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!

Rick Nason project described in recent Canadian Business article

by Stephen McPhie, CA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

In a recent Canadian Business article on October 20, 2011, "What's your thesis?" by Michael McCullough, RSD Solutions Partner Rick Nason had his thesis: "Financial regulation isn’t rocket science" described in the article.  Rick's thesis is one of five quoted in an article that looks at the latest academic thinking being applied to the business world.  Rick's background of physics allows him to bring a unique perspective to business solutions and in particular the area of risk.  

 

To read the article follow the link:  http://tinyurl.com/3clb8m2

Lessons for European and US politicians – How not to create jobs

by Don Alexander, MBA

RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

A striking feature of recent equity market volatility is that politicians and government bureaucrats are making the news.  It seems that statements about bailouts, restructuring, budgets and regulatory reforms are driving stock market volatility.  Policymakers’ and bureaucrats choices are dominating headlines in the global crisis.

 

Policy uncertainty and the stalled recovery (Scott Baker, Nicholas Bloom & Steve Davis, VOXEU, October 22^nd).  The authors distinguish between economic uncertainty and economic policy uncertainty, constructing an index to measure policy-related uncertainty and argue that reducing policy uncertainty would add dramatically to job creation.  Prior to the financial crisis of 2008, stock markets moved in response to economic numbers such as GDP or employment and corporate earnings.  But today, it is politicians and government bureaucrats.  They cannot agree, generating massive economic uncertainty.  This policy uncertainty is a key factor in stalling the recovery and contributing to the risk of a double dip.

 

Baker et al constructed a new index of US policy uncertainty by combining three types of information: frequency of articles that reference economic uncertainty and policy, references to expiration of various federal tax code provisions and disparity among forecasts about inflation and government purchases of goods and services.  In addition, the authors are able to separate an indicator of economic uncertainty from that of policy uncertainty.  They note the key drivers of policy uncertainty are dominated by monetary and tax issues.

 

When businesses and investors are uncertain about taxes, health care costs, budget prospects and regulatory initiatives, they adopt a cautious stance.  They find it costly to make a hiring or investment mistake, waiting for calmer times to expand or consider riskier investments.  As a result, the recovery never takes off as business remains cautious on making investments in capital goods, research and worker training – key determinants for long-run sustainable growth.

Investors remain on the sidelines in “safe” investments avoiding risk.

 

The lessons for European and US policymakers are clear.  They need to take action that will reduce policy uncertainty for business and investors.

 

For more on this follow the link:  www.voxeu.org/index.php?q=node/7137

Issues that need to be addressed to reduce European sovereign risk

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by Don Alexander, MBA

Associate, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

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European leaders face a deadline this Sunday to implement policies to help resolve the sovereign debt crisis.  A review of these issues is summarized in a recent commentary.

 

A deadline for solving a deadly Eurozone sovereign debt crisis (Guillermo de la Dehasa, VOXEU October 20^th) Time is running out for EU leaders to put an end to the Eurozone crisis.  European leaders face the following issues: 1. find a definitive solution to Greek insolvency, 2. isolate solvent countries from possible Greek contagion, 3. improve EU governance by creating a true European Parliament and 4. refocus on a pro-growth policy mix. 

 

Eurozone leaders must reach a clear and definitive solution to Greece’s insolvency without triggering a credit event.  Private sector involvement is not the best solution since “voluntary haircuts” can be an oxymoron and impede decisions.  Haircuts can be imposed on banks and a Brady-like swap program can be implemented for Greek bonds into European Financial Stability Facility (EFSF) bonds of longer maturities.  A challenge for policymakers is to isolate solvent members from contagion.  The can be implemented through a backstop for Eurozone member debt, such as a leveraged EFSF.  The guarantee is implemented in return for debt consolidation and structural reforms. 

 

Long-term, the present structure of European governance and crisis management needs to be addressed.  This issue can be resolved by amending the treaties and moving away from the current system where council decisions need unanimous approval within national governments.  Long-term, the EU needs to move to a federal system of governance by a true European parliament.  It should set up an independent European treasury to monitor states compliance to debt limits and structural reforms.  Lastly, policymakers need to implement a policy where Eurozone growth rate can exceed the real interest rate on its debt.

 

European banks will need to be recapitalized.  However, this will only be a stop gap measure without addressing the other issues.   Otherwise the concept of the euro will be at risk.    

 

The Cost of a Capital Cushion for Global Systemically Important Banks

by Don Alexander, MBA

Associate, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

Recently, a number of financial institutions along with the International Institute of Finance (IIF), an industry association owned by financial institutions, have raised concerns about the economic costs for a capital cushion for global systemically important banks (GSIB).  The BIS has answered some of these questions in a recent report Assessment of the Macroeconomic Impact of Higher Loss Absorbency for Global Systemically Important Banks (BIS Macroeconomic Assessment Group, October 10^th).

Weakness in large financial institutions has often played a central role in the triggering and propagation of systemic financial crises.  The Financial Stability Board (FSB) and the Basel Committee on Banking have made a number of proposals for improving the loss absorbency of the GSIB and put together a Macroeconomic Assessment Group (MAG) to investigate the macroeconomic costs and benefits of these proposals. 

The GSIB proposal costs stem from the adverse impact on economic activity, bank policies to increase rate spreads and reduced lending to build up their capital buffers.  The 30 potential GSIBS, for the study, were based on their domestic market lending share and share of financial assets in their domestic economy.  

The initial result showed a 1% increase in the capital requirement reduced GDP by 0.06% over 8 years, or a little less than 0.01% per year.  The primary driver of this macroeconomic impact was the increase in lending spreads by 5-6 basis points.  The overall results conceal differences across countries related to role of the domestic financial system, existing capital buffers and international spillover effects.  It was found that by varying key assumptions: such as asset size, a larger bank list, a shorter implementation period or authorities altering only had a limited impact of growth. 

The MAG group looked at the full impact of implementation of all the Basel proposals and increased the capital buffer by an additional 2% for the GSIBs implemented over 8 years.  The actual results of the two components indicate reduced GDP growth by 0.04% per year while lending spreads rise by 31 basis points.  As noted earlier, different assumptions lead to different effects, while faster implementation or a weaker monetary response increasing the impact on GDP. 

The benefits for the GSIB framework relate primarily to the reduction in the exposure of the financial system to systemic crises that can have long-lasting effects on the economy and financial markets.

For more on this follow the link to the BIS:  http://www.bis.org/publ/bcbs202.htm

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.