Why Wall Street Ignores Real Risk And Why History Will Repeat Itself

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Sun, 05/08/2011 - 06:16 | 1252589 The Alarmist
The Alarmist's picture

Risk management is the lie they tell the unwitting to think they have given some thought on how to protect the unwitting from the inevitable meltdown that must come from a system that is based on laying off risk on other parties and then "re-setting" the system so they can set it up for another round.

As I said above, Wall Street is a wholesaler of risk, so it is hardly in their interest to actually minimise it ... risk management means that they have given some thought on how to shunt it off on others, much like those giant culverts you see in the Alps or other mountain ranges to shunt avalanches off on the next poor schmuck below.


Sat, 05/07/2011 - 12:26 | 1251035 falak pema
falak pema's picture

risk management in financial wealth management is very rigorous...Its true if you're an Oligarch. "If you own 100 Million...it's inevitable to go to 101 Million..." Now that is risk management mantra down to a button. Inevitable is key word...But if you want to go from zero to 1 million...it's inevitable that you'll lose...so that the guy with a 100 can go to 101..You lose from zero to -100 as you are owned for life! Wow, its so simple really risk management when the table is not level; when the roulette wheel doesn't pay you for zero number...it's inevitable you lose more the longer you stay at it!

Math is the only language that the Gods and the Oligarchs speak well!

Sat, 05/07/2011 - 09:50 | 1250752 twotraps
twotraps's picture

Alarmist, well said.  I would add that a really sinister layer of complication comes from the fact that none if it is illegal per se.....due the extraordinary, heavy, complicated and constant lobbying pressure in Washington.  Look at the many players involved in the housing debacle, a bankers dream, no risk and not illegal, no one is held accountable for anything.  Perfect.  THAT is the ultimate example of spreading risk around for the extreme benefit of the few.   Not the change the subject, but what can we do about it?  What happens if the stock mkt 're-prices' like crude over the next month? 

Sat, 05/07/2011 - 09:46 | 1250744 chinaboy
chinaboy's picture

Not just risk managers. The market itself does not act on investment needs. Everything is a trade. Risk on you make money, risk off someone else makes money. In many cases, money is made within micro-second.

At this point, we ridicule risk management. In history, generations will ridicule us for the the crazy market we are trading up.

No one doubt it will happen again. The only thing is no one knows when.



Sat, 05/07/2011 - 09:02 | 1250711 The Alarmist
The Alarmist's picture

The premise is totally bass-ackwards.  Wall Street does not ignore risk, Wall Street is a wholesaler of risk for parties who wittingly sell it to parties who wittingly or, more often than not, unwittingly buy it.  The beast cannot get enough risk to spread around to feed its enormous appetite, and so the blow-ups have been getting bigger and bigger in order to keep the beast fed. 

I would go so far as to say that Wall Street is no less than Shiva the Destroyer, except that (1)  no true karma Yogi would take credit for his acts, and (2) the destruction of Shiva ultimately makes way for some future good through recreation.


Sat, 05/07/2011 - 10:15 | 1250785 jm
jm's picture

another dup.

Sat, 05/07/2011 - 10:15 | 1250780 jm
jm's picture


Sat, 05/07/2011 - 10:10 | 1250777 jm
jm's picture

Bad risk management isn't exclusive to  finance.  I remember a month ago all kinds of nuclear engineers (they could be sanitation engineers for all we know) got on here spewing crap about how Fukushima was nothing.  Move along, let the experts handle it.  These "experts" are just as pathetic as financial "experts". Maybe more if Godzilla shows up and eats Tokyo, or some people over there get massive radiation problems.  

Finance is not all bad.  People can get returns.  Finance is about innovation, and it does this.  More people than ever before are able to get exposure to fixed income and commodities via ETFs.  Innovation isn't the problem. 

The problems are corruption and lack of enforcement.  Another deeper problem is that people and institutions at all levels are accustomed to blaming others and getting bailed out.  Responsibility is fading off into the sunset.   

I think this good article adequately captured the weird sociology that goes on in wealth management.  You shock and awe people by hiring very smart people to work on insoluble problems.  You wrap everything in a cloak of complicated jargon to impress.  You say everything is now under control.  If you believe this, you are a fool. 

Luck and bad luck dominate control.  Nobody has it all figured out.  Even when you figure something out, everything blows up in your face.  We'll never figure it all out.

Nobody can predict the future, and we don't have good enough imaginations to see every contingency.  Our Maker made us such that we don't handle non-linearity well at all.

As to risk management.  The intractible problem is liquidity.  Compensate its lack of solution with rules of thumb.  Buy cheap; cut your losses; diversify with a mix of fixed and floating cashflows; stay within your system.  Think of things that can go worng and use that to supplement historical.

Everything humans touch, make, and do is imperfect. 


Sat, 05/07/2011 - 08:29 | 1250682 Coldfire
Coldfire's picture


Risk [management] in wealth management [is] very rigorous.

That is simply, fucking absurd.

Sat, 05/07/2011 - 07:39 | 1250641 destiny
destiny's picture

This is why history repeats itself......



its actually quite long but those who have done their homwork will find here a clear and precise, nicely ordered synthesis to what is known to many.

Sat, 05/07/2011 - 07:04 | 1250632 Love and money
Love and money's picture

Great reporting from sunny California.

Great comments.

Great link to House of Representatives true colors, as if we didn't already know....

Thank you, all.

Sat, 05/07/2011 - 06:21 | 1250617 Kickaha
Kickaha's picture

While people like to speak the phrase "systemic risk", I find it odd that nobody seems to expound on it.

Perhaps in doing so, you cannot avoid excoriating the system from which all milk and honey flows to the uberrich.

Investing requires a lot of hard work, part of which is a long-term commitment to personally managing the risks inherent in your investment.  With stock, after you invest in it, you have to participate in corporate governance to try as best you can to insure that your investment does not go awry.

A securities trader goes a different route.  He pretty much has to, since profits hinge not upon any particular knowledge of the underlying investment, but in acting immediately and just before everybody else when his TA pinpoints a bottom or a top.  The strategy to prevent risk is to buy a derivative as a hedge

There is always somebody willing to sell a derivative.  It's like printing money, and the income statement for the current quarter looks great, especially if the accounting model is one which doesn't require the creation of a loss reserve just in case the insurer has to pay out on that policy at some point in the future.

Buying a derivative to hedge a risk does not cancel the risk.  It is, instead a transfer of the  risk.  The trader feels comfortable leverage himself to the hilt and trading continuously, since his risks are limited due to hedging.  But the system takes on increasing amounts of risk via that hedging.  Totalling up the value of outstanding derivatives is a good measure of the systemic risk.  What is that number these days?  I think I read it is something higher than some multiple of world GDP?

You cannot address "systemic risk" without attacking the entire trading structure and the selling of derivatives. 

That is why nobody addresses it.  The sellers of the derivatives want no regulation, no transparancy, because they understand perfectly their role in pocketing instant present day profits by creating and selling insurance policies which give the illusion of limiting the personal risk of the trader/buyers.  It is an illusion, because the insurance sellers are frauds having no loss reserves created to cover possible losses. 

I imagine that supporters of the system readily rationalize that "hedges offset each other" and the risks are really statistically insignificant even if the amounts insured are bigger than the entire financial universe.

But to expect anybody in finance to seriously address "systemic risk" would require them to rethink the entire present day trading culture on Wall St.  Or come up with a political solution such as treating the US Treasury and the Fed as their pool of loss reserves.

Certainly, it can happen again, as long as traders are allowed to hedge their risks via derivatives in a financial world where undercapitalized players can sell insurance without adequate loss reserves.


Sat, 05/07/2011 - 10:29 | 1250803 Urban Redneck
Urban Redneck's picture

I think some of the problem with institutions' risk management structures is that they are solely concerned with financial risk and they always take a quantitative approach to addressing the risk, which leads to either ignorance of systemic risk or really ugly math equations.  That they would recommend  emerging markets as a risk mitigation strategy is strange and makes me question their actual risk mitigation skills, since one of the primary risk management concerns in undeveloped and emerging markets is managing non-financial risks (such as expropriation, civil unrest, natural disaster, unreliable public services, et al.)   

Sat, 05/07/2011 - 01:44 | 1250487 williambanzai7
williambanzai7's picture

Thanks for this. I have thought about this on many occasions. But bringing it up at the Milken event is a nice touch indeed.

It is all about contingent liability tefloning.

Sat, 05/07/2011 - 01:10 | 1250454 I am a Man I am...
I am a Man I am Forty's picture

financial institutions make a living screwing over their customers so their biggest concern is how to avoid losing lawsuits when they get sued

Sat, 05/07/2011 - 00:09 | 1250375 boiltherich
boiltherich's picture

Why Wall Street Ignores Real Risk And Why History Will Repeat Itself

As long as there is a federal reserve and politicians for hire there will be no risk.  REAL RISK?  Risk is risk, there is no such thing as real risk.  There will always be two sets of FASB accounting rules, there will always be too big to fail and those like me will always have a lower standard of living than last month or year.  There will always be preferential tax laws and enforcement for those with something to tax, there will always be two definitions of fraud, there will always be a class war. 

One day soon those of us not in the investor class will give a very VERY nasty shock to those with positive net worth, both of you, so do enjoy your toys and puff up your pretty little egos now, you will not have them much longer.

Fri, 05/06/2011 - 23:12 | 1250298 InfiniteHedge
InfiniteHedge's picture

Systemic risk?

Gold. Cash. Land. Lead. Prayer.

Hmmm. No commissions.

Fri, 05/06/2011 - 23:00 | 1250277 AccreditedEYE
AccreditedEYE's picture

Alternative Investments & Emerging Markets? That's sooo post financial crisis version I. Capital is moving away from massive, collective institutional control. The Squid fears this...

Fri, 05/06/2011 - 22:59 | 1250275 sangell
sangell's picture

Interesting post and good question. I came across a Saturday Evening Post from 1912. Old magazines are very interesting for a lot of reasons, not least because they are time capsules. The ads in particular. One I recall was from the American Gas Association or something like that. Gas lighting was under tremendous pressure at the time from the 'high tech' industry of the day, electricity. The gas guys were selling yesterday, a stable Victorian world that was about to be vaporized by technology and WW1. They sensed it and to use a more recent cliche they sought to minimize 'cognitive dissonance' as other ads in that ancient magazine were extolling new fangled gadgets like El Toasto, electric lamps and vacuum cleaners and other expensive electric appliances. That toaster and lamp were, as I recall about $12 bucks. A lot of money back then but... if you still had one today, it would probably still work.

BTW the I found the magazines in the attic of the house I was living in and it still retained the old gas lighting fixtures on the walls though some had been converted to electric screw in bulb fixtures.

We are in a similiar, transitional era. Your panelists were guys stuck in 1912. It is the world they know and are comfortable with. It pays them well. That it may be as obsolete as gas lighting is something they would refuse to see even if they saw it.

Sat, 05/07/2011 - 01:20 | 1250465 DarthVaderMentor
DarthVaderMentor's picture

Well said Sangell. A con man will keep running the same con they know and love until either they run out of sheep to fleece or they go to jail.

Sat, 05/07/2011 - 10:29 | 1250799 Rainman
Rainman's picture

It is true of all Ponzis.....keep selling or die.

Fri, 05/06/2011 - 22:40 | 1250231 tom a taxpayer
tom a taxpayer's picture

"We don't need no stinkin' risk management. We have Brother Ben, Cousin Timmy, Uncle Sap, Godfather Hank Paulson, and millions of taxpayers to pay us win or lose."

Fri, 05/06/2011 - 23:04 | 1250287 Manthong
Manthong's picture

Yes, but do not forget the spiritual enlightenment of Maharishi Madoff.

Fri, 05/06/2011 - 22:33 | 1250216 Thorny Xi
Thorny Xi's picture

The Michael Milken Institute ... how appropriate. 

But hey, at least he did some time playing golf at Eglin's minimum security "prison" after he robbed his clients.

Fri, 05/06/2011 - 22:36 | 1250238 SloSquez
SloSquez's picture

Uh, excuse you.  Michael Milken was a "financial innovator" of the highest order.  Shame on you for pointing out there is no difference.

Sat, 05/07/2011 - 09:13 | 1250719 victor82
victor82's picture

And, I should add, he had a wonderfully shaped piece of furniture in his main trading office back in his Salad days.

There really was an "X-Desk".

Peons! How dare you bring into question the tastes of your Bankster Masters!

Fri, 05/06/2011 - 23:32 | 1250329 Spastica Rex
Spastica Rex's picture


Fri, 05/06/2011 - 22:20 | 1250194 tony bonn
tony bonn's picture

"in my opinion, have done nothing to deal with investment risk"

of course not.....they were bailed out and enriched from the economic implosion....nothing has changed except that the hubris and arrogance is only larger.....but we know exactly what follows such arrogance...

Sat, 05/07/2011 - 09:48 | 1250746 JW n FL
JW n FL's picture

Leverage? 0.04% skin in the game you say? v. 0.4% which still sucks you say?

how dare you cut into the bonus pool of monies, they are not making loans.. they have to show income some way! why not leverage the shit out of the cash already on hand! YAY!


****** "Who has an incentive to increase debt relative to equity in really big ways? Again, it’s the largest banks. The executives in these companies are paid based on their return on equity -- and the easiest way to increase that is to add leverage. Of course, this increases returns only when times are good. It also increases the potential losses when markets tumble. In other words, greater leverage increases risk." ******




Investment Bankers’ Culture of Ownership?

Sanjai Bhagat
University of Colorado at Boulder - Department of Finance

Brian J. Bolton
University of New Hampshire

August 24, 2010

We study the executive compensation structure in the largest 14 U.S. financial institutions during 2000-2008. Our results are mostly consistent with and supportive of the findings of Bebchuk, Cohen and Spamann (2010), that is, managerial incentives matter - incentives generated by executive compensation programs led to excessive risk-taking by banks leading to the current financial crisis. Also, our results are generally not supportive of the conclusions of Fahlenbrach and Stulz (2009) that the poor performance of banks during the crisis was the result of unforeseen risk.



But hey! why not RISK! MORE!!

****** "Dimon also wants JPMorgan to become more global, especially by expanding more into emerging markets. U.S. Treasury Secretary Timothy Geithner endorsed this approach in an interview he gave to the New Republic, effectively arguing that we should want big, highly leveraged U.S. banks to make large bets on highly volatile emerging markets." ******




Fri, 05/06/2011 - 22:09 | 1250159 RockyRacoon
RockyRacoon's picture

No risk unless the person whose money you are playing with demands normal fiduciary behaviour and honest dealing -- and wants the money back.

Fri, 05/06/2011 - 21:20 | 1250004 tawdzilla
tawdzilla's picture

Risk management???  They have no risk!  What is there to manage??

Fri, 05/06/2011 - 21:51 | 1250091 SloSquez
SloSquez's picture

Exactly, there is no risk for these types. 

Fri, 05/06/2011 - 23:37 | 1250332 JW n FL
JW n FL's picture
Republican-controlled committee voted for a 18-month delay of regulations intended to reduce risk in OTC derivatives.
Sat, 05/07/2011 - 01:16 | 1250459 rocker
rocker's picture

They are still blowing on the bubble.  Robo is sucking it in. LOL    Way too frothy now.  

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