Follow-up of “The Fantods of Risk: Essays on Risk Management” Part 3

Two Quotes (Well, Ok Three)

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

In a previous blog I reviewed H. Felix Kloman’s book “Fantods of Risk:  Essays on Risk Management”, published by Seawrack Press, 2008.  The Amazon link is:
http://www.amazon.com/Fantods-Risk-H-Felix-Kloman/dp/1436302269/ref=sr_1_1?ie=UTF8&s=books&qid=1276378958&sr=8-1

As a follow-up to my review, I thought I would post a couple of thoughts that Kloman’s book produced in my own little brain.  I hope you find these blogs interesting so that you will be inspired to go get Kloman’s book.  The field of risk management needs more people to know about Felix Kloman, his writing and his books.

In this blog I want to focus on two different quotes of others that Kloman uses in his book.

“I’ve come to the conclusion that there is nothing good that doesn’t have bad consequences and nothing bad that doesn’t have good consequences.”
Pete Seeger
The second quote is:

“We cannot legislate for the unknown consequences of consequences of consequences.”
Isaiah Berlin

Now, the question to ask yourself is:  “when was the last time you read a book that quoted both Pete Seeger and Isaiah Berlin?”  That is what makes this collection of essays so interesting and useful for the risk manager.

For those in the risk community who think this is stretching it, Kloman also quotes the well known academic risk textbook writer Carol Alexander,

“Quantification will never be a substitute for good risk management”. 
Carol Alexander
There, hopefully that makes everybody happy.  (Probably not, but then again is the goal of risk management to make everybody happy all of the time?)

Follow-up of “The Fantods of Risk: Essays on Risk Management” Part 2

Riskipedia


by Rick Nason, PhD, CFA
Partner, RSD Solutions Inc.

In a previous blog I reviewed H. Felix Kloman’s book “Fantods of Risk:  Essays on Risk Management”, published by Seawrack Press, 2008.  The Amazon link is http://www.amazon.com/Fantods-Risk-H-Felix-Kloman/dp/1436302269/ref=sr_1_1?ie=UTF8&s=books&qid=1276378958&sr=8-1

As a follow-up to my review, I thought I would post a couple of thoughts that Kloman’s book produced in my own little brain.  I hope you find these blogs interesting so that you will be inspired to go get Kloman’s book.  The field of risk management needs more people to know about Felix Kloman, his writing and his books.

Does your organization have a Riskipedia?  What the heck is a “Riskipedia”?  Well Kloman has hit upon the idea of a Riskipedia as a resource and mechanism for all employees (and perhaps stakeholders) of an organization to input their views on risk assessment in the organization.

Such a transparent self-analysis and reporting of risk assessments would definitely increase the transparency and relevance of risk monitoring in the organization.  It would also dramatically help develop a risk culture within an organization. 

The idea of a Riskipedia has some other precedents.  For instance McKinsey (as well as other consulting companies) go to great lengths to create a database of consulting projects that future consultants can use as learning templates as they develop ideas for similar situations and assignments.  Having such a database greatly aids in efficiency and institutionalizes and synergizes knowledge.  (Great Scott!  That last sentence sounds like something out of one of my MBA classes – sorry about that.)

How would your organization use a Riskipedia?  Would it be useful?  Would it be allowed?  (Is transparency something your organizations talks about but rarely practices?)  Who would be the most frequent users and / or contributors?  Would its use increase or decrease with time?  Would it make the organization less risky?  (Whatever that means.)  Fun questions and a neat idea.

Follow-up of “The Fantods of Risk: Essays on Risk Management” Part 1

Part 1:  Three Unsolved Problems 

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

In a previous blog I reviewed H. Felix Kloman’s book “Fantods of Risk:  Essays on Risk Management”, published by Seawrack Press, 2008.  The Amazon link is http://www.amazon.com/Fantods-Risk-H-Felix-Kloman/dp/1436302269/ref=sr_1_1?ie=UTF8&s=books&qid=1276378958&sr=8-1

As a follow-up to my review, I thought I would post a couple of thoughts that Kloman’s book produced in my own little brain.  I hope you find these blogs interesting so that you will be inspired to go get Kloman’s book.  The field of risk management needs more people to know about Felix Kloman, his writing and his books.

In this blog I would like to point out Kloman’s “three problems that remain unsolved”.  Before I get to his three problems, what would you answer if asked what three problems of risk management were that remained unsolved? 

If you are like most risk managers, you would probably have a hard time limiting your list to just three problems of importance that you thought remained unsolved.  Probably within your own organization you can come up with at least 10 risk problems that you believe are core and that you would give your eye-teeth to have solved. 

Perhaps it is ironic that as risk managers we are trained to think of problems.  Perhaps the title of CRO should be more aptly named Chief Worrier and Problem Spotter.  However that leads into the first unsolved problem that Kloman states (they are on page 101 if you are following along).  Paraphrasing, Kloman states that the first unsolved problem of risk management is that of “seeing risk as a negative result”.  I suspect that many risk managers (without the experience and insight of Kloman) are now scratching their heads and saying “Huh?!?!?  How in heck can that be an unsolved problem of risk management, much less a major unsolved problem?”  Next time you use a mathematical model that incorporates standard deviation or variance, then you might be able to see the disconnect.

I will never forget the first time I went to a risk conference sponsored by an auditing organization.  I was one of the few people in attendance who had never conducted an audit.  However I was reasonably confident in my knowledge of risk.  I found out real quick that I was real stupid, or else I had entered the wrong conference!  How the auditors thought about and acted on risk was dramatically different from my views.  Later I learned the insurance risk masters thought very different yet again.  Likewise one of my best friends is an expert in workplace safety and a “risk-expert” as well.  He and I have a difficult time conversing on risk issues since we speak the same words, but they seem to have very different meanings!  This brings up Kloman’s second unsolved problem of risk management – namely that risk is limited to specific areas of expertise.  Taking the liberty to expand on his idea, I take this as a call to develop more universal standards and concepts of risk that can be used and applied across disciplines.  (You might interpret Kloman’s view of this concept very differently than I did.)

When asked what you organization’s risk unit’s objective is, the responses will likely vary widely within any given organization.  Different managers (from outside the risk unit) will have their own responses, with the likely theme that the risk unit is the “Department of No!”  If you ask the risk unit what it believes its goals and objectives are, you are also likely to get a range of responses.  This brings us to Kloman’s third unsolved problem of risk management which is that the goal of risk management is too restricted.  More accurately Kloman states that the goal of risk management has become “corrupted” on “improving shareholder value”.  I will let you read Kloman’s response to this problem (I have to admit that I am not sure that I am in 100% agreement with him on this point). 

I asked you at the start of this blog what you thought were the three greatest unsolved problems in risk management.  Now the interesting question is this:  did you have the same problems as Kloman?   

Review of “The Fantods of Risk: Essays on Risk Management”

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

Quite a while ago a purchased a slim volume of risk essays titled “The Fantods of Risk”.  This book of essays is written by Felix Kloman who has probably one of the most extensive backgrounds in risk, and is an acknowledged leader in the field of risk management.  I have had the pleasure of meeting Mr. Kloman in person, and his knowledge, and more importantly his understanding of risk management, is impressive.  It was with great anticipation that I started reading his essays.  Unfortunately, since it is a slim volume, my housekeeper put it in my stack of academic papers – which I only sometimes choose to look through.  (The academic stuff only gets looked at when I need help going to sleep.)  In any case, my completion of the book was much delayed – my loss!

This wide ranging collection of essays is a true treat to read.  They touch on a variety of sources, and attack risk from a broad assortment of angles and viewpoints.  In its breath of topics it can be compared to Taleb’s “Black Swan”, except Kloman does not spend the majority of his words trying to convince you how smart he is like Taleb does.  His musings on risk itself are also much more multi-dimensional than Taleb’s.

I really liked this collection of essays – if for nothing else Kloman is one of the few writers who (like myself) defines risk as having both an upside and a downside component.  (See for example my earlier blog posting, “What is Risk?”)  Kloman is also a fan of letting critical thought, rather than rigid process determine the proper risk responses.  He convincingly makes the point that it is unreasonable to expect risk to be eliminated – something that I wish the regulators would try to understand.

The one unfortunate aspect of the book is that it was published in 2008 (which means that it was probably completed in 2006).  It would be fascinating to have Kloman’s thoughts on the crisis included in this collection.  His writings on various risk topics (such as the overreliance on mathematical techniques) are very prescient. 

Although H. Felix Kloman is already well known in risk management circles and is a respected practitioner and thinker, I fear that this book will not get the attention that it deserves.  Hopefully it does not wind up ignored on your “academic” reading pile!

Here is the Amazon link. (it is also available in Kindle format)   http://www.amazon.com/Fantods-Risk-H-Felix-Kloman/dp/1436302269/ref=sr_1_2?ie=UTF8&s=books&qid=1275868820&sr=8-2

Watch for a series of future blogs were I plan to expand on several of the points that Felix Kloman puts forth.

Counterparty Risk Management

by Rick Nason, PhD, CFA
Partner, RSD Solutions Inc.

I was asked by the Association of Financial Professionals to chair a roundtable discussion earlier this week at their AFP of Canada Treasury Management Forum in Toronto.  The roundtable discussion format is one that I like to participate in at conferences and this one was especially interesting.  By the number of people participating in the session it was definitely a topic that was top of mind with the audience.  The discussion we had was great and I appreciate the participation of all of those who were present.  Here are some of questions that we discussed along with my best attempt at a micro-encapsulation of the discussion.

1.  Are Canadian Bank clients isolated from counterparty risk issues?

·       Of course not.  Although the Canadian banks are considered to be amongst the strongest, the recent crisis has shown us that systemic risks can attack anyone and do so quickly.  Besides, most companies have global banking relationships.

2.  Is counterparty risk an issue if you are not heavily exposed to your bank?

·       Yes.  Counterparty risk is a two-way street.  At present you may not be exposed, but your bank might be exposed to you.  This may lessen the bank’s ability to finance you with as great a flexibility.  Also it is future potential exposure that is the key issue.

3.  How can you mitigate counterparty risk beyond the usual collateral / netting / tight legal agreements (ISDA’s and termination agreements)?

·       The best way to mitigate counterparty risk is to choose good bankers (the individuals that are your representative with the bank).  A good banker makes sure the lines of communication are two-way.

·       Be aware of the credit paradox of banks.  (Banks that specialize in lending to specific sectors.)  This may leave your bank exposed to a systemic risk in that sector that, in turn, your company gets caught up in.

4.  How can we monitor the strength of our banking group?

·       Looking at the Credit Default Swap rates for banks in your banking group is a more real-time indicator of the perceived strength of a bank than the credit ratings which are based on a business cycle and tend to be less reactive.

·       The change in the CDS spread over a short period of time may be just as relevant an indicator as the absolute level of the CDS spread.

5.  What can be done if one of our banks gets into trouble leaving us exposed on a transaction?

·       Not much.  The best way to fix a bad situation is to avoid it in the first place.  Diversification of banking group and being proactive at the first signs of trouble are the best proactive responses.  

Prepping for Book Club

by Rick Nason, PhD, CFA
Partner, RSD Solutions Inc.

I facilitate a book club for the alumni of the Faculty of Management at Dalhousie University where I am an Associate Professor of Finance.  (Brew and Books – check us out on Face Book!)  The book for tonight is “Shop Class as Soul Craft:  An Inquiry into the Value of Work”, by Matthew B. Crawford (published by The Penguin Press, 2009). 

This non-fiction book describes the author’s experiences of giving up a high profile role as the head of a think tank to become a partner in a vintage motorcycle repair shop.  Quoting from the book jacket, “A philosopher / mechanic destroys the pretensions of the high-prestige workplace and makes an irresistible case for working with one’s hands”.  I highly recommend the book, especially for those who have uncritically jumped on the Richard Florida (Who’s Your City) and other knowledge worker / creativity worker bandwagons.

I was getting my notes together for tonight’s meeting when I came across this quote. 

“The mechanic and the doctor deal with failure everyday, even if they are expert, whereas the builder does not.  This is because the things they fix are not of their own making, and are therefore never known in a comprehensive or absolute way.”

Isn’t that a little bit like the plight of the corporate risk manager?  Doesn’t the corporate risk manager face failure everyday as the situations or incidents that arise are rarely of their own making? 

I recognize that it is the role of the risk manager to put in place systems and procedures that prevent or at least mitigate negative risk events happening.  The perception (hope, falsehood?) is that the risk manager is a control manager.  However the reality is that realized events are often beyond the control of even the most thoroughly prepared risk manager.  World events are not of the risk manager’s making, nor are they under the control of the risk manager - no matter how expert they may be.

The situation for the financial risk manager is even more pronounced, as no matter how large their financial institution of fund may be, they are mere minnows in the ocean of the world’s financial markets.  Nothing in their expert toolkit can prevent or foresee the specifics of a tsunami until it is too late.

Despite my best intended efforts, I will not be in complete control of tonight’s book club meeting.  While I will attempt to steer the discussion as I believe to be most appropriate, I know that the thoughts of the book club members are not of my own making, and thus not under my control.  That is an optimistic comment, as it has the potential to produce many wonderful surprises – not only for me, but for the book club members as well.  Perhaps risk managers should also celebrate the fact that not everything is of their own making and thus not under their control.

 

Plato vs. Freud

by Rick Nason, PhD, CFA
Partner, RSD Solutions Inc.

Have you ever wondered what some of the great thinkers might have thought about our current practices of risk management?  While reading on a topic totally unrelated to risk management (?), namely religion, I came across this wonderful description about how Plato and Freud thought about the ability of humans to reason.  I quote:

“Plato argues that the highest form of human nature is reason, and that reason works to make our passions subservient in order to reach our true end.  Freud, by contrast, argues that reason is not supreme but is the handmaiden of passions.“[1]

Now what made this passage particularly interesting and timely for my tiny brain is that I had just finished Akerlof’s and Shiller’s book “Animal Spirits: How Human Psychology Drives the Economy, and Why it Matters for Global Capitalism” (Princeton Press, 2009).  In this book, Akerlof and Shiller argue that the “Animal Spirits” of humans often override the assumed rationality of the economic man and thus we get economic events such as the recent economic crisis.

When thinking of these “Animal Spirits” or the passion versus rationality divide in the context of risk we quickly realize that it is a rich avenue for thought and exploration.  We tend to think of risk managers as being rational, controlled and analytical.  Passion is seldom a word that is associated with the risk manager, much less the risk department.  But is a risk manager truly devoid of passion?  Are senior managers devoid of passion when they make judgments about risk?  What about Board Members?  The answer of course (when framed in this blunt way) is that risk managers, mangers, and even Board Members are always making decisions based at least as much on passion or animal spirits as they are reason and rationality.

A follow-up question is to ask whether or not this is a bad thing?  To that I would argue that the question is a moot point, as there is little to nothing that we as risk managers can do about it.  However we do need to be cognizant of it, and incorporate the fact somehow into our analysis and suggestions.  That requires empathy as well as creativity – along with a host of other skills.

In several recent talks (see for example “Beyond Behavioural Finance”) I have argued that risk managers need to think like sociologists.  Perhaps we also need to spend a bit of time boning up on our philosophy.

---

[1] Foster, Richard J., and Gayle D. Beebe, 2009, “Longing for God:  Seven Paths of Christian Devotion”, IVP Books, Downers Grove, IL