Risk Should Bother Us But We Need to Be Grown Up About It

I met with a couple of friends who are working in Fintech and we were discussing risk and how well banks understood it. Many years ago when I was implementing Risk Management systems into several London banks they discovered their real risk was different from what they reported and cleaned up their act.

We discussed that a once in a lifetime event can happen three times over a short period because the clock is reset each time and the cosmos has no memory that it has caused recessions in 2008.  The herd effect means that too many people have the same ideas at the same time and distort the market (thanks 24-hour news and analysis)and the only things that are reported are the downside for a sector on the population and not the upside. Example: If the exchange rate weakens for sterling it makes holidays more expensive but it makes our services and exports more competitive. If our businesses do well then the stock market does well and so do our pensions.

My friend was saying he was risk-averse and his partner had a higher risk threshold. The challenge is that there is a curve that goes from high-risk and high reward to low-risk and low reward. He said he was a medium-risk and medium reward person. The problem is that most people are the same but the market does not look at the theory and a lot of people invested in medium-risk assets and lost a lot. You need to have a combination of zen patience, opportunism like a gambler and the stamina of a donkey to keep pushing on.

My other friend quoted an analysis from the Economist that predicted the last recessions and reckons a new one is on the way. Way back in history there was a Dr Dee who used mathematics and astrology to provide a service to the court of Queen Elisabeth. He provided input on when to go to war and other important decisions. He was quite successful for a while and I think the Economist has resurrected his thinking and approach. They can now predict the past with 100% accuracy. No wonder people are disillusioned with the elites if they are reduced to simple spreadsheets to predict the future.

As Minsky said too much stability can be destabilising. We need change and flux and we need to understand there will be winners and losers and it is not possible to ensure against every eventuality.