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The WordPress.com stats helper monkeys prepared a 2012 annual report for this blog.

Here’s an excerpt:

4,329 films were submitted to the 2012 Cannes Film Festival. This blog had 28,000 views in 2012. If each view were a film, this blog would power 6 Film Festivals

Click here to see the complete report.

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.

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!

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.

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.

I will very irregularly have any time for a full post over the next few weeks due to work pressures. I seem to be spending most of my time here trying to sort out one commenter on what I believe to be his misunderstandings of banking. Oh well.

Just for your reading pleasure, though, I read a very good post regarding the role and future of the Credit Ratings Agencies on the usually excellent “The Sheet” today. Have a read – it is worth it.

Conclusion:

The agencies proved that they are poor at rating complex structured finance products. Their approach to rating sub-prime mortgage backed securities was not sufficiently rigorous and their models for assessing other more complex products were inadequate.

By virtue of this, their opinions on these products should now be viewed as being of little value and the market should effectively withdraw the agencies’ ‘licence’ to rate such products. This will open the door for new specialist structured finance ratings agencies to enter the market.

This seems a better approach than more regulation and the unintended consequences that could result.

If you are in the business of reading banking news on a regular basis please subscribe. It may help in your understanding of what banks actually do.

While this may be a little tangential to the normal run of posts here, to me managing regulatory risk is one of the things that any good risk manager has to do. Understanding the abilities and restrictions that the law has is an important part of that.

Over the last few months I have been putting the occasional post up here on what I feel is wrong with a lot of the regulatory framework. Skepticlawyer, being the very good lawyer she is, has done it better.

Legislation has two limits. One is practical (call it a ‘means-end’ limit). The other is principled (call it a ‘normative’ limit). Most philosophers spend all their time arguing over the latter: John Stuart Mill’s ‘harm principle‘ represents an attempt to get at what a principled limit on the powers of legislation may look like. This is philosophically interesting and forms a major part of my DPhil thesis here at Oxford. In the case of conservatives and social democrats, however, both groups engage in major legal wish-fulfillment: they think they can ignore ‘means-end’ limits. That is, they seem to think that passing a law will make it so. If wishes were horses, people, beggars would ride. They think they will, for example, be able to make abortion illegal (or greatly restrict access to it) with no social or economic comeback, or impose salary caps on business executives without hemorrhaging talent overseas or to other industries.

This is in the context of a piece on the Left in Australia – but the second half of the piece goes on to more general issues and it is this section of the post I would encourage you to read. It starts at the third paragraph after the blockquote in her piece.

Putting together a blog cavalcade was an interesting task – and one that took a fair bit longer than I expected. Not, I might add, because it was a painful one, but because there was so much to read and so much that I had not covered – focussing as I do on banking with the occasional foray into insurance along with the occasional amateur foray into economics.

Health

The quantity of posts on health that were submitted was interesting. Living in Australia the issue of health insurance is not a big one. The idea of being bound to an employer’s health plan is an interesting one, so the issues that arise from this – in particular where the employer has to choose a plan caused me to think carefully. While this post read a little like an advertisement for “Best Doctors” I did have to stop and think.

Being a little late, as I am, in posting this at least let me look at the latest stff out there. One post from the Cav’s organiser (Henry Stern) just popped up with a question about the US health system and where it is headed. Given how much you guys in the States are paying I am not surprised you are looking at alternatives, but, to (hopefully correctly) paraphrase where Henry is going, just because you need a change and that what is proposed is a change does not necessarily mean that the change that is proposed should be adopted.

To go with the slightly Australian flavour, though I should note a recent controversy over here – whether midwives should be able to attend home births and be covered by insurance for doing so. To me, it flows on to the question in the next section – whether perceptions of risk become the guiding methodology, rather than the facts of the matter. This is backed up by a piece from Colorado on home births.

Risk Generally

I found this post, while short, on risk response to be interesting – why do we sometimes respond to risk in an illogical way, taking the “safe route” rather than the one that is more likely to give the desired outcome? Perceptions of risk are often, but not always, wildly different to the actuality.

Banking

One of the warnings I received on agreeing to do the Cav was against posts on credit cards. Sorry – but I will have to make one exception. This one talks about the popularity of credit card default insurance – and why you probably do not need it. This has always been my perception of this type of insurance, so I thought it should be added to.

The TARP bailout has been fairly big news all around the world, with the US government pumping huge funds into the banks. I have always been a skeptic on this sort of action, but some hard data can cause me to rethink. I am not persuaded as yet, though.

One possible option for the future was canvassed on BankWatch – make the banks a lot safer than the current ones. I am not sure exactly how to enforce it, but it is a good thought.

To get through all this, some general advice is sometimes handy – this post gives some very general advice on possible strategies. I particularly liked the last one on sorting out an exit strategy. It is always a good idea to have a backstop. More advice comes from the Digerati Life – and again, the last one is the money quote. If you are thinking of trading it is worth a read.

I can’t leave without giving a little plug to one of my favourite bloggers in Kenya – Bankelele. His series on the use of mobile phones to make payments in Kenya has been very interesting.

Insurance

Given this is a risk cavalcade, I was surprised that there was so little (read: nothing) on general or life insurance submitted. Other than health insurance, there does not seem to be a lot out there. Perhaps readers can direct me to some useful ones in comments? Perhaps a brief look at an alternative may help.

To sum up – thanks to Hank for the oppotunity to do this. It was certainly interesting.

I received an interesting piece of blog spam a couple of days ago and, because of the content instead of deleting it I decided to do some digging. This was the text of the spam:

I’m happy to describe at this page an interesting kind of making money. Can you imagine that one can earn up to 3% a day through investments without limitations in without sum limits? I. e. that even having US$1.000,00 one can make the same money in a monthly!

If someone is interested welcome to visit my web site http://www. theinvestblog .com.

I have removed and doctored the link in the spam as I really do not suggest that you follow it. It points at this page.

While I do not have any idea of what this company is it bears all the hallmarks of a classic Ponzi scheme. It offers “guaranteed” high returns (between 1.2 and 3% per day), the investment strategy is vague at best and self-contradictory at worst, with the front page implying that they are investing in (UK) AIM listed shares and the “Our Strategy” page saying it is “…quality and high yield investment into different international financial instruments…”.

They are based in Panama, apparently for its “…political and economic stability…” and its name mimics some of the more reputable investment managers in the UK – notably its namesake, the AIM Trust plc, with which it does not seem to be associated.

Again – I do not know if this company is definitely a Ponzi – it may be perfectly legitimate and earning these sorts of returns by really good investment management – but it certainly looks like one. The use (and abuse) of the English language on the website is neither here nor there.

If you go to the site and decide to put some money into it do not claim that you have not been warned.

Just a quick note that Ozrisk will be hosting the next Cavalcade of Risk. If you can think of any blog posts on the area of risk management and believe they deserve a bigger platform, feel free to submit the post using this form.

Note, though, that submission does not guarantee publication.

The current edition is here.

Following up on the previous post on the GFC, there is a very interesting article in the Wall Street Journal that makes a very good point on the causes of, and solutions for, the current recession. In a simple table, (about half way down) it makes a very strong point – the depth of each country’s recession has been very strongly linked with the amount of government debt. Those countries that avoided recession had little or no government debt in 2007. Those that had big government debt have had a long recession.

If I remember my university economics properly, a good Keynesian economist would at this point rush in and point out that Keynes himself believed that debt should be net zero over the cycle and, as 2007 was pretty much the peak of the boom debt at that point should have been zero or less than. They would be right.

It does, however, show the importance of fiscal responsibility if you want to avoid prolonged downturns.

A second point that the author makes is that having the US Fed seems to have resulted in more severe and long term downturns than happened before the existence of the Fed. Again, this clear point must be equivocated by pointing out that the economy has changed since 1913 – but it is clear evidence that should be taken into consideraion when we are looking at policy responses to the recent (and now possibly finished) recession.

Hat tip – Cattalaxy.

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