Is Our Future of Black Swans or Risk Perception?
Finland’s most respected economist, MIT professor Bengt Holmström recently stated that no one, even Janet Yellen or Mario Draghi knows right now where our economies really stand. The financial system is currently in the situation where no one really knows what happens next. Living in the world of zero interest rates is baffling us. It is hard to handle because it is a risk that has born inside the system. The central bankers recipe is now to print more money but the point is they have no clue what might be the consequences. It is the feeling what you get when you know something is wrong with your car, its wheels are rolling but you have no idea what is wrong and when something nasty will happen. And now we are talking about the global economic system. The blur and the mist around future has never been so thick.
Nikolaus von Bomhard, the CEO of Munich Re, the world leading re-insurance company – thus the forerunner of global risk perception - wrote recently a highly interesting article about risk management. He pointed out that we all too often name events as black swans – events that are totally unpredictable - simply because we make some elementary mistakes. Above everything else, he named but two: first, we have too short scope when we observe the past. Secondly, we too often simply extrapolate the current visible trends into the future.
This is all very true when we observe some major turnaround events of the recent past. He observes that financial crisis was NOT essentially a black swan, neither events in Ukraine. They were predictable outcomes but only to those who were not falling to these to above mentioned traps. Financial crisis had occurred in the past with essentially the same recipe. The financial crash of the “Asian Tigers” in late 1990’s had occurred in a much similar fashion. And indeed, Russia has had the tendency in the past to solve their problems in a particular way, by using their power in a massive scale. We Finns should know something about this.
A proper risk management never does this kind of elementary mistakes. In understanding the present problems or managing future risks, we should always look at the distant past to observe the historical patterns. In their brilliant book “Why Nations Fail” Daron Acemoglu and James Robinson capture “the machine” that produce successes and failures in the modern history. We need to look at the malfunctioning institutions that had been once designed in the country, still occupying their future. For instance, the institutions that were established by colonialist to Southern America, seem still hold sway in some of those countries, producing social structures that prevent those countries from moving forward.
Von Bomhard goes on to suggest that in the same manner as insurance companies have Chief Risk Officer position, countries should have them as well. They should be the ones to observe and safeguard from risks by understanding the historical patterns and by not counting too much on the continuation of the present trends. They should be sensitive in signs that are showing the patterns. A lot of the signs implying that financial markets were falling into old crisis pattern were there before the massive meltdown in 2008. We just didn’t have the eyes to see them since “what cannot be, does not exist”.
I want to embrace this great idea of von Bomhard. In our ever more complex and fragile world, we should learn this particular lesson fast: stop falling the same trap again. Use your intelligence and learn. Perceive the risks in their totality. There are much fewer black swans than we ever thought. Stop being harnessed by your past. Indeed, we should have a Chief Risk Officer in each government.
Coming back to Holmström’s observation, again two things need to be warranted: first, this is not the first time we are in this type of situation where future is hard to see. So what is the pattern we should be observing, right now? Secondly, things will not stay this way for too long. We should NOT believing in perpetual continuum of present trends.
A proper risk manager enters a careful analysis of various options. And prepares for the kinds futures that are sensitive to archetypal fallacies of the future. As Dr. Louis Pasteur famously said, “chance favors the prepared mind”. Seizing the future is all about your level of awareness.