Risk and Management

As the American housing market clenches its butt for a hard landing, so can we all. And unlike global warming or peak oil or pandemic threats, which at least are the result of misunderstood interactions with the natural environment and therefore vastly complex, the financial world is a purely human construction, anything Good or bad that comes out of it is our own doing.

And right now there's debt bomb about to blow in the middle of it as all the companies, banks and finance houses, even General Motors for cryin out loud, have been lending large wads of money to people with a common factor; they have no hope of ever paying it back.

So how did these business genii get themselves, and ultimately us, into this mess? Risk and Management.

On the way home from Sweden last week I picked up the wall Street Journal which had an interview with Myron Scholes, one of the wise guys behind the Long Term Capital Management fiasco that almost crashed the global economy back in 2000. One of his points is that we humans have a level of tolerance for risk and where that level is not being met, we push the limits until we bump up against our comfort level with the risk.

Incidentally, on Discovery Channel the other day there was a crash Science episode that pointed out that as cars became safer, the amount of risky driving increased as more of us pushed our risk perception to the edge of our comfort level.

This is actually really important because, on the other side of the equation, business habitually rips Governments for any uncertainty that they cause or allow in the business environment. We are constantly told that business cannot advance unless it has regulatory and financial certainty. Business people form corporations and companies, the main purpose of which is to reduce risk, and then use their economic clout to demand ever more guarantees of certainty in which to place their "risk" or venture capital; and then they set out to push the boundaries of their safety to squeeze every last drop of profit out of the process, dragging with them the legislators whose job it is to reset their risk level by amortizing it across the whole community.

Within business there is the whole Risk management process which, at first glance, looks and sounds, like a process for minimizing the risk to which a business is exposed; preferably by getting someone else to carry that risk at no, or low, cost to the company.

Paradoxically, I suspect, that this simply enables the company to assume more and more risk in other areas until it reaches again its limits on comfort with the risk.

But the fact is that the actual risks are not extinguished or countered or canceled out by risk management, they are simply externalized to the business and bedded into the surrounding community. Where they accumulate.

The sub-prime lending debacle that is just now unwinding and that may yet carry us all down an economic sewer of historic proportions is exactly this kind of behaviour. Through ever more baroque derivative contracts, the financial industry has managed to give the impression that if the risk is spread sufficiently thinly, it effectively disappears, leaving plenty of headroom for the acceptance of more risk.

Spreading my half million dollar mortgage across a 1.5 trillion economy really does make it disappear, but just because we can't see it, doesn't mean that it isn't there, and slowly those invisibly thin slices stack up, fed by compliant governments and greedy banks printing ever more money to feed the process. it all works beautifully, until it doesn't.

It happens every time. Its also a fact that it happens about every 70 years and every depression has always been bigger than the previous one, and the last one in 1932 was a life threatening doozy.

The interesting question is whether we have now reached a moment when risk (a knowable danger to which we can assign value) has been pushed into uncertainty (an inherently unknowable danger of infinite variability), because once we go into that space, all economic activity, not just the share markets, becomes a crapshoot.

Bizarrely, we will accept that our lives should be turned to custard, not because the oil is running out or the food wont grow any more or we fall sick to some appalling new disease, but because two rows of numbers no longer add up.

Our entire social and political and economic lives will be held hostage to those rows of numbers, and rather than just dump all the trouble on the people who caused it, we will be forced to protect those people who have apparently earned the right to have their numbers add up, even if getting them to do so costs us our livelihoods, our futures and our lives.

Because make no mistake, people will die because of the fallout of those discrepant numbers, or as nyceve at Kos calls it, murder by spreadsheet.

Comments

[Jon Husband]

Evidently this past Thursday Alan Greenspan said that if only house prices were to magically rise by 10% there would be no problem with all those sub-prime mortgages that are about to re-set.

Via Clusterfuck Nation .. you probably already saw it.

The comments are quite interesting .. I'd say there are early not-so-weak signals. Amazing Mental Rot

I'd like to imagine that history will show Greenspan to have been an absolutely bought-and-paid-for charlatan who had a major role in helping the American economy go down the tubes whilst enabling the enrichment of his masters. In other words, a master criminal.

[cavrisk]

Cavalcade of Risk #23 is up, and your post is included...

The latest edition is at:

http://insurancehelphub.com/2007/04/11/presenting-the-cavalcade-of-risk-23/