Italian Earthquakes

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

A few weeks ago a story came out of Italy that most people brushed aside as a quirky news story.  Risk managers with much better things to do than worry about quirky news stories probably paid no attention whatsoever – but they should have!

The story I am talking about was the conviction of Italian scientists for manslaughter because they were not being able to predict the deadly 2009 earthquake.  To those who understand the state of the art of earthquake science this was pure foolishness.  To the Italian courts it obviously was not.

Why is this important to risk managers?  Simple – if convictions can be made based on the inability to predict earthquakes, how far behind are convictions for not being able to predict (and prevent) the actions of a rogue employee, or a financial debacle, or a systems failure, or a manufacturing mistake, or any of the other countless things that happen daily in the course of managing an organization?

Director’s insurance is de-rigour.  How long before risk manager’s insurance is as well?

Risk Charisma

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

It seems that every management or business journal has on the cover the smiling mug of a charismatic leader.  This raises the question of whether or not risk managers should be charismatic.  In my impression this would go against the stereotype of risk managers.  I suspect the Hollywood version of a risk manager is someone who never smiles, has a constant worry furrow creasing their forehead, and talks in grave and measured tones.  Not the epitome of charismatic.  But what if that were changed?  What if the face of risk management was changed from pessimistic to optimistic, from boring to exciting, from dull to charismatic?  Wouldn’t that perhaps help to push the risk agenda along? 

Movember

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

We are now two weeks into Movember – the fund raising month for prostate cancer research where men grow mustaches in the hopes of raising money for prostate cancer research.  It is a worthy cause, and II have to admit that having an excuse to have a silly mustache for a month prompted me to grow a ‘stache (it also prompted my wife to ignore me for a month …)

Of course prostate cancer has been in the news over the last few months after U.S. health officials declared the PSA test was causing more harm than good.  The PSA test (Prostate-specific antigen test) has for years been a recommended procedure for men in their 40’s and 50’s.  With early detection, the prognosis for someone with prostate cancer is generally quite good.  Thus the PSA test was highly recommended, and widely recommended.

Many men with prostate cancer live full lives with few to no adverse effects of the cancer.  Of course it must be said that the cancer can be deadly as well.  However, the rise of PSA testing has led to many men having biopsies performed, and these biopsies can have adverse effects.  Thus it becomes a trade-off between the harm caused by the follow-up biopsies, versus the usually, but not always benign effects of the cancer itself. 

The decision of whether or not to have a PSA performed is a discussion that each man should have with their physician.  I am not advocating one way or the other, and that is not the purpose of this blog.

What I do want to point out in this blog is the interesting fact that many physicians are asking whether the preventative medicine (or preventative test in this case) is causing more harm than good.  I think that we as risk managers also have to ask if some of our actions to prevent even the most minor downside risks might have unintended consequences or side-effects that are also causing more harm than good. 

Meanwhile, I wonder if my wife would notice if I again grew a mustache for Movember …

Complexity, Future of Financial Intermediation and Regulation

By Don Alexander, MBA
Associate, RSD Solutions Inc.
Mr. Alexander also lectures at NYU and SunySB

Since the onset of the financial crisis, what financial regulatory structure will deliver the right balance between growth and stability?  Finance and financial innovation are essential to growth, but finance is a two-edged sword. Indispensable for growth, the financial system can grow so large that it turns into a drag on activity. As recent events indicate, the fundamental links between the real economy and the financial system make it difficult to isolate the former from shocks originating in the latter.

This means that the size and structure of the financial system have aggregate real consequences. These externalities justify regulation.  And regulation, while necessarily focusing on the incentives and actions of individual agents and institutions, has systemic stability as its ultimate objective.  This is a question that Stephen Cecchetti, of the BIS, addresses is a recent speech The future of financial intermediation and regulation (October 2012).  What should the financial system look like 20 years from now, and how should we design financial regulation to deliver it?  Answering this question requires that we know what we want the financial system to do and what a financial institution is to look like – its size, scope and complexity – its appropriate role in the economy.

The main role of banks acting as intermediaries includes: pooling savings, safekeeping and accounting, providing liquidity, risk-sharing, extension of credit and information services.  In addition some of the larger banks provide: payment services across borders and currencies, underwriting securities for

Breaking Up Is Hard To Do II

by Don Alexander, MBA
Associate, RSD Solutions Inc.
Mr. Alexander also lectures at NYU and SunySB

Conversations about the breakup of the Eurozone are changing as the debate about a break up continues to evolve.   Some analysts (including the author) argue that ’avoid breakup at all costs' dogmatism may not be a prudent view. Getting good data may well be difficult, but any arguments about the cost of a Eurozone breakup must be compared to the ongoing cost of the status quo.

Jens Nordvig looks at this issue in a recent VOXEU communique (6th Nov.) called The Eurozone breakup debate: Uncertainty still reigns. In the spring of 2012, political tension in Greece was the debate focus while in the summer the focus shifted to Spain’s funding difficulties, especially the redenomination risk on Spanish assets. Then the ECB stepped in and reduced sovereign funding costs in the periphery. Subsequently, the Eurozone breakup debate has again shifted focus to core countries.

There is limited consensus on the implications of various forms of breakup and on the preferred path for the Eurozone. European policymakers remain adamant that the Euro is irrevocable. Meanwhile, academic economists and market strategists continue to disagree about both the merits of keeping the Eurozone together and about the costs of any breakup scenario.

Despite years of debate, little progress towards reaching an informed consensus has been achieved. While, the question remains on what can be done to more objectively evaluate the implications of various breakup scenarios?

The Eurozone remains unique as a currency union: (1.) The Eurozone is large in economic terms and differs from past currency unions that have split. (2.)  Eurozone countries are substantially wealthier than other countries that have experienced a breakup in the past. (3.) The euro serves a unique role both as a reserve asset and as a currency widely used in international capital markets.

The effects from a Eurozone breakup on macro-level balance sheets will be determined by the relevant external assets and liabilities that are defined as those cross-border positions where the legal jurisdiction of underlying financial contracts is foreign to the country in question.  Basic macroeconomic datasets - such as net foreign asset positions and cross-border banking statistics - are really useful if we wish to analyze the implications of currency union breakups. Yet current official data sources tell us nothing about the legal jurisdiction of the assets and liabilities in question.  The author estimates the euro’s international dimensions of €20 trillion of euro-denominated contracts in existence outside the jurisdiction of individual Eurozone countries, not a minor issue.

The breakup scenarios being debated, involving strong countries exiting, also change the analysis. Problems associated with extreme capital flight that have been used to argue that the cost of a breakup would be prohibitively costly, would be smaller in a situation where a strong country leaves. For instance, a Finnish exit could be managed without devastating disruption to financial markets. Thus, 'avoid breakup by all means' is not a universal truth.

The costs of the status quo need to be considered; how much would non-breakup cost? The cost of the current policy path is not explicitly accounted for. Quantifying the cost of the status quo is a dynamic exercise and most would agree could be more costly than was predicted earlier.  A robust cost-benefit analysis is needed that includes specific Eurozone breakup scenarios versus the costs of the current path of gradual integration. Many different Eurozone breakup scenarios have been debated but without being able to properly quantify the effects of breakup scenarios, uncertainty still reigns.

www.voxeu.org/article/ez-breakup-contest-take-ignorance

Breaking Up Is Hard To Do II

by Don Alexander, MBA
Associate, RSD Solutions Inc.
Mr. Alexander also lectures at NYU and SunySB

Conversations about the breakup of the Eurozone are changing as the debate about a break up continues to evolve.   Some analysts (including the author) argue that ’avoid breakup at all costs' dogmatism may not be a prudent view. Getting good data may well be difficult, but any arguments about the cost of a Eurozone breakup must be compared to the ongoing cost of the status quo.

Jens Nordvig looks at this issue in a recent VOXEU communique (6th Nov.) called The Eurozone breakup debate: Uncertainty still reigns. In the spring of 2012, political tension in Greece was the debate focus while in the summer the focus shifted to Spain’s funding difficulties, especially the redenomination risk on Spanish assets. Then the ECB stepped in and reduced sovereign funding costs in the periphery. Subsequently, the Eurozone breakup debate has again shifted focus to core countries.

There is limited consensus on the implications of various forms of breakup and on the preferred path for the Eurozone. European policymakers remain adamant that the Euro is irrevocable. Meanwhile, academic economists and market strategists continue to disagree about both the merits of keeping the Eurozone together and about the costs of any breakup scenario.

Despite years of debate, little progress towards reaching an informed consensus has been achieved. While, the question remains on what can be done to more objectively evaluate the implications of various breakup scenarios?

The Eurozone remains unique as a currency union: (1.) The Eurozone is large in economic terms and differs from past currency unions that have split. (2.)  Eurozone countries are substantially wealthier than other countries that have experienced a breakup in the past. (3.) The euro serves a unique role both as a reserve asset and as a currency widely used in international capital markets.

The effects from a Eurozone breakup on macro-level balance sheets will be determined by the relevant external assets and liabilities that are defined as those cross-border positions where the legal jurisdiction of underlying financial contracts is foreign to the country in question.  Basic macroeconomic datasets - such as net foreign asset positions and cross-border banking statistics - are really useful if we wish to analyze the implications of currency union breakups. Yet current official data sources tell us nothing about the legal jurisdiction of the assets and liabilities in question.  The author estimates the euro’s international dimensions of €20 trillion of euro-denominated contracts in existence outside the jurisdiction of individual Eurozone countries, not a minor issue.

The breakup scenarios being debated, involving strong countries exiting, also change the analysis. Problems associated with extreme capital flight that have been used to argue that the cost of a breakup would be prohibitively costly, would be smaller in a situation where a strong country leaves. For instance, a Finnish exit could be managed without devastating disruption to financial markets. Thus, 'avoid breakup by all means' is not a universal truth.

The costs of the status quo need to be considered; how much would non-breakup cost? The cost of the current policy path is not explicitly accounted for. Quantifying the cost of the status quo is a dynamic exercise and most would agree could be more costly than was predicted earlier.  A robust cost-benefit analysis is needed that includes specific Eurozone breakup scenarios versus the costs of the current path of gradual integration. Many different Eurozone breakup scenarios have been debated but without being able to properly quantify the effects of breakup scenarios, uncertainty still reigns.

www.voxeu.org/article/ez-breakup-contest-take-ignorance

Policy, Risk & Future of the International Banking System

By Don Alexander, MBA
Associate, RSD Solutions Inc.
Mr. Alexander also lectures at NYU and SunySB

The international banking industry faces a challenging future, having to consolidate at a time of heightened global financial volatility, anemic growth in advanced countries, and shifting global growth balances. After a long period of sustained expansion and accommodating regulatory treatment, the structure of   international banking is changing as global banks’ business strategies shift toward fast-growing emerging-market economies. 

The center of gravity for international lending is shifting, with the role of European banks shrinking and American, Japanese, and emerging-market banks filling in the space.  These issues were raised in a recent World Bank Economic Premise called What Does the Future Hold for the International Banking System  by Mansoor Dailami and Jonathon Adams-Kane (October 2012).

As the international banking community goes through a long-period of soul-searching and introspection in an effort to understand the causes and consequences of the 2008 global financial crisis, in which international banks were at the epicenter, looking ahead to anticipate the configuration of the international banking system would help to formulate regulatory reforms to strengthen the banking sector itself, but also to inform the current debate on international macroeconomic policy. The forward-looking analysis contains a policy warning regarding the current mix of fiscal and monetary policy stances in the context of ongoing deleveraging by banks. By now there is a fair degree of consensus that progress in fiscal consolidation in advanced economies is likely to be slow, painful, and charged with political tensions as austerity kicks in.

Against this backdrop, the current debate on adding economic stimulus to support the global economic recovery should consider the possible contractionary impacts of bank deleveraging, even with global interest rates remaining at historically low levels.  The timing of the deleveraging cycle currently underway is poor in terms of its impact on near-term global economic conditions.  Deleveraging among banks is reinforcing the contractionary economic environment already at work in the form of tight government budgets.

At the same time, there is a limit to how much monetary policy can be relied upon to simultaneously provide macroeconomic stimulus and address the specific needs of sovereign and banking finance, especially given the ways central banks have intervened to stabilize financial markets . The important implication that emerges from the current policies and public debt profiles is that the banking sector may bear a significant part of the burden of elevated sovereign debt distress. For euro area banks affected by sovereign debt distress, the most visible sign is deteriorating funding market conditions, significant credit rating downgrades, and a decline in market capitalization. Indeed, given the significant international presence of European banks and their role in global interbank markets, the potential for spillover of the negative feedback loop among public finances, the financial sector, and the real economy currently underway in the euro area should be of concern to the broader international policy community and risk managers.

www.siteresources.worldbank.org/EXTPREMNET/Resources/EP94.pdf