Posts Tagged ‘risk’

Japan World Markets

Most of us are pretty cautious when it comes to spending our money. The amount of money we have is pretty small—and the global economic, financial, and political landscape is pretty shaky right now.

And even if we’re not cautious, if we’re not prudent savers, then no harm done. Spending everything we have may be a personal risk but it doesn’t do any social harm.

It’s different, however, for the global rich. The individual decisions they make do, in fact, have social ramifications. That’s why, back in 2011, I suggested we switch our focus from the “culture of poverty” to the pathologies of the rich.

Consider, for example, the BBC [ht: ja] report on the findings of UBS Wealth Management’s survey of more than 2,800 millionaires in seven countries.

Some 82 percent of those surveyed said this is the most unpredictable period in history. More than a quarter are reviewing their investments and almost half said they intend to but haven’t yet done so.

But more than three quarters (77 pct) believe they can “accurately assess financial risk arising from uncertain events”, while 51 percent expect their finances to improve over the coming year compared with 13 percent who expect them to deteriorate.

More than half (57 pct) are optimistic about achieving their long-term goals, compared with 11 percent who are pessimistic. And an overwhelming 86 percent trust their own instincts when making important decisions.

“Most millionaires seem to be confident they can steer their way through the turbulence without so much as a dent in their finances,” UBS WM said.

Most of us can’t afford that kind of arrogance in the face of risk. But the world’s millionaires can. Just as they did during the lead-up to the crashes of 1929 and of 2008.

They trusted their instincts—and everyone else paid the consequences.

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While Wells Fargo (whose CEO blamed employees for his bank’s failings) has put traditional banks in the news lately, the resurgence of the so-called shadow banking sector has largely gone unnoticed.

Until now.

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The Dallas Fed (pdf) has issued an alarming report concerning the growth of financial activities that, while connected to traditional banks, remains largely unregulated—even under Dodd-Frank.

“Shadow banking,” an almost sinister-sounding term that originated in 2007, describes large banks’ practice of constructing off-balance-sheet legal entities to circumvent regulatory oversight. These operations initially traded in instruments that repackaged bank-issued loans as bonds, selling them to investors.

Shadow banking has since become a catchall for financial markets and intermediaries that perform bank-like activities—transforming the maturity, liquidity or credit quality of capital. True to the term’s origins, shadow banking remains lightly regulated, potentially harboring unique risks without the oversight and deposit insurance offered to more traditional counterparts.

The risk arises, not only from the size of shadow-banking activities, but also because of the “intricate and inextricable links to its regulated peers through lines of credit, derivatives, insurance, coinvestments, securitization and securities clearing, wealth management, counterparty arrangements and other bilateral services” and the fact that, given the multiple links before banks and nonbank intermediaries, a collapse in shadow banking can spread throughout the rest of the banking sector.

That’s exactly what happened in 2007-08.

Some nonbank intermediaries (such as money market mutual funds and securitization vehicles) were highly leveraged or had large holdings of illiquid assets and proved vulnerable to runs when investors withdrew large sums on short notice.

The forced sell-off led to fire sales of assets, reducing their value and propagating the stress onto traditional banks. Banks, facing their own financial difficulties and fearing heightened economic risk, tightened lending standards across the board, potentially impacting otherwise creditworthy borrowers and leading to a broad economic slowdown.

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Clearly, Federal Reserve and taxpayer-financed bailouts worked for the financial sector—as profits quickly rebounded and have continued to soar since 2008. But the search for additional financial profits has recreated some of the same systemic risks that, just eight years ago, shook the world economy and took it to the brink of disaster.

Once again, the shadows of the financial institutions continue to lengthen.

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Harmen de Hoop and Jan Ubøe, “Permanent Education (a mural about the beauty of knowledge)” (Nuart 2015, Stavanger, Norway)

Ubøe, Professor of Mathematics and Statistics at the Norwegian School Of Economics, gives a 30-minute lecture on the streets of Stavanger on the subject of option pricing.

Drawing on Black and Scholes explanation of how to price options, Ubøe will explain how banks can eliminate risk when they issue options. Black and Scholes explained how banks (by trading continuously in the market) can meet their obligations no matter what happens. The option price is the minimum amount of money that a bank needs to carry out such a strategy.

While the core argument is perfectly sound, it has an interesting flaw. If the market suddenly makes a jump, i.e. reacts so fast that the bank does not have sufficient time to reposition their assets, the bank will be exposed to risk. This flaw goes a long way to explain the devastating financial crisis.

This theory, and similar other theories, led banks to believe that risk no longer existed, so why not lend money to whoever is in need of money? In the end the losses peaked at 13,000 billion dollars – more than the total profits from banking since the dawn of time.

My guess is, most of the members of the audience did not understand the mathematics. However, Ubøe assures them it works—both as a form of knowledge (the manipulation of the mathematics) and as a strategy for banks (to eliminate risk)—and they can’t but believe him. It has a kind of beauty.

And then he explains that other effect of the math: it led banks to believe they had found a way of eliminating risk (because, like the audience, they believed the mathematicians), which fell apart when markets made sudden jumps and the traders weren’t able to reposition their assets quickly enough.

In that case, the beauty of the knowledge is undermined by the ugliness of the results.

Addicted to risk?

Posted: 12 December 2011 in Uncategorized
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Are we addicted to risk? Or, perhaps better, are those in power addicted to risk?

Naomi Klein, in her TED talk (above), argues that we (or they) are addicted to risk, especially with respect to the natural environment—and it’s because there is a master narrative of limitlessness.

George DeMartino, in a recent paper [pdf] published in the Real-World Economics Review, that mainstream economists are addicted to risk—and it’s because they often use a maxi-max decision rule when they advise or decide for others.

Klein’s answer is interesting, at least in relation to mainstream economics, because the usual neoclassical assumption is scarcity not limitlessness. But if the natural environment is treated as a completely external object, then the scarcity assumption with respect to the rest of the economy is quite compatible with a presumption of limitlessness in terms of everything else—the natural environment but also the extent to which the majority of people are capable of enduring the effects of economic crises and austerity measures.

As for DeMartino, his argument is that, while no sane individual would adopt a maxi-max rule with respect to their individual life, it’s precisely the rule that guided mainstream economists “in two of the most important policy matters they confronted over the past several decades”: the neoliberal economic restructurings, first in the global south from the 1980s onward and then in post-socialist transition economies of Central and Eastern Europe in the 1990s.

The examples that Klein and DeMartino invoke are examples of economic engineering that have entailed extraordinary risk—to the natural environment and to large numbers of people around the world. Does this mean we, or at least those in power, are addicted to risk?

Let me suggest, in addition to the causes suggested by Klein and DeMartino, there’s another factor: the small minority of people who have taken those enormous risks are not those who have been made to pay the costs of those risks. Those in power appear to be addicted to risk because the potential gains for them are enormous, and because, in the way the economy is currently structured, they are able to shift the costs of their risky decisions on to others.

That’s why the one percent can continue to take risks—because the 99 percent are the ones who are forced to pay the costs.

End of capitalism

Posted: 27 November 2009 in Uncategorized
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The end of capitalism is a real possibility. That’s according to a report, “Extreme Risks,” by the prestigious investment consultants Watson Wyatt [ht: ja]. The firm listed the demise of the capitalist way of organizing society as the twelfth of 15 threats to investors and the global economy that probably won’t happen but which it reckons are worth worrying about.

Capitalism’s basic premise is that the pursuit of self-interest and the right to own private property are morally defensible and legally legitimate. In a pure capitalist economy, the market drives the allocation of resources and any economic decisions.
In our view, the most likely scenario is moving along from one end of a spectrum where market is king (minimum regulation) towards the other end, where we could see more onerous regulations and government intervention in, and control of, the economy. The extreme risk, however, is the demise of the capitalist system and the end of the market as the primary means of resource allocation.

The other threats revealed by their use of “extreme value theory” are the following: excessive leverage, a banking crisis, an insurance crisis, depression, a currency crisis, sovereign default, hyperinflation, the end of fiat money, the rise of protectionism, a political crisis, disunity in Europe, climate change, a killer pandemic, and war.

Since all the rest are associated with—as either cause or consequence of—the crises of capitalism, why not just get rid of capitalism itself?