How can risk management help restore confidence and trust in financial institutions and the stock market in particular?
Robert Shiller of Yale University believes that we need a new information infrastructure that provides comprehensive financial advice for everyone. He compared receiving professional financial advice to how most people have access to professional medical advice today. Imagine, for example, that if you got sick you had to go to a major drug company and ask them what to do and their advice would always be centered around their products, even if they knew a competitor had a drug that would be just right for you. For the majority of people, this is the situation we are in today with respect to financial advice and Shiller believes this needs to change even if it requires subsidizing financial professionals. Shiller also discussed ways to help improve the housing crisis where more than 12 million homes are now under water (mortgage-wise). He suggested that we need improved retail products such as home equity insurance and continuous workout mortgages that would adjust mortgage balances as housing prices decline.
Zannie Beddoes, Global Economics Editor at the ECONOMIST, gave her opinion on how we get rid of the inevitable headaches we are experiencing after moving from bubble to hangover, where assets went bust, greed changed to fear, and where thrift is foremost in everyone’s mind. Annie believes that letting Lehman fail was a major blunder and instead of an orderly wind down we were thrown into a major financial crisis. Her global to-do list for a recovery includes strengthening banks, lowering interest rates, and injecting money to provide credit liquidity.
A prominent theme from most speakers was the need to bring fairness to the restitution process. Shiller cited the example of how Germany was treated after World War I as the wrong approach. But public sentiment is definitely against the privatization of profits and the socialization of losses that seems to be happening within the financial services industry. And there is no question that providing NINJNA loans (no income, no job, no assets) was a colossal mistake but how should individual borrowers be treated in the aftermath? Should the general public be subsidizing borrowers who in many cases should not have purchased a home in the first place?
Nick Mongue, from the MACQUARIE GROUP, said that the good news is that very few banks have lost more than their capital models suggested. But, the bad news is that they lost it all in one year and that most of the losses have come from the good assets where there was hardly any risk allocated. He suggests that the current period will be rich in lessons to learn, but for risk professionals you want to learn from other banks as opposed to your own.
Although there were differing opinions about the main causes of the current financial crisis, most speakers at RiskMinds in Geneva were unanimous in their belief that the worst is still to come in what many were referring to as the “Great Recession.”
Robert Shiller of Yale University drew many parallels between the Great Depression and today’s crisis. For example, we have lost 60% of the stock market value since the 2000 high, while during the great depression there was an 80% drop. But Shiller refuted many of the commonly believed causes of the current crisis such as weak underwriting standards, unsound risk management practices, increasingly opaque financial products, and aggressive leverage. He maintains that the speculative bubble in both the real estate and stock markets were largely to blame for the worst financial crisis since 1929.
Maureen Miskovic, CRO at State Street, opened her presentation with a quote from Dickens’ Tale of Two Cities: “It was the best of times, it was the worst of times, …” and went on to claim that we are in the midst of a financial revolution. Miskovic predicts that we will see unemployment levels of close to 10% in the U.S. next year which will in turn cause problems in the prime mortgage market. She also predicted that the current political climate will result in punitive regulation which will transform the large U.S. banks into institutions that are very similar to public utilities (increased disclosure, more transparency, and intrusive examination).
Zannie Beddoes, Global Economics Editor at the ECONOMIST, predicts that shrinking personal wealth will greatly effect demand and eventually push the world into depression era economics. She stated that the current situation is unlike other post war recessions due to the asset bubble burst and so we are in for a deep, long recession. She also fears an anti-market backlash which could result in subsidy wars and protectionism policies.
While the speakers painted a picture of doom and gloom, they were clear about the increasing role that risk managers need to play in helping financial institutions restore confidence and trust, as well as create a sense of opportunity in the financial markets.
I’ll summarize some of their recommendations in tomorrow’s blog.
This weekend the president-elect Barak Obama was interviewed by Tom Brokow on Meet the Press. The interview covered a wide variety of topics, but one caught my eye as it impacts the risk management business moving forward.