Tuesday, 24 March 2009

The Socialization of Risk: FSA Report (3)


Turner muses on the subject of whether mathematical modelling of risk – e.g. for determining capital adequacy – is valid.

“it is unclear whether … we need to recognise that we are dealing not with mathematically modellable risk, but with inherent ‘Knightian’ uncertainty. This would further reinforce the need for a macro-prudential approach to regulation." (page 45)

Many will have read Taleb on this subject, Fooled by Randomness being much more measured than the later, more famous and intemperate diatribe The Black Swan. Turner goes on:

“But it would also suggest that no system of regulation could ever guard against all risks / uncertainties, and that there may be extreme circumstances in which the backup of risk socialization (e.g. of the sort of government intervention now being put in place) is the optimal and the only defence against system failure."

Well. Obviously, since it’s happening right now, socialization is indeed the ultimate back-up: it always will be. But ‘optimal’ and ‘only’ are strong words – could the current nonsense be described as optimal by anyone except a successful banker-looter who’s made his escape ?

To argue that planning for this to happen (even in a more orderly fashion) once in every 50 years or so, is optimal, is akin to saying that government should always make every capital investment because it has the lowest cost of capital. Defeatist, statist claptrap. And ‘only’ is strictly for Marxists.

Conventional risk management can do much better than this without recourse to ‘state insurance’ – has Turner never heard of margining, for example ? Of course he has, see pages 83 and 110-3. Only if the state knew what risk margin, or ‘insurance premium’ to levy (or to set aside from general taxation by way of subsidized ‘sinking-fund’), could a true optimisation calculation be made. But if the appropriate margin is known, this can be handled, as with on-Exchange or bilateral margining, within the commercial sphere itself.

And if for a particular deal or player such margining were ‘too expensive’, that is a strong indication the deal in question shouldn’t be transacted at all !

What ‘society’ should demand is not the dubious privilege of socializing ultimate risk, but the proper implementation of conventional risk management between the consenting adults involved.

ND

6 comments:

Anonymous said...

Why should "society" be involved at all.

The parties to the contract were free agents, they took the risks, measured or not.

Why should they be back stopped?

Bankruptcy laws do exist.

Any entity that causes risk to society because of its size, or operations, becomes an explicit danger to that society.................

And knowing that it has a back stop increases the frequency and magnitude of risk taking exponentially.

And that includes banking cartels.
And corrupt politicians.
And corrupt heads of enquiries.
And corrupt judicial reviews.

But while ever we have a supine, controlled, media, forums such as this become the sole newsagent of relative truth.

And THAT is the problem.

The beneficiaries will continue the spin.

Sebastian Weetabix said...

Why not have almost no regulation & also no bail-outs? Guarantee deposits but that's it. This too big to fail crap distorts the market & encourages demented risk taking.

Plutarch said...

Since the entire "risk taking" business is based on uncertainty, then the uncertainty principles apply. Thus any statistics simply fly out of the window.
It is pure (if that is the correct word here) gambling. Should society bail out the bookmaker or the punter???
They are both in it for personal gain.

Anonymous said...

This man is spouting nonsense at an ignorant public who don't know what to believe. Any rational person would do what FDR did. Glass Steagall. Separate investment banks who take risk from deposit taking institutions. These deposits would be guaranteed. They would be heavily regulated and capitalised. They might not even make sense as classic stock market entities and have to be semistate. The investment banks can do whatever they want but on circumstances would they be bailed out. Simple solution but Turner doesn't want to even discuss it. He wants to keep the failed status quo while talking tough and trying to fool people into thinking there has been change. I do think improvements like a clearing system for CDS and more regulation in credit would help on top of this but this is the icing - the cake is Glass Steagall.

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