Politics and Risk Management

The intersection of politics and risk management came together in a big way recently with the crash of the financial markets. Politicians from both parties could not help themselves from using the collapse of the economy to point blame and feed at the trough of public funding. It is clear that there is little consensus in how to address the problem and worst yet little willingness to work together to come to a common framework.

If the past track record of governmental intervention is any prologue for what can be expected the politicians will be more interested in posturing than real systemic remedies. On a recent Sunday morning talk show politicians and the CEO of the US Chamber of Commerce showed that the status quo will be very difficult to change course. Wrapped up in all of the acrimony is a lesson on the very basics of risk management. If we take a step back to look at the role of government how it performs oversight has changed significantly. Depending on your political perspective you may come to different conclusions.

However, by taking an independent view, I would propose that the very essence of government and the role it should play may determine if risk management is part of the responsibility of government. I don't mean to say that government should intervene in ways that restrict the free flow of goods and services or the risk taking that is embedded in the American way of doing business. What I am proposing is that there may be a role for government to play in large systemic risk events. The role of government should be to understand the threats to financial systems and develop mechanisms to mitigate systemic risks that threaten the viability of our economy and financial markets.

Whoa, you say! That sounds like some form of socialism! The government does not understand business and does a terrible job of managing its own resources efficiently, you say! Why would we want government to manage business risks? Let me be clear, I am not advocating for governmental involvement in managing business risks. However, what I am advocating for are policies, legislation, and systemic controls that monitor risks across industries and act on key indicators when threats to markets reach levels that force politicians to mitigate these risks before they occur.

Sounds like a tall order! It is and the consequences of not doing so are playing out in the economy today! Here is how it would work. First, there is no need to change the governance and oversight committees that exist in Washington, D.C. today. What would be different is regular and consistent dialogue about risks in financial markets gathered from existing regulatory bodies or a central regulator who looks across all markets for systemic breaks that threaten individual or linked markets. The difference is that the key risk indicators and the policy and legislation that is promulgated from these reports could not be influenced by lobbyist or political contributions. Risks to our way of life should be free of narrow political interest groups or powerful individuals with the ability to ignore these threats.

What are the mechanics? Setting limits on the level of margin or leverage used, the net capital needed, the efficient operation of markets, such as the settlement of derivative contracts are but a few examples! The arbiters of these key risk metrics would be the regulators themselves and not congress. Congressional committees would simply take the appropriate risk mitigation steps that must be established in advance and acted upon once the thresholds are breached. By setting up prearranged checks and balances and making the actions automatic you begin to pro-active manage systemic risks as they increase in severity.

When there are multiple systemic risks or large scale failures these same committees would have scenario plans in place that would act on their contingency plans for "fat tail" events. This approach does not prevent risk taking it simply acts as a "governor" to reduce the types of large scale systemic failures that we are experiencing today!

Idealistic!? Yes, but why not dream big! Its only our future and the future of our children that we are attempting to fix.