National debts are growing worldwide. It seems we're drowning in a sea of debt. Who's gonna survive?
By experience we know that whenever our gut-feeling takes us for a ride, help of statistical models is necessary to rebalance and get sight at the real problem.
Sovereign Risk Monitor
In this case of 'national debt', the help of CMA's Sovereign Risk Monitor comes in. The CMA Sovereign Risk Monitor identifies and ranks the world’s most volatile sovereign debt issuers according to percentage changes in their 5 year CDS. CMA also calculates the Cumulative Probability of Default (CPD), the 5 year probability of a country being unable to honour its debt obligations.
Let's take a look at the world's most risky countries in Q4 2009:
Yet, the 'Default Landscape' is rapidly changing as becomes clear in CMA's interesting daily 19 March 2010 report showing Greece 'Cumulative Probability of Default' rising to 24.27%.
On the other hand we've got the world's best Countries, with Norway on top....
More actual information is available at CMA (registration required).
You're at a birthday party or having a social evening. Everybody is having fun, talking to each other and - like usual - discussing the latest financial topics, scandals and solutions.
Suddenly someone turns to you and says: Heee.. you're an actuary, you can tell us what a a hedge fund is!
Of course as born or raised actuaries we all know what a hedge fund is. But when it comes down to explaining what a hedge fund is to clients, board members, friends or family, probably not one of us can explain it better than Paddy Hirsch, Senior Editor at Marketplace, can in the next Youtube video:
Now, when a Hedge Fund or a (Lehman)bank 'unexpectedly' gets into trouble, it simply uses the Repo 105 technique to to survive. Paddy Hirsch explains again.....
As professional risk managers we would expect these high risk Hedge Funds to operate under excessively severe capital requirements. Too bad...., this is not the case, as Mr. Timothy Geithner explains in the next video......
From Mr. Geithner's statements it's clear that Hedge Funds are de facto treated as 'Hedge Fun' until the systemic risk shows up.
However, when this risk becomes manifest, it will be to late to take appropriate measures.
Misunderstanding: Risk management One of the great public misunderstandings of Risk Management is that most people - obviously including Government -think that Risk management is all about 'Managing Damage' after the corresponding loss has occurred.
As we know, Risk Management is about something else:
I. Identify, Analize & Prevent Risk About 70% of Risk Management is about constantly identifying, analyzing and preventing risks from happening.
II. Emergency Response Plan Another 20% is about proactively creating and updating Emergency Response Plans (ERP's) on how to deal with loss and how to limit and reduce that loss in case of the unfortunate event that a risk materializes in a loss.
III. Damage Reduction Only the last 10% is about 'damage reduction' by executing the ERP's and tackling losses in case a risk - notwithstanding the measures taken - has resulted in a loss.
Perhaps we should offer (one volunteer is worth two pressed men) Mr. Geither a free Risk Management Course from the institute of actuaries.....
Read more about (the regulation of) Hegde Funds in an excellent (2006) paper by Dale A. Oesterle called Regulating Hedge Funds.
It's clear: there's nothing funny about fundy hedge funds....
Based on an idea as presented in a joshing blog by Henry Blodge, CEO of The Business Insider, here's the slightly changed formula for making thousands of investors happy, becoming a millionaire within months while having a successful career as well.
Become a banker! All it takes, is to start a new bank. Don't worry, it's simple as will be shown.
This is how it works:
Form a cooperative bank called: Cooperative Magic Bank (CMB). A cooperative bank is a financial entity which belongs to its members, who are at the same time the owners (shareholders) and the customers of their bank.
Appoint yourself CFO together with two of your best friends as Board members. Set your yearly Board Bonus at a modest 10% of CMB's profits.
Make a business plan (this blog IS the business plan)
Raise $ 100 million of equity and $ 900 million of deposits, as follows
Offer your prospects/clients a guaranteed 4.57% guaranteed return on investment.
Offer a 70% yearly profit share. First year return on investment guaranteed 13,35% !
Everybody who wants to join the bank becomes a 'Lucky-Customer-Owner' (LCO)
Every LCO is obliged to invest 10% of his investment as shareholder capital.
The other 90% is invested in the CMB-Investment Fund (CMBIF).
CBMIF guarantees the return (and value) on the LCO's account based on a 30 year Treasury Bond
Borrow $3 billion from the Fed at an annual cost (Federal Discount Rate) of x=0.75%.
Ready! Sit back and enjoy high client satisfaction and your Risk Free career and bonuses as a professional banker!
Magic Banking Wrapped up in a 'Opening Balance Sheet and a first year ''Income Statement', this is how it looks like:
This is how the FED helps you to become a millionaire. but the party is not yet over.....
Pension Funds and Insurance Companies If your the owner of a pension fund or an insurance company, starting a 'Magic Bank' could help you achieve a total 'risk free' return of 4,57% with an upward potential of 13,35% as well.
So why should you set up a complex investment model that you don't really see through, to achieve a risky 6% or 8% of return on investment, if you can have more than a 'high school comprehensible' 10% return without any substantial downside risk by starting a Magic Bank instead?
Together with the new Basel and Solvency regulation, this 'magic bank principle' will cause banks to sell their investments in more risky assets like insurance companies. On the other hand, insurance companies and pension funds will probably be interested in starting new banks to profit from the FED's 'free credit lunch'.
Criticasters and Risk Some criticasters will rightfully point out that the magic bank is not completely risk free. Indeed there are some risks (e.g. the treasury bond volatility), but they can be adequately (low cost) managed by means of stripping or derivatives (e.g. swaptions).
Of course there's also the risk that the Fed will raise the short rates (Federal Discount Rate).In this case, instead of using derivatives upfront, one might simply swap or (temporarily) pay off the FED loan. Yes, your return will temporarily shrink to a somewhat lower level. But who cares?
Moreover, keep in mind that as long as we're in this crisis, the Fed's short money will be cheap. Don't ask why, just profit! By the time the crisis is over and Federal discount rates are more in line again with treasury notes, simply change your strategy again.
And if - regrettably - the federal discount rate and the treasury bond rate rise at the same time, simply book a life time trip to a save sunny island to enjoy your 'early pension' of $ 11.1 million (ore more).
For those of you who still doubt and for all of you who like a humorous crash course in investment banking, just click on the next video by Bird & Fortune....
Let's get serious Although for us actuaries it's clear that because of the Asset Liability Mismatch, the magical bank is a running gag, the principles and consequences of the situation as described above are bad for the economy.
Financial Health Management Banks and financial institutions in general are discouraged to act in their primary role as risk transfer institutes by performing on bases of professional calculated risk.
Why would they take any additional (credit) risk if they can generate their revenues almost 'risk free' with help of the Fed?
We all know that without risk, there's no economic added value either. Continuing this Fed policy will lead to Bob hopes:
A bank is a place that will lend you money, if you can prove that you don't need it.
Maintaining the current Fed policy keeps the banks alive, but ill. What's needed is a new Federal Financial Health policy.
Over the last decades the relative equity (equity in % of assets) of Banks deteriorated from a 20% level to a 3-5% level in this last decade.
Banks need to be stimulated to take appropriate healthy risks again, while maintaining a sound individual calculated 'equity to assets ratio', increased with an all over (additional) 5% risk margin.
The Fed should therefore act decisively and:
stop the ridicule and seducing leverage risk levels Redefine the Capital Adequacy Ratio (CAR). The new Basel III leverage, calculated as 'total adjusted assets divided by Tier 1 capital', won't do. Strip the nuances, limit 'adjusting', add a surplus.
Limit and make all new financial products subject to (Fed) approval
Limit the proportion of participating in products that only spread risk (e.g. Citi's CLX) instead of neutralizing or matching risk
Raise the discount rate as fast as possible,
to prevent moral hazard and economical laziness that eventually undoubtedly ends in a global economic melt down.
However, there's one small problem..... The FED has to keep the discount rate low because otherwise financial institutions that run into trouble aren't able to finance their loss in a cheap way and will activate the nuclear systemic risk bomb (chain reaction).
It seems we're totally stuck in a governmental financial policy paradox. Nevertheless the FED should act now!
Actuary Info is a brain teaser Blog with non-conventional, witty, remarkable and serendipitous financial and actuarial related news.
Target audience: actuaries, accountants, CEOs, CFOs and management of financial (international) institutions.
The blog topics cover a wide field of interests. From Investment Management, Life Insurance, Disability, Pension Funds to HRM, Bonus, Compliance and Ethics.
Actuary Info stretches the mind, creates a smile or helps you to break out of your comfort zone.
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More actual information is available at CMA (registration required).
More actual information is available at CMA (registration required).
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