National Economic Risk Management

“For Want of a Nail”: ERM for the Regulators

Comment: A long article that is difficult to summarize or excerpt. A good read.

Excerpt:

It’s ironic, but tragic, that the fundamental core of all U.S. financial regulation—the requirement that firms identify, assess, plan for, and ameliorate market risks—has long been missing from the way this country’s regulators oversee our financial and capital markets. With the release of Treasury’s Blueprint for a Modernized Financial Regulatory Structure, we’re only now just embarking on a long overdue examination of the way this country regulates its financial and capital markets. But, it does not take a blueprint to identify the one obviously missing ingredient in our regulatory arsenal—the application of risk assessment and amelioration, in the form of enterprise risk management. Government long ago should have learned the folly of a mantra that encourages the private sector: “Do as I say, not as I do.” And yet, for all the requirements of transparency and risk assessment imposed on those who provide financial services, the government has been woefully inept at requiring at least as much of itself.

It’s long been noted that there’s no foolproof way to make money on Wall Street, but there are plenty of time-tested, proven, and foolproof ways to lose large amounts of money with absolute certainty. The 1987 October equity market sell-off was triggered by “portfolio insurance.” Brokers established programs for financial institutions that allowed them to control their market exposures by constructing theoretical “put” positions and delta trading them. This is fine, but that technique requires financial institutions embracing it to accelerate selling as the market falls. If enough large institutions engage in selling at the same time, markets panic and the result is what was produced in October 1987.

Comments: It is difficult to make money in the stock market. First dividends are doublely taxed (the firm pays income tax on its earnings, and then the investor pays tax on the dividend income); secondly one pays capital gains taxes (which are complex to calculate and require odious record keeping AND their is no indexing for inflation). Its no wonder few people invest! It's a spend as fast as one can borrow economy!