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This is the second hosting of the Cavalcade of Risk at Ozrisk. The first concentrated on the perceptions of risk, so perhaps we should move on to its actuality in this one.
Health Insurance
The recent (very recent) legislative changes in the US health insurance area makes this quite topical – but I have to admit it is not my specialist area. To put it mildly, these changes do not seem to have attracted universal acclaim amongst the health risk community in the US. The posts on it range from the concerned to the condemnatory. The most favourable to a post that was in favour was this one from Louise – but that could hardly be seen as a strong endorsement. Coming from a country that has a reasonable (but by no means perfect) health system I have always found it difficult to understand the US system, but the Australian one is not much easier to understand – but the political arguments are a little less shrill. But only a little.
Perhaps there is another way to do this, but surely it can’t be that simple.
On areas other than the health bill, Jason Shafrin looks at the perennial problem in health insurance – cost effectiveness.
Political Risk
One of my favourite topics is the attempts by the unskilled to impose their idea of the right thing to do by legislative fiat. This one, from Arizona, is a good example of an attempt to increase compliance with speeding laws – which just ends up making a mockery of the idea of compliance.
The big element of political risk is that you just do not know what the politicians are going to do next, but you can hazard a guess it will be big. Attempts to re-shape the mortgage market looks like the next big issue, and Calculated Risk has been looking at changes to Fannie and Freddie.
Nancy Germond also has a look at the hazards arising from changes in the law – and how to insure against it. Personally, I prefer mitigation, but when you can be dragged through the courts over what seem to be small things, perhaps mitigation is no longer enough. Doing the right thing can be impossible to demonstrate at times.
Lists
There were a couple of intriguing lists submitted this week as week. I am not entirely sure they are risk related, but they are worth a look for the list compulsives amongst us.
- Smruti Ranjan presents Top 10 Economic Journals for Economics Scholars .
- Mariana Ashley presents 100 Business Experts You Should Follow on Twitter.
Insurance
Millie Kay G presents Get The Right Coverage! Insurance Policies You Need and Those To Avoid. Her advice seems good – particularly on pet insurance. That said, several people I know have spent thousands on operations for their pampered pooch, so maybe you should take another look at this.
Consumer Boomer looks at the possibilities of cheap Term Life Life Insurance. Perhaps sometime you do get what you pay for.
Perhaps if you do not like a contract you have just signed, you can get it declared unfair – and ignore it. Australian law can do that at times – but I am sure it is not just here.
Banking
Chris over at the Financial Services Club blog has a number of historical quotes to look at – from FDR to the IMF. It can pay to remember that there very little that is new in rhetoric about banking. If you like your analysis a little less “worksafe”, try this one on systemic risk. Always amusing, just be prepared for your internet filter to kick in.
The operational risk of dealing with the interface between a bank’s systems and its customers (i.e. the tellers or lending officers) is discussed at The Bank Channel. This can be the biggest source of operational risk of all.
It is always interesting doing a blog round up – while not as long as some, I hope you have enjoyed this one. Thanks to Henry and the Blog Carnival!
I have not had much to say here over the last few weeks as work has been pretty intense. In the mean time, for those of you more interested in monetary questions, head on over to the Daily Kos for a good read on Hayek vs. Keynes.
Great quote from the piece – “Trying to cure a recession with more cheap credit is like trying to cure chemotherapy with more cancer.
Following the publication of a document on Islamic Finance (IF) by Austrade this week, perhaps we may get something serious in the way of development of this area in Australia.
Interestingly, the Trade Minister, in releasing the document, announced the release of a new product by Westpac – I wonder when Westpac will get around to announcing it. I would not find anything on their website. My guess is that this is just a toe in the water, because if they expected it to be a significant part of their business, they would have to make an ASX release about it. In that, I think they are right. A single specialised product is not going to be big in the context of and institution that size. That said, getting some credibility and experience will be a good thing.
For those interested in the area, a full read of the Austrade publication would be a useful thing. It provides a decent discussion of the IF market (although some of the data seems a little out of date as market growth has been hit by the Dubai problems). The issues identified in it are similar to the ones I identified a while back – the tax and regulatory structures in Australia need to be changed to remove the artificial impediments, find or develop appropriately qualifies Islamic scholars and we need to increase the knowledge base of banking professionals in Australia.
None of this is impossible – the regulatory stuff can be done quickly by essentially copying (at the State level) what Victoria has done and, at the Federal level, copying what the UK has done in regulation terms. Improvements on these could be made, but this would be a good first step.
Good to see at least something happening, though. It is a fascinating area of banking. In the mean time, read the Austrade document. It is pretty good.
I have been asked several times for a summary of what I think about the changes to the US banking system mooted by the Obama administration. Apart from not actually addressing the root cause of the collapse I believe the suggested changes will just make the whole thing more likely to recur next time the economy downturns.
The root cause, by the way, was over-lending by small commercial banks for mortgage purposes, aided and abetted by Fannie Mae, Freddie Mac, US regulations and bigger US banks that did not look too closely at some of their risk models in pursuit of short-term profits.
The best summary I have heard, though, and one that is close enough to my own views, is this one from the BBC, which I heard driving home yesterday. Give it a listen and then think about it.
It looks like the IASB is really interested in our opinion on the own credit risk issue. If you want to give them your opinion (and mine is pretty clear) then you need to become a registered user of the IASB website (come on – you know you are really interested and you do not have to admit it to anyone) and then email them at “owncreditsurvey@iasb.org”.
It would be worth doing if it gets them to a sensible position. Of course, many banks and other enterprises may find it “sensible” to allow the inclusion of own credit risk in the value of a liability – it would serve to reduce the disclosed value of the liabilities of the company, perhaps taking a failing enterprise to a position where they are then able to show a positive net worth. It would also improve the capital position of banks.
That would be a truly perverse outcome.
Once for the real financial accounting for financial instruments nerds*.
IFRIC 19 Extinguishing Financial Liabilities with Equity Instruments was released a few days ago. This is the interpretation designed to cover debt for equity swaps, where an entity gives up some equity in exchange for the extinguishment of some or all its liabilities.
There will be no surprises in the final decision(s) – when you issue equity then that equity forms part of the consideration for the extinguishment, the shares issued are measured at fair value unless fair value cannot be measured, in which case they are measured as a residual amount on the liabilities (which are measured at fair value) and any resulting differences are put through P&L in the current period.
All of this follows what was expected and, to be honest, good sense.
The more astute of you may look at this and note that I am supporting the measurement of financial liabilities at fair value in this case – and you would be right, I normally do not. In this case, though, the liabilities are being extinguished, rather than being measured, so using fair value is appropriate.
The questions I would like to ask from a theoretical view is on the equity side – IFRIC 19 is clearly canvassing a situation where equity instruments cannot be fair valued, yet the new IFRS 9 says they must be.
Am I the only one to see a conflict here? I would guess this IFRIC will lapse on full implementation of IFRS 9.
Oh – and if the AASB can get a version of both of these up there soon I (and many others) would appreciate it.
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*I like it that “financial” can be in there twice. I tried to work out how to get rid of it, but I did not try too hard.
Following a suggestion I have been reading a book by Naomi Lamoreaux on the development of banking in New England1. It is called Insider Lending: Banks, Personal Connections, and Economic Development in Industrial New England.
She makes a number of excellent points in the book, and, to me, anyone with an interest in the development of modern banking should give it a look. Quite a few of the points she makes relate to the way that the improving understanding of credit risk, and the development of modern risk management, was, to a large extent, responsible for the development of modern, large banks.
I would argue, consistent with my earlier post on regulation, that it was not solely this, as an increase in regulation did play a major part, but I think it was more of a virtuous (or perhaps vicious) circle – with an increase in the size of banks, and an increasing ability to lend to whoever happened to turn up to the bank driving further regulation – which then effectively forced the smaller banks to grow or perish – creating more regulation.
The central point of the book is simple – early banking in the US (and, she presumes, elsewhere) was severely hampered by an inability to assess credit risk, so what happened was when a bank was founded it generally had several directors, men (and they were all men) of substance who effectively both lent their names to the bank and risked a large part of their fortunes in the venture.
In return, what they got was access to the banks funds, with a typical bank lending between 20 and 50% of its funds either to the directors or family members of the directors – the “insiders” of the title. They were, to an extent, protected from unlimited liability by the bank’s charter, but this protection was often more illusory than real as to default would normally not only spell the end of the bank, but also the reputation of the individual directors.
The result was that the directors typically had an overwhelming say in the allocation of the bank’s lending, and they often lent to themselves or to others they knew well.
While today this may be looked on askance (and as possible criminal activity) then it was considered normal business for the reasons set out above. The difficulty of assessing credit risk meant that only lending to people you knew well (and, presumably trusted) was reasonably safe and, as you effectively had your own money on the line, you wanted to be really safe.
This had several effects – most people were effectively locked out of the banking system until they reached a point where they were rich enough to either own their own bank or to know someone who did. The second was that banks tended to be small – really small – with around 6 directors each and few employees. They also tended to have really high capital and liquidity ratios and charge really big margins. This then locked still more people out of the borrowing market.
The development of modern risk management practice, in all fields but particularly credit risk management, put paid to this model. While a few micro banks lingered into the modern era (and a few unit banks survive in the US) the bulk either went out of business or were bought out in the period up to the first world war.
The simple fact is that bigger banks, once you can overcome the difficulty of finding the good risks to lend to, are much, much more efficient2. If you can lend to more people, and people you do not personally know, you do not need your (comparatively expensive) directors to take every decision. You can directly obtain diversification benefits, cutting down losses per dollar lent. You can also, as a consequence, reduce your liquidity and capital ratios so you can drive more lending off the same amount of deposits (not, of course, that you can lend more than you have in deposits) and you can generally make more money.
For those campaigners for “social equity” it also makes a clear point – without modern risk management the poor are effectively locked out of the banking system entirely – so if they want (or need) to borrow funds they need to go to the loan sharks to get one. Personally, I would prefer to pay 6 to 10 percent to a bank than 20 to 50 percent to a loan shark. The bank also tend to not threaten to break my legs for non-payment. Banks can be funny that way.
The directors also become much more removed from the day-to-day operations,becoming more like the modern directors of a bank, able to reduce the risk to their own personal assets that may result from a bank collapse.
I would encourage readers to have a look for this book and give it a read, as it fills in a hole often left in the discussions on the development of modern banking.
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1. For those not familiar with the term, or who may be thinking of another New England as there are several, she means the US states to the north east of New York.
2. They can also, as I pointed out earlier, deal with the regulation better, and they can lobby government more effectively – i.e. be more efficient rent seekers.
Following on from the recent discussion regarding bank logos, this post (from this week’s cavalcade) made me think that perhaps we could do something with Australian bank names.
In the spirit of French Connection UK, then, suggestions are requested for bank names relevant to Australia (or New Zealand) that would have as big an impact as the name FCUK did.
The best entry will be close to an existing name, have real impact and would be legal to put on the outside of a bank branch.
Warning, though – anything outright obscene will be summarily deleted.
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