were given a free tour pass anyway).  Eliminating one perceived risk that actually did not exist created a worse one by forcing kids to walk along the road. 

 

There was a dinner one evening for all competitors.  They had to be delivered by the parents to the competition pavilion.  They were then organized into groups, counted and led along in lines to the dinner venue at the other end of the grounds where they were counted again.  Had they been delivered by parents directly to the dinner venue in the first place, only one count would have been necessary, nor would they have had to form groups and lines.

 

These things did not really lesson the overall experience or enjoyment of the week.  However, it would not take much thought and imagination to allow some flexibility and remove some of the petty irritants.  This made me wonder how many businesses are similarly losing sight of the risks in favour of process and bureaucracy.  This could be why risk management has a bad name in many organizations and does not get buy in, so is consequently ineffective. 

 

Preliminary Thoughts on Bernanke’s Speech at Jackson Hole and Fed Policy Options

by Don Alexander, MBA

Associate, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

The most important event this week is tomorrow's speech by Fed Chairman Ben Bernanke at the annual Kansas City Fed Conference.  The speech is expected to focus on three elements: the downgrading of US economic prospects, a defense of past policy actions and an outline of Fed policy options.

 

Last year, Mr. Bernanke outlined details for QE II and Fed policy options: the purchase of long-term securities, communication and lowering the interest rate paid on excess reserves.  The Friday speech will most likely focus on:  the possibility of additional purchases of long-term securities and changing the composition of the balance sheet. 

 

The Fed will note the downgrading of US economic prospects, as mentioned in the recent FOMC minutes.  This view will be consistent with the lowering of US growth prospects done by a number of Wall Street (WS) analysts.  The most recent FOMC communiqué noted “a slower pace of recovery in coming quarters” and “downside risks to the economic outlook have increased”.  However, the Fed economic outlook has one key difference from WS analysts as evidenced in recent speeches by Fed officials “weakness in economic activity in the first half was due to temporary factors …” and “restraining forces have abated and thus, we should see stronger growth in the second half”.  This suggests the Fed takes the view that the slowdown was partially caused by temporary factors.  The Fed scenario is for weak growth followed by a modest recovery going into 2012.  This is slightly more optimistic than private sector forecasts.

 

The next point, to be addressed by Mr. Bernanke, is the defense of previous Fed easing efforts.  The combination of weakness in growth and downward revision to economic forecasts raise questions about effectiveness of recent policy efforts.  Previously, he argued that QE helped reduce deflation risk and raised inflation expectations.  Mr. Bernanke will most likely address these issues as follows: the first is that central banks (Fed) cannot be the sole source of stimulus in a global fiscal tightening environment; secondly, one way QE II was successful by avoiding another recession (to date) and deflation; and lastly there is evidence from economic studies that QE does have a positive impact on growth.  The jury is still out on QE II, but it has helped the economy – the question is how much?

 

As indicated earlier, the three options open to the Fed include: communication, asset purchases and balance sheet management and changing the interest rate paid on excess reserves.  The Fed has already implemented a variation of its communication policy by stating that rates will remain low for an extended period.  The Fed will not consider changing the interest rates on excess reserves due to technical aspects of implementation, potential damage to banks from already low rates and questionable impact on bank lending.

 

This leaves the last option of large-scale asset purchases and changing the composition of the balance sheet.  There are studies that suggest that selling short-dated treasuries and buying long-dated can have a significant impact on reducing real rates.  The reason why this option may be favored is that it will not change the size of the Fed balance sheet which would keep politicians happy.  The view among WS analysts is that Mr. Bernanke will present these options, but not pre-commit to any policy action except through the FOMC.  The recent rise in core inflation will keep policymakers cautious.  The use of any unconventional policy options such as a higher inflation target, price level targeting, a long-term interest rate target or option twist (used in the early 1960s) may be considered at a later date.

The uncertainty shock from the debt disaster will cause a double dip recession

by Don Alexander, MBA

Associate, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

The author, Nicholas Bloom, in a short communiqué (VOXEU, August 22^nd updated from August 9th) notes the increased risk of recession and predicts a short downturn in the next 6-12 months and a recovery in 2012.  A number of Wall Street analysts place the probability of a double-dip recession around 30-35%.  The short note of Bloom’s introduces other tools to forecast recessions.

 

The potential explosive combination of Eurozone debt contagion, vulnerable banking systems, and European and American political paralysis has pushed stock-market volatility, as measured by the VIX, to levels nearly as bad as the days following the 11 September 2001 terrorist attacks and early onset of the 2007-09 crises.

 

Bloom starts with looking at the VIX as a traditional measure of market uncertainty or what he calls a fear factor.   The author introduces alternative measures of potential volatility, such as the frequency of news headlines or the use of the word “uncertainty”, and finds these measures elevated.  The role of news, headlines or specific words are additional information now being incorporated into credit models.

 

Nobody knows what happens next?  How long will the current stock-market panic last? This column reviews research by the author on 16 previous episodes of uncertainty shocks (going back to the 1950s) and concludes that today’s uncertainty shock will create a short, sharp contraction.  He notes that uncertainty shocks have a 1.9 month life (it takes about two months for volatility to decline by 50% from the peak).  Hence, the current panic has another six weeks to run based on historical data.

 

During a period of uncertainty, hiring and new investment grind to a halt with the durable goods sector being the most severely impacted.  Bloom is negative in the short-term, but positive over a long-term horizon.  He notes that the current uncertainty may force the necessary structural reforms in Europe and the US, while growth in China and India may offset some of the adjustment costs.

 

The author provides specific metrics from his research of a 1% contraction in late 2011 and a rebound in late 2012. This research looks at the average impact of the previous 16 uncertainty shocks to predict the impact of future shocks. Typically these leads to reductions of growth of about 2% immediately after the shock, with a recovery about six months later once uncertainty subsides.

 

The author notes that early work in this area was done by the current Fed chairman (Bernanke 1983).

 

What risks do you face in a double-dip recession?

For more on this click on the link:  www.voxeu.org/index.php?q=node/6846

 

Humor

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

How much humor is there in your risk group?  Is the risk gang a fun bunch of people who are always pulling gags and taping Dilbert cartoons to their cubicle walls?  No?!  I thought not.

 

I recently read this quote by the Canadian author Robertson Davies.

 

The people who fear humor, and they are many, are suspicious of its power to present things in unexpected lights, to question received opinions, and to suggest unforeseen possibilities.

 

At the risk of pointing fingers (and poking fun at), I suggest that the above quote sums up the stereotypical risk manager.  It is not that risk managers are boring – it is just that the profession has forgotten to occasionally laugh at itself.  It may also be that, as Mr. Davies suggests, that the profession has become “… suspicious of its power to present things in unexpected lights, to question received opinions, and to suggest unforeseen possibilities”.

 

Perhaps we all need to lighten up.

 

The Euro Crisis Reaches the Core – What is your Risk?

by Don Alexander, MBA

Associate, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

 

The author, Daniel Gros, noted in a recent communique (VOXEU, August 11^th) that the current euro crisis has reached the core.  Investors and treasurers need to ask themselves what is their exposure in a worst case scenario?

 

Investors anticipate the unraveling of the 21 July 2011 “solution” and a potential Lehman type breakdown of the interbank-market and put the European economy into an “immediate recession” like the one experienced after the Lehman bankruptcy. The European Financial Stability Fund (EFSF) was designed to provide liquidity financing and not solve solvency issues.  Gros argues that without quick and bold action such as giving it access to unlimited ECB re-financing there will be a generalized breakdown of confidence.    

 

Greece is not interpreted as a special case, but viewed as the manifestation of a general problem: (1) as a sign that the Global Crisis was spreading to public debt; and (2) as a sign that capital markets would no longer refinance excessive levels of public debt, especially in the Eurozone members who could no longer rely on central bank support.   The EFSF was sized to provide the financing promised to Greece, Ireland, and Portugal and provide lower rates for their long-term financing.  However, if the borrowing costs of Italy and Spain stay at crisis levels, how can they be expected to provide billions in euro in aid to peripheral countries at 3.5% when they pay a much higher rate?  Any decline in the core Eurozone members that remain to back the EFSF and the debt burden would become unbearable. Italian government debt alone is equivalent to the entire German GDP. 

 

The situation is critical due to a domino effect. At this point the Eurozone needs a massive infusion of liquidity.  Given that the cascade structure of the EFSF is part of the problem, the solution cannot be a massive increase in its size.   

 

Banks are the weakest link due to European debt exposure.  This increases the cost of capital for banks exposing them to a breakdown in the interbank market and credit circuit.  If the EFSF was registered as a bank and given access to unlimited re-financing by the ECB, it is the only institution to provide liquidity quickly and in convincing quantity.  This solution has the advantage that it leaves the management of public debt problems in the hands of the finance ministries, but provides governments with the liquidity backstop that is needed when there is a generalized breakdown of confidence and liquidity as a lender of last resort.  A massive increase in the ECB’s balance sheet (which if the US experience is any guide will not lead to inflation) constitutes a lesser evil compared to a breakdown of the Eurozone financial system.

 

What is your exposure to European sovereigns and banks?

http://www.voxeu.org/index.php?q=node/6853