Category Archives: Risk and risk management

The Fed Fails, Um, Does Irony

The Fed routinely makes decisions and pursues policies which result in it achieving the opposite of its stated goals and forecasted outcomes.

Nomi Prins on the Credit Derivatives Systemic Risk Bomb

Yves here. Former Goldman managing director turned journalist Nomi Prins spoke on RT about unresolved systemic risk issues, most importantly, credit derivatives.

Philip Pilkington: The Efficient Markets Hypothesis Has Been Proved Wrong But Economists Do Not Want to Listen

Yves here. The Efficient Markets Hypothesis, along with the Capital Assets Pricing Model, is one of the cornerstones of financial economics. Pity both are wrong.

Actually, it’s worse than a pity, since financial economics informs not only how professional investors construct their investment portfolios, but similarly is the foundation for orthodox thinking among retail investors. And the Efficient Markets Hypothesis and the Capital Assets Pricing Model both understate market risk, so following their dictates leads investors to take on more risk than they intended to.

Huarong’s Shadow Bank Bailout: This Changes Everything

Two days ago, we learned that the Chinese government was behind the bailout earlier this year of a trust product—a type of financial product that the central government has heretofore emphatically distanced itself from. Huarong Asset Management, using a 3 billion RMB loan from the Industrial and Commercial Bank of China (ICBC), the trust product seller, was the mystery lender behind the January bailout of the Credit Equals Gold trust product, the Financial Times reported on August 31. ICBC and Huarong Asset Management are both state-owned entities.

New Zealand Companies Office’s $612Mn Money-Laundering Snooze

The Organised Crime and Corruption Reporting Project recently (21st August) published one of their periodic investigations, concerning a rather large moneylaundering scheme: Call it the Laundromat. It’s a complex system for laundering more than $20 billion in Russian money stolen from the government by corrupt politicians or earned through organized crime activity. It was designed to not only […]

Ballooning Finance: How Financial Innovation Produces Overgrowth and Busts

Yves here. It’s a welcome surprise to see economists devise a model that delivers generally sensible results. Here, three economists looked at how financial innovation leads to an bloated financial sector as well as greatly increasing the risk of meltdown.

Summer 2007 Deja Vu: Banks and Short Sellers Dump Risk on Chumps Via Complex Products

NC contributor Michael Crimmins flagged a Bloomberg article yesterday that described the proliferation of complex synthetic structures, depicting it as return to some of the bad risk-shifting of the blowout phase of the last credit bubble.

The amusing bit is the headline was toned down after the post was launched (you can tell by looking at the URL, which almost certainly tracks the original). The current version is the anodyne “JPMorgan Joins Goldman in Designing Derivatives for a New Generation.” But the very first paragraph flags the troubling resemblance to the last hurrah of the pre-crisis credit mania:

“A Financial Casino Would Be a Step Up From What We Have”

This is a terrific and very accessible interview with Boston College professor Ed Kane, who is a long-standing critic of the failure to rein in financial firms that feed at the taxpayer trough. At one point in the talk, Kane and his interviewer Marshall Auerback discuss how casinos are well aware of the fact that the house can lose and they monitor gamblers intensively to make sure that no one is engaging is sleight of hand. Thus if we treated our banking system like the financial casino that it has become, we’d be much better off than we are now.

Only Now Does Influential Bank Group Complain That Low Volatility is Producing Too Much Risk-Taking

The spectacle of banks wring their hands about how low volatility is leading them as well as investors to take on too much risk bears an awfully strong resemblance to a child who has killed his parents asking for sympathy for being an orphan.

New York Fed Worried About Gambling in Casablanca, Um, Ethics Problem at Big Banks

This story would be funny if it weren’t so pathetic. Yesterday, the Financial Times reported that the New York Fed woke up out of its usual slumber and realized that the crisis has changed nothing and that banks still ~~are in the business of looting~~ have unaddressed ethics issues.

Wolf Richter: UBS Warns Everything Is Overpriced, Prepares For Sell-Off

We think the market is stretched. If this is true, the market is already pricing most of the potential good news and is prone to react to bad news.

US Port Strike Threat Highlights Supply Chain Risk

One issue we’ve raise over the year is the ways that the corporate fetish for offshoring and outsourcing greatly increases business risk. Even when savings are realized (and as we’ve discussed, in many cases, the main result is a transfer from factory/lower level workers to managers and executives), they are seldom weighed properly against the increased fragility of the operation, and the resulting exposure to big losses. For instance, extended supply chains entail more communications across the chain, longer production cycles, more shipping, all of which increase the odds of writeoffs via having too much inventory or inventory in the wrong place, and those occasional losses can swamp the savings over time.

Those supply chain risks have come into focus, as the Financial Times reminds us, as the possibility of West Coast port strikes looms.

Financial Interconnectedness and Systemic Risk: New Fed Report Flags 7 Behemoths

Yves here. This post addresses a topic near and dear to my heart: the importance of financial interconnectedness, or what Richard Bookstaber called “tight coupling” in his book A Demon of Our Own Design. Tight coupling occurs when the processes in a system are so closely linked that when certain types of activities begin, they propagate through the system and cannot be halted. Or as Bookstaber put it in 2011:

Non-linear systems are complex because a change in one component can propagate through the system to lead to surprising and apparently disproportionate effect elsewhere, e.g. the famous “butterfly effect”….
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Are Neocons in Iraq Thinking Like the Banks that Blew up the Global Economy?

Yves here. For the normally anodyne OilPrice to run an article, Obama Fiddles While Iraq Burns, that is openly frustrated with US conduct suggests that there is considerable consternation in the oil industry about the lack of a coherent policy in Iraq. One school of thought has been that the US wanted a breakup, but history like the dissolution of Yugoslavia shows that they are ugly, bloody affairs that hurt the population and infrastructure. Both are bad for business, such as drilling for and refining oil, which was apparent reason we occupied Iraq in the first place.

I’ve discussed with Lambert the difficult of coming up with a coherent rationale for the US stance towards Iraq.