Monday, November 24, 2008

Rethinking Risk

In all the replays of what went wrong with the economy, the recurring theme is the failure of risk management--by the government, Wall Street and overreaching home buyers.

Over the weekend, we get disheartening replays of how the Bush Administration abdicated responsibility for regulation and how greedy hotshots at Citibank created a mess that taxpayers will now have to clean up with billions in a bailout.

"In normal times," the Economist says in its piece on Treasury Secretary-to-be Timothy Geithner, "risk aversion damps economic cycles; in a crisis, it accentuates them, leading to withdrawn credit, evaporating liquidity, margin calls, falling asset prices, and more risk aversion. 'The brake becomes the accelerator,' as he puts it."

So we have a topsy-turvy world now in which prudence that has morphed into fear is causing the freezing of credit, and the kind of gambling that caused the problem is the prescription for curing it:

"Mr Geithner understands better than almost anyone that in crises you throw out the forecast and focus on avoiding low probability events with catastrophic consequences. Such judgments are excruciating: do too little, and you undermine confidence and generate a bigger crisis that needs even bigger policy action. Do too much, and you look panicked and invite blowback from Wall Street, Congress and the press. At times during the crisis Mr Geithner would counsel Mr Bernanke on the importance of the right 'ratio of drama to effectiveness.'”

For those of us who grew up with a Depression mentality (my parents wanted me to be a teacher because in hard times they still have jobs), this upends a lifetime of trying "not to live beyond your means."

We watch in wonder as a beleaguered government frantically throws billions into rescuing institutions that broke all the rules of our lifetime and wonder, when this is mercifully over, how will we get back to a sane balance of risk and reward to help our children and grandchildren pay for all this madness?


Mike said...

The cowboys took over Wall Street and pop culture. Risk-taking was considered manly and admirable, risk aversion wimpy and risible. Excessive spending and borrowing was regarded as glamorous, caution in personal finances borrowing.

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