Our greatest export is democracy

Published in the Australian Financial Review 27 June 2018

James Laurenceson’s “We need China in an age of Trump” (June 19) lacks basic rigour and balance. It’s a propaganda style piece presented as a scholarly work from the Australia China Relations Institute attached to the University of Technology Sydney.

Laurenceson refers to an open letter by “80 of Australia’s leading China scholars” concluding there is “no evidence” that China’s actions aim to compromise Australia’s sovereignty. No mention of the near 50 leading China scholars who signed an opposing open letter, many of whom are Chinese Australian.

The “no evidence” scholars group includes experts in things like Chinese gardens in the Ming dynasty. They invite expression of “as wide a range of viewpoints as possible, Chinese and non-Chinese alike”, yet in the same letter smear those expressing concern about the Chinese regime’s influence, by alleging a “racialised narrative of a vast official Chinese conspiracy”.

To understand the threat to Australia look to the invasion and suppression in Tibet, the tightening noose around Taiwan, the betrayed people of Hong Kong, the gross mis-treatment of Nobel Peace Prize laureates the Dalai Lama and Liu Xiaobo and many more, the cunning no-shot-fired military capture of the South China Sea, and Clive Hamilton’s book “Silent Invasion“.  The Chinese regime is intolerant of opposing opinions and balanced debate.

Laurenceson is an economist. His repeated calls not to offend the Chinese regime rest solely on the growing dominance of Australia’s exports to China. Instead, he should be calling for an exposure limit to high risk economies, and more diversity.  India, the largest democracy in the world also has the fastest growing economy.

With tinted glasses Laurenceson ignores that which trumps all else – protection of basic human rights, fairness and freedom of expression. Over-trading with a country controlled by an authoritarian regime and shocking human rights record endangers the wellbeing of all Australians.

Compared to the Chinese regime Australia is a super power of democracy and human rights. Australia can use this power. Apply export limits to countries with governments that view democracy as its enemy. This will help seal the risk hole that Laurenceson wants to dig deeper. It will restore balance between long term security and short term profit. It will support the majority of Chinese who did not choose their dictatorial government.

Version submitted to the Australian Financial Review

James Laurenceson’s, June 19 commentary, “We need China in an age of Trump” lacks basic rigour and balance. It’s a propaganda style piece presented as a scholarly work from the Australia China Relations Instituteattached to the University of Technology Sydney, published first by the Australian Financial Reviewthen republished by the ACRI.

Laurenceson refers to an open letter by “80 of Australia’s leading China scholars” concluding there is “no evidence” that China’s actions aim to compromise Australia’s sovereignty. No mention of the near 50 leading China scholars who signed an opposing open letter, many of whom are Chinese Australian.

The “no evidence” scholars group includes experts in things like Chinese gardens in the Ming dynasty. They invite expression of “as wide a range of viewpoints as possible, Chinese and non-Chinese alike”, yet in the same letter smear those expressing concern about the Chinese regime’s influence, by alleging a “racialised narrative of a vast official Chinese conspiracy”. Of course many of the most concerned are Chinese Australians.

While the evidence of interference in Australia is clear, none need exist on Australian soil to warrant concern. To understand the threat to Australia look to the invasion and suppression in Tibet, the tightening noose around Taiwan, the betrayed people of Hong Kong, the gross mis-treatment of Nobel Peace Prize laureates the Dalai Lama and Liu Xiaobo and many more, the cunning no-shot-fired military capture of the South China Sea, and Clive Hamilton’s book “Silent Invasion“.

The Tibetian people have been silenced totally. Hundreds of monks have self-immolated in deadly silent protest. Our political leaders will not meet with the Dalai Lama. Qantas and many others no longer refer to the democratic country of Taiwan as a country separate from China. All from fear of offending the Chinese regime. The Chinese regime is intolerant in the extreme of opposing opinions and balanced debate.

Laurenceson is an economist. His repeated calls not to offend the Chinese regime rest solely on the growing dominance of Australia’s exports to China. Instead, he should be calling for an exposure limit to high risk economies with opaque risk holes, as with China — basic economic risk management. More diversity. India, the largest democracy in the world also has the fastest growing economy.

With tinted glasses Laurenceson ignores that which trumps all else – protection of basic human rights, fairness and freedom of expression. Over-trading with a country controlled by an authoritarian regime and shocking human rights record endangers the well-being of all Australians. It’s the same short sighted focus on short term profit that infects, and failed, the finance industry.

Compared to the Chinese regime Australia is a super power of democracy and human rights. Australia can use this power. Apply export limits to countries with governments that view democracy as its enemy. This will help seal the risk hole that Laurenceson wants to dig deeper. It will restore balance between long term security and short term profit. It will support the majority of people in China who did not choose their dictatorial government.

Where did you get your China facts?

Published in the Australian Financial Review 17 December 2017

In reference to the new foreign interference laws, Professor James Laurenceson, from the Australia-China Relations Institute, University of Technology, warns the Australian Government and media not to offend the Chinese Government else Chinese consumers will stop buying, (Turnbull’s blowhard approach to China will cost us, 11 December).

Propaganda or science?  How did Professor Laurenceson measure opinion in a country where the people have no basic democratic freedom to vote or express opinions that offend the authoritarian regime?

Expression of opinion is extremely dangerous in China. Dissidents can expect a miserable and shortened life in jail. In Tibet since 2009, over 150 Tibetans, mostly monks have resorted to self-immolation as their only voice to world. The oppression is brutal.

Why would the majority of Chinese people, not linked to the regime, be offended by efforts to limit the coercive powers of the Chinese Government?

Academics have a professional obligation to speak the scientific truth. And a higher moral obligation to protect democratic values and basic human rights from value free economics. Value free trading with foreign powers has a high blowback price.

Traps in electronic election voting

Published in the Australian Financial Review 18 July 2016

Malcolm Turnbull, Bill Shorten and many others are calling for electronic voting in Australia (“Leaders call for e-voting as count meanders,” July 11).

As the most experienced online voting practitioner in Australia, many may expect I welcome this call. In fact, I see serious danger for democracy.

The NSW Electoral Commission’s iVote system, used in the 2015 state election, is touted by some as a success. Actually all 280,000 votes harvested by iVote were exposed to tampering risk. No votes were genuinely verified as authentic. The scientific evidence is clear. iVote is not a safe solution for government voting. I agree fully with the many security concerns expressed by respected network security scientists, such as University of Melbourne’s Vanessa Teague in her various publications and media comments on iVote. No one has a safe answer yet for remote online voting in government elections.

The NSWEC has not acknowledged or denied its iVote re-voting security flaw. Just 1.7 per cent of electors attempted to use its flawed vote verification process and all who did risked loss of anonymity. The NSWEC has not released statistics on re-voting in the 2015 election or other essential data required to assess the election integrity. The NSW Electoral Matters Committee has delayed its routine hearing following its call for submissions until the end of the year.

Banks need risk management

Published in the Australian Financial Review 28 October 2018

Blind spot on human rights

Published in the Australian Financial Review Monday 29 March 2010

Shareholder dabs on CEO pay

Published in the Australian Financial Review 3 March 2010

Climate panel requires vote by Experts

Published in The Australian Financial Review, 19 Feb 2010

In “Shoot the messenger but accept the facts” (February 11), Nobel Laureate Peter Doherty says, “What keeps scientists honest is the constraint that their published data must be verifiable,” meaning peer-reviewed publications.

However reports like the Himalayan glacier errors and others in the Intergovernmental Panel on Climate Change’s findings and East Anglia “climategate” show that peer review alone is not enough verification for an issue as big as climate change.

East Anglia is evidence that scientists with a vested interest cannot always be trusted. This adds doubt to the peer-review process which has never been perfect anyway. No one trains scientists on how to peer review but it’s the most verifiable and objective science available.

The IPCC engages committees that attempt to represent the best overall assessment of relevant peer reviewed publications. It’s an opinion measurement task that attempts to represent a scientific consensus. Just as peer review makes research more objective, a vote makes consensus measurement objective. Yet the IPCC has never verified its opinion measurements with a vote nor acknowledged dissenting opinions in its reports.

As I said in, “Copenhagen: red herring or lame duck?” (Letters, September 3, 2009), “A vote by experts is the only robust way to measure expert opinion on the science and economics of global warming”. Copenhagen was set to fail in its main objective because it was not supported with a resolute verified measure of scientific opinion. The right objective remains unclear without a vote.

A science vote will quantify the full range of opinions in a unified expression that respects all sides of the debate and sharpen the focus of peer reviewers. In contrast the IPCC’s less inclusive, unverified committee-style assessment process encourages division that confuses the public and policymakers.

All scientists agree that climate change science is extremely complex with many critical unknowns in the feedback mechanisms. Caution demands open debate and rigorous assessments of informed opinion resolved with frequent verifiable votes — inviting all specialists, working and retired and leading scientists like Doherty from other disciplines. The most verifiable, effective and practical vote will be transparent, continuous, interactive and online.

Risk transparency still essential for banks

Published in The Australian Financial Review

In (“Change the structure of the banking system”, January 27), renowned Yale University professor of economics, Robert Shiller, supports a proposal from the Squam Lake Working Group for a new bank debt funding instrument called regulatory hybrid securities.  It’s a form of debt that converts automatically to equity in the issuing bank but at a time when both the bank and the financial system are under stress.

The idea can smooth a few bumps in a banking crisis but while hailed by Shiller as a “major new idea that might fix the problem of banking instability”, I believe it may even make things worse overall.

The intention is to protect the public from the cost of bank rescues. However it’s unclear if this saving will offset the implementation cost. Shiller admits these instruments will raise the cost of capital to banks. This means higher interest rates that will hurt national economies in normal times. The precise specification of the conversion trigger is messy and exposed to unintended risks such as market manipulation to force conversion triggers.

The idea attempts to shift more risk to the private sector. However wealth is still destroyed which means lost jobs. Net bank equity can still be negative even after conversion. It’s a more formal coding of what inevitably happens when a bank too-big-to-fail gets into trouble. One way or another, the market or a regulator causes the bank to restructure. The idea does nothing to fix the root cause of bank failures — that is, the ease with which banks can create dangerous hidden risk.

An idea which does attack the root weakness in the banking system is to force banks to make bank risk transparent. Real transparency is an online virtual place where all banks too-big-to-fail must report daily their exposure to wide-ranging movements in all economic variables to which they are exposed. What’s needed is a transparent, continuous stress analysis. This idea will immunise the global banking system against excessive risk in the most effective way possible. The cost to implement this idea is while it guarantees a net reduction in dangerous bank risk and the first integrated global management of bank risk.

Shiller often mentions the importance of human psychology in understanding market bubbles. However the psychology that causes bankers and regulators to fear transparency gets little attention.

Cyber attacks: we’ve got bigger problems than China

Published in Crikey

In “Cyber attacks: we’ve got bigger problems than China” (Monday, item 1). Crikey downplays the China risk as “economic espionage” from just another “friendly” country.

No mention of the authoritarian Chinese government’s shocking human rights record or Google’s statement, “we have evidence to suggest that a primary goal of the attackers was accessing the Gmail accounts of Chinese human rights activists”.

Apparently our “friend” was seeking information on people who respect democratic values. Anyone discovered in China by this “economic espionage” can expect long term imprisonment, torture or execution.

The most powerful bully in the world is now our biggest trading partner. However the bigger problem is our timid silence as our economic partner trashes the values that so many of our young died trying to protect.

IPPC fails basic test of transparency

Unpublished letter submitted to Sydney Morning Herald

The chief UN climate official Yvo de Boer strenuously defends the procedures of the Intergovernmental Panel on Climate Change, saying, “I do not believe there is any process anywhere out there that is that systematic, that thorough and that transparent.”  (Leaders defend climate science”, December, 9).

In fact the IPCC’s procedure for representing scientific opinion fails the most basic test of robustness and transparency. It has never invited scientists to vote. A vote is the only scientific means of resolving group opinion.

Vocal and frustrated scientists concerned about global warming say there is no debate about its cause while others write letters and books in strong disagreement. None are calling for a vote. Scientists don’t vote. Climate scientists ignore the science of opinion resolution. Not surprising, warming science remains hotly disputed in Parliament — as it should until scientific opinion is measured scientifically.

Politicians admit they don’t understand the science of global warming but do understand how to resolve group opinion. Yet no politician has asked for the obvious, a vote from scientists.

Collective opinion cannot be resolved fairly or safely without a vote. Scientific opinion on the biggest risk management issue in history is no exception. Ask scientists to vote, resolve each debate and move forward.

Hold boards to account, let the majority rule

Unpublished letter submitted to The Australian Financial Review

Threatened with a 25 per cent two-strike rule, suddenly Australia’s boards are passionate about corporate democracy. Their placard reads, “A minority of shareholders should not impose their will over the majority”, “Debate rages over ‘two-strike’ spill move”, (November 9). It’s exactly what trampled shareholders want to hear but as yet are too numb to realise.

The core complaint of abused shareholders is summarised in exactly the same placard. The majority of people with capital at risk including superannuants have no voice and no vote. Real democracy will fix it, nothing else can — it’s the answer to fair pay, board diversity, management ethics and talent.

Give shareholders a real vote on the issue that matters most — the appointment of the CEO. The non-binding vote, the two-strike rule, enforced pay caps are all absurd ideas against the obvious fair democratic solution. The problem is boards appointing the CEO. It’s a failed idea.

Expect potential CEOs, worthy of the job and superhuman pay, to assess their own value and win the CEO position in a competition for shareholder votes. Asking price should be part of the CEOs election platform. 

It follows automatically from the majority rule placard that the corporate voting system must be fixed and made fair. This means superannuants get a vote, every election has an audit trail, no vote is ever lost, voting is convenient and efficient and proxies cannot be abused or cherry picked. None of this is true at present. All can be satisfied with direct online voting.

Unearned pay is a measure of greed not talent. Some of the nation’s best managers work in the non-profit sector — which leads corporates on voting reform.

Don’t let the nation’s most highly paid cherry pick the democracy debate. Hold boards to account on their democracy placard — let the majority rule.

Corporate democracy

Unpublished letter submitted to The Australian Financial Review

In condemning the Productivity Commission’s 25 per cent two-strike idea as “rule of the minority”, Australia’s most senior business leaders opened a debate on corporate democracy, “Boards slam executive pay reform” (Headline, October 12). It’s a debate worth having. The system our business leaders know and defend is a sham democracy.

Real democracy needs participation. Yet the super industry blocks it, as illustrated by the frustration of small shareholder David Albert in, “Shareholders need backing in board pay” (Letters, 23 October). Every year he and most other small shareholders vote against board pay increases while institutional shareholders, with the controlling votes, vote in favour or abstain. The two-strike rule recognises that David Albert’s votes are more likely to align with the interests of superannuants than the votes of those representing them, the super funds.

The two-strike idea attempts to patch a sham democracy. It’s creative but messy with uncertain effectiveness. The fair democratic solution is to abandon compulsory super or let superannuants exercise the votes on their capital invested in super funds. This idea is rejected by the super industry as too complex and too expensive. Yet it’s neither. With electronic processing and voting the cost and technical hurdle is tiny in comparison with the industry size and payoff.

Real democracy needs competition. In “Time’s up for closed-shop Australian boards” (Friday 23), Peter Wilson, national president of AHRI, calls for competition as the solution to the “national disgrace” of low diversity in Australian boards. Competition is also central to fair pay and management quality. Competition matters most in selecting the CEO.

What is fair competition? In “Why not a fair and transparent contest” (Letters, April 2) I suggested CEOs be selected by shareholders in an open contest and direct voting. Real democratic transparent competition is the best risk manager of the nation’s wealth. Yet this idea that shareholders, not the board, select the CEO is not even on the agenda. Why not? The same shareholders select our national leaders and ordinary board members and are equally capable of selecting a CEO. The non-binding vote is part of a choked democracy with no contest. CEOs on superhuman pay ought to be capable of winning their title in an open contest, assessing and stating their own value upfront — without wasting shareholder funds on remuneration boards and consultants.

Real democracy needs a reliable, cost effective way to harvest and count votes. Direct online voting is the answer to the current expensive paper system with no audit trail that loses votes and allows chairmen to cherry pick proxy votes.

Many of the best managers work for modest pay in the non-profit sector. No one can directly manage more than 12 or so people effectively regardless of company size. Public company CEOs rarely accept personal risk — like the risk of continuing this debate.

Foreign trading taxes warrant analysis

Published in The Australian Financial Review

Ross Buckley, professor of international financial law at the University of NSW, supports the idea of a small tax to inhibit short-term speculative foreign currency transactions (“Forex tax just the antidote to hubris”, September 3).

In essence the argument is that short-term speculation increases market volatility, defined as “white noise”, and that this noise decreases the market‘s efficiency in reacting to long-term transactions and thus interferes with monetary policy.

Actually, it’s not clear that natural white noise volatility in a free, open economy is a bad thing. It’s a sign the economy is alive and breathing. However, constrained and opaque economies are prone to sudden shocks, a very dangerous form of volatility that costs jobs.

Volatility does affect the cost of asymmetric instruments like options but the expected return is no more or less. White noise has no impact on the expected or average short-term or long-term exchange rate. Monetary policy can ignore it. White noise volatility is measured as dispersion about the mean exchange rate.

Exchange rates can move dramatically over time in a market with zero volatility or show no net change in a market with high volatility.

The assumption that a Tobin tax [a tax on currency speculation] automatically reduces volatility also warrants analysis. A Tobin tax affects volatility in several ways.

Firstly, the additional cost of a tax acts like a widening of the bid/ask spreads or increase in dispersion and in this sense contributes to increased volatility. Secondly, spreads tend to widen with less trading volume, again an increase in volatility.

 Thirdly, the Tobin tax argument assumes that the transactions it inhibits — those most sensitive to an increase in transaction cost – act to increase market volatility. The opposite may be true. Short-term trading can increase or decrease market volatility. For example the manufacture of a long synthetic option tends to increase volatility, a short position tends to decrease volatility and both are highly sensitive to transaction costs. Speculative trading will contain elements of both.

Nobel laureate James Tobin had Buckley’s chance of understanding the real impact of his tax idea 37 years ago – without access to relevant market data to test it and before volatility was explained in the development of the Black-Scholes option theory.

A more obviously useful tax is a tax on “dark noise”, the transactions and risk hidden from the market.

Published version - AFR - 16 Sep 2009

Copenhagen: red herring or lame duck?

Published in The Australian Financial Review

The Business Council of Australia and the Opposition Leader Malcolm Turnbull are in conflict over when the Parliament should vote on an emissions trading scheme (“Copenhagen a ‘red herring'”, 25 August). All sides are divided. Copenhagen is not a red herring but a lame duck because everyone is focused on the wrong vote.

A vote by experts is the only robust way to measure expert opinion on the science and economics of global warming. Without it no one has authority to represent the experts and the most basic questions of climate change science and economics will remain unanswered. Vested interests will determine the outcome. It may be a dangerous overreaction or expensive and useless under-reaction to the actual threat.

The public has a right, and policy makers an obligation, to really know expert opinion on the issue. And the expert opinion that matters is the current consensus of experts and its sensitivity to change. Accurate reliable measurement of this consensus is a critical bit of scientific data missing from the debate.

The IPPC attempts to be the authority on the science. However the IPCC’s measurements of scientific opinion are neither robust nor objective, regardless of intention. The use of working groups is an efficient way to condense peer reviewed scientific papers and other material into a single less technical report. However this process does not guarantee that the authors of the scientific papers endorse the IPCC reports. The process also excludes the views of many scientists qualified to comment on the published research. Without the vote doubts remain and its voice weakened.

Financial derivatives risk theory is based on robust arbitrage pricing formula. Yet the “rocket scientists” in banking led the world into an economic fire storm with an unscientific risk measure called value at risk, without real debate or a vote. Neither the climate scientists or economists have risk measurement models remotely as accurate as the financial scientists — another reason not to repeat the same errors in open debate and opinion measurement.

The Parliament should require scientists and economists to vote online before it votes. Have all relevant scientific and economic bodies invite their members to participate in a regular global and secure vote. Give every expert equal control over the voting agenda. Make the voting records, credentials and funding sources of each expert transparent. Let the vote to run continuously enabling experts to revise their votes any time. Technically there is no risk or reason to delay a vote. It could start today.

Published version - AFR - 3 Sep 2009

Quarterly stress test of banks not enough

Published in The Australian Financial Review

In “Not enough stress in US bank test,” (June 24), Professor Lucian Bebchuk, Harvard Law School, says, “As long as banks are permitted to operate this way, the banks’ supervisors are betting on the banks’ ability to earn their way out.” Bedchuk is referring to the recent flawed stress testing of US banks. His message is that stress testing is essential but that it must be rigorous. As the author of a book on the finer details of stress testing after many years experience of building stress testing related technologies and using them to successfully manage billions of dollars of complex financial exposures, I agree.

A rigorous stress test measures bank exposure to wide ranging movements in all relevant economic variables. There are many ways to get a stress test wrong or be tricked. The value of a stress test depends critically on its frequency and transparency. The prudential regulator, APRA, requires banks to report quarterly and results are not published. Bank trading is a daily activity. A quarterly stress test leaves 99 per cent to trust.

I have repeatedly invited the authorities through my letters to publish rigorous bank stress tests daily in a website. Nothing could be more efficient or cost effective as a regulator of excessive bank risk.

Why not reduce risk and cost with an automated bank risk watch website? Minister Nick Sherry, answered in a letter to me dated 16 April 09, then as Minister for Superannuation and Corporate Law, “To require daily reporting as proposed in your email (to the Treasurer) would impose significant additional costs. These costs would ultimately be paid by the bank customers.” The Minister was poorly advised. Bank customers now know the much higher cost of weak risk management.

What is the cost of rigorous daily bank stress testing and reporting? Daily stress testing is already core risk management for a well managed bank — the entire process is electronic and automated. So the additional cost of daily electronic reporting to a central website is insignificant. There is no reason in the public interest to withhold risk transparency from taxpayers now underwriting bank deposits.

There is another cost however. Banks will lose the freedom to speculate in darkness. It will become apparent that even the current quarterly stress testing ignores the housing price risk — something US investment banks do too. And what about exposure to US sub-prime mortgages?

Governments and regulators have not understood where risk hides. Many senior bankers will fail a rigorous risk test. On the current course, the risk-free prediction is that more avoidable banking disasters will follow, in similar frequency to recent decades.

Published version - AFR- 1 Jul 2009

After Tiananmen let’s welcome the Uigher

Published in The Australian Financial Review

In Tiananmen Square, June 4th, 1989 unarmed Chinese students chanted “Freedom will not be suppressed,” fearless in peaceful protest. Thousands were slaughtered for it, many crushed by tanks along with their 10 meter high statue, Goddess of Democracy. Thousands were imprisoned.

Published version - AFR - 04 Jun 2009

In Australia freedom to support democratic values was not suppressed. The Hawke Labor government reacted by granting permanent residency to 20,000 Chinese students then in Australia. On Iraq in 2003, Labor in opposition had a strong moral message for an ally too, not intimidated by a powerful friend and gained from it.

How secure are our democratic values now?

On the 20-year anniversary of Tiananmen Square, a parliament not compromised by a growing authoritarian power will tell the Chinese government openly to admit it happened; to release up to 200 people still in detention for it and to release many others imprisoned for reporting it.

Treat China like a friend gone astray. Don’t be intimidated. Tell its authoritarian government what it needs to hear. Unfreeze the past and let it go.

Nobel Peace Prize laureate Aung San Suu Kyi lives without freedom — under house arrest most of the last 20 years, a prisoner of conscience, in failing health, denied her democratic right to lead Burma, the country that elected her in 1990. Her oppressors, the Burmese junta, are the Chinese government’s friends. Our democracy is weak if our elected leaders lack the courage and skill to ask the Chinese government to assist this living Goddess of Democracy.

Tell the United States and Chinese governments that Australia will take the 17 Uighur men persecuted by both powers, held for nearly eight years in Guantanamon Bay charged with nothing.

Moral poverty is not a fair trade for high priced minerals. A robust long term economy has a rock solid moral foundation.

We need transparent stress testing

Published in The Australian Financial Review

In “Turnbull makes a few good points”,(18 May 2009), Alan Mitchell comments on the merit of a new indepedent institution to increase tranparency of economic management and notes the Business Council of Australia agrees.

Transparent stress testing is what we need; exposing the variation in outcomes to alternative market conditions. Treasury’s growth forecasts charting the budget course back to surplus will be wrong for every one of its five years and beyond. This is the one reliable economic forecast relevant to the budget papers. How much it matters is exposed by stress testing.

The value of the Treasury’s forecasts is transparent in its statement of risks in Budget Paper No. 1: Budget Strategy and Outlook 2009-10. It’s all a guess as it must be. The science of long term growth forecasting does not exist. A useful stress test shows how the government’s promises will change over a wide range of variations in the growth forecasts. Elastic promise are honest. Promises made on a fixed point guess are framed to be broken.

The BCA can endorse transparency by publishing its stress testing of the nation’s growth forecasts and superannunant returns to the alternative market conditions for selecting and paying CEOs — ranging from the entrenched closed opaque market to a transparent open and competitive market where CEO candidates compete for shareholder votes.

Another stress test for the BCA is the impact on the nation to changes in the shareholder voting system — ranging from the clumsy, inconvenient, expensive, opaque, auditless paper system in use to a secure, transparent, direct, greener and cheaper online vote.

The Australian Prudential Regulation Authority might follow and improve on the Obama administration’s lead by announcing robust  transparent stress testing of the Australian banking system. A bank stress test is out of date the next day. A regulator committed to bank transparency will publish daily stress tests. Why not? It’s not the cost. Daily stress testing is core business for banks.

Treasury’s guess work is as much affected by the unseen risk holes in the banking system and corporate governance as it is by the opaque capitalism of China.

Published version - AFR- 26 May 2009

Why not a fair and transparent contest

Published in The Australian Financial Review

In “Executive excess is not out of control” (Letters, March 30) Owen Thomas remarks that any system that sets all salaries, “will distort the market and result in inefficiencies in the allocation of resources”.

Quite true, as illustrated by the current system of CEO selection and remuneration. Industry captains are selected in darkness, the deal done behind closed doors and shareholders get a toothless non-binding vote after the deal is done. It’s a rigged market in comparison with the open and transparent share market that sets the value of the listed companies the CEOs manage.

How about a fair market transparent contest that naturally bids CEO pay down when too high and up when too low and pays nothing to remuneration consultants? Such as a process that requires boards to advertise the CEO position, allow anyone to nominate and present his or her credentials and asking price to shareholders and invites shareholders to select the winner with an optional preferential secure online binding vote with automatic transparent audit trail. Free market capitalism failed us because we never had it.

The top end of town will laugh at this idea — so distorted is the current system

Published version - AFR -02 Apr 2009

CEO rewards divorced from reality

Published in The Australian Financial Review

Investment and Financial Services Association chief executive Richard Gilbert says it’s criticaly important that the board remains the predominant influence on the setting of salaries (March 20).

“Critically important” to protect an old regime prone to bankster-like rewards divorced from reality. The board’s dominated influence is safe, even with a binding shareholder vote, when shareholders do not doubt the system’s integrity. Shareholders appoint the board with a binding vote and can be trusted to select part of the board, chief executive and remuneration with a binding vote.

Published version - AFR- 24 Mar 2009

Risk transparency: the key to a secure financial system

Published in Crikey

In Washington this week Prime Minister Kevin Rudd said, in reference to toxic assets polluting bank balance sheets, “This is the core of the global economic problem.” Actually the source of toxicity is the core problem and removing it central to restoring confidence and a lasting fix.

The global banking system collapsed because it is opaque. Giant financial institutions fell into their own massive risk holes. Risk holes grow out of sight as capital is attracted to assets with upside risk but with unseen hidden downside risk. Blind capital flows into risk holes like a bath-tub vortex drains the bath.

Risk transparency is the remedy. It avoids exposure to excessive unknown risk which means fewer and smaller surprises. Risk averse capital naturally flows away from transparent dangerous risk.

How is risk made transparent? Stress testing is the way to expose and measure risk holes. A stress test measures a bank’s balance sheet sensitivity to small and large changes in interest rates, exchange rates, property values and derivatives. It’s what VAR (Value at Risk), the global bank risk standard at the root of the crisis, does not do. Risk transparency simply means comprehensive price transparency — the most basic requirement of an efficient free market along with fair competition. Free market capitalism failed us because we never had it.

In February U.S. Treasury Secretary, Timothy Geithner, unveiled the Obama administration’s bank stress testing program. This was a defining moment in the management of the global crisis. It demonstrated Geithner’s grip on the problem. Apparently stress testing is also in the Brown-Rudd plan. However, as yet, no administration has mentioned the obvious and potent way to stress test the global banking system — that is, a permanent bank risk website delivering transparent, continuous, integrated, automated bank stress testing. It’s the kernel of a new global regulatory institution — the International Risk Monitor (IRM).

World leaders, the IMF, G20, FSF and Basel Committee all call for tighter regulations to fix the causes of the current crisis. The single most important regulation missing in the world’s financial system is enforcement of the IRM. A virtual place where all banks in the world must report daily their exposure to wide-ranging movements in all the economic variables to which they are exposed. Non-bank counterparties to OTC derivatives should also report. A market in regulated transparent credit derivatives can feed into the IRM to rate counterparty risk adding a further layer of security. The IRM is just an online integration of data every bank should already have on hand. The IRM needs bold leadership, standards, protocols, modest resources and time. There is no reason to delay the start. The first step in this direction will ignite confidence in the banking system. Any hesitation in real transparency justifies the fear in the banking system.

The IRM has many payoffs. It will forever immunise the global banking system against excessive risk in the most effective way possible. The market will self-regulate risk continuously. Sound banks are protected as malicious rumours wither with nothing in doubt to feed them. The market can see and deal with risk holes as they form before the storm.

Some attractive add-ons go with global integration of risk. Market risks can be netted across regions and industry sectors, automatically, daily for all to see. Derivative risk nets to zero, this has very important audit implications in a global risk system. Any global deviation from zero in the IRM is unreported dark risk in the system — an immediate alert to the risk cops.

At last week’s G20 meeting of finance ministers in Sussex Treasurer Wayne Swan was greeted with the news that the UK Foreign Office had placed Australia in its low priority list. It’s a measure of G20 confidence in Australia’s economic creativity. Mr Swan has the perfect Australian black swan remedy in the IRM, calming many storms as Mr Rudd flies to the April 2 G20 leaders summit.

Australia can set an example to the world now. We are told our banks are healthy. Let’s see it. Capture the ground of a new global financial institution.

Ralph McKay is the author of the book, “Risk Mechanics, Financial derivatives, finding and fixing risk holes”.

CEO remuneration

Published in Crikey

Why is public company CEO remuneration out of control? Political leaders are paid a tiny fraction in comparison, as are top managers in the non-profit sector. We are told it’s necessary to compete in the international CEO market. Just how efficient is this CEO market?

The listed companies managed by the CEOs compete for capital in the global equities markets. This is free market capitalism at its best — competition regulated for transparency and fair play. It’s the most efficient mechanism known for setting the fair market value of a company. Yet the market for public company CEOs the world over operates more like a rigged market. Shareholders get a non-binding vote on a deal already done by the board behind closed doors. A choice between one and none is not a choice. And it’s not a real vote in more ways than one.

The democracy of the parliament killed off real democracy in the equities markets with compulsory super. The financial institutions dominated by the super funds control the voting rights. Vast amounts of capital are transferred from ordinary workers to the super funds along with their voting rights. How many super funds ask their members how they should vote with their capital? Those with super can answer. However diligent the super funds may be they have failed on the CEO pay issue. The outrage at CEO pay is coming from the ordinary worker, forced to hand over capital along with their voting rights.

An enlightened board could set an example by inviting anyone with a published biography and asking price to nominate for CEO then invite shareholders to participate in a secure preferential vote. No vote is wasted and a fair market result is guaranteed. Dissatisfied shareholders might call for competitive offers and a vote on the entire board plus CEO team.

However it will not be a fair vote until the superannuants are all invited to vote their share of the capital — a kind of reverse proxy back to the real owners. When offered a choice the vast majority of people choose online voting over paper voting. Online direct voting is already common place in the non profit sector. It’s vastly more secure with an audit trail, flexible, convenient, green and much cheaper than paper voting. Yet it’s rare for public company boards to offer direct voting even by paper. It’s entirely practical to offer superannuants an online vote on the relative portion of their shares. Technically it’s a straightforward application of existing well seasoned technology.

Rio’s Chinalco bid a critical test of moral compass

Published in The Australian Financial Review

Graham Middelton (“History casts doubt on stimulus”, Letters February 9th) points out that Roosevelt’s New Deal in the 1930s was followed by a deep recession. It’s one reason for caution. How can an impulsive $42 billion plunge into debt with contracting revenues be safe, right and urgent? Because, we are told, it’s endorsed by a consensus of economists.

Yet the consensus of economists did not predict this global financial crisis or any other in human history. If economists cannot predict they know even less about tinkering. The profession has a dismal track record. The economic forecasting business is raw speculation. The profession avoids science because science would destroy it. In truth no economist knows if this $42 billion allocation will strengthen or weaken the economy. But it’s not the commonsense economics known to small business which created the nation’s wealth. The urgency avoids thoughtfulness and serves no other useful purpose.

A consensus of Wall Street bankers speculating in darkness discovered the personal economics of pay caps and the jobless. The banker speculations all happened under the watch of the most powerful economists. The same economists are now compounding the speculations protected by a shield of consensus. Speculating is not made safe with a consensus — except apparently for economists.

The complexity of modern economies far exceeds the status of any science of modeling. A useful analogy is the less complex business of fluid turbulence. The equations of turbulent motion have never been solved. However unlike economists, fluid mechanists admit their limitations and avoid dangerous speculations.

If it’s really about jobs $42 billion would fully fund 500,000 jobs for almost three years at $30,000 a year — in practice more people for a longer period because most employers could accept partial support. It could kick start a massive 420,000 wealth and job generating small businesses at $100,000 each. But there’s no time, our government and the economists are rushing to save a few jobs.

Published version - AFR - 25 Feb 2009

Economics: just raw speculation

Published in The Australian Financial Review

Graham Middleton (“l-Iistory casts doubt on stimulus”, Letters, February 9) points out that Franldin D. Roostevelt’s New Deal in the 1930s was followed by a deep recession. It’s one reason for caution.

How can an impulsive $42 billion plunge into debt with contracting revenues be safe, right and urgent? Because, we are told, the stimulus is endorsed by a consensus of  economists.

Yet the consensus of economists did not predict this global financial crisis or any other in human history. If economists cannot predict they know even less about tinkering. The profession has a dismal track record. The economic forecasting business is raw speculation. The profession avoids science because science would destroy it. In truth, no economist knows if this $42 billion allocation will strengthen or weaken the economy.

But it’s not the commonsense economics known to small business that created the nation’s wealth The urgency avoids thoughtfulness and serves no other useful purpose.

A consensus of Wall Street bankers speculating in darkness discovered the personal economics of pay caps and the jobless. The banker speculations all happened under the watch of the most powerful economists. The same
economists are now compounding the speculations protected by a shield of consensus. Speculating is not made safe with a consensus — except apparently for economists.

The complexity of modern economies far exceeds the status of any science of modelling. An analogy is the less complex business of fluid turbulence. The equations of turbulent motion have never been solved. However unlike economists, fluid mechanists admit their limitations and avoid dangerous speculations.

If it’s really about jobs, $42 billion would fully fund 500,000 jobs for
almost three years at $30,000 a year — in practice more people for a longer period because most employers could accept partial support. It could jump-start a massive 420,000 wealth and job- generating small businesses at
$100,000 each.

But there’s no time: our government and the economists are rushing to save a few jobs.

Published version- AFR - 19 Feb 2009

Bank website to fix risk holes

Published in The Australian Financial Review

It’s refreshing to see a sensible argument in favour of short selling (“Short selling is the oxygen that markets need”, Opinion, January 28). In short, more realistic valuations mean less unwanted risk.

However, research fellow Sam Wylie’s argument for exempting financial firms from the same pricing rigour falls short. More leverage demands more pricing rigour, not less. The peril of mispricing bank risk is obvious now.

The downward spiral of GoldmanSachs and Morgan Stanley after a ban on short selling was lifted ir1 August is not an argument against short selling. The reputations of Wall Street investment banks have been crushed and for good reason. Why stop the market telling the truth?

Short selling will not destroy a good bank with transparent risk. Malicious rumours wither with
nothing to feed them.

The single, most important financial regulation missing in the world’s financial system right now is compulsory risk transparency. However, the security of risk transparency is threatened when the share price may not reflect the risk, as when one side of the market is shackled.

Security for the world’s economies is tied to bank risk transparency — immediately accessible to all, nothing less than a permanent bank watch website, a virtual place where all banks in the world must report daily their exposure to wide-ranging movements in all the economic variables to which they are exposed. And a share price that tracks risks like a wind sock.

The risk transparency idea will need strong political leadership. Yet it’s a difficult concept for most
lawmakers to embrace because their own house is opaque. Hansard is not transparency. Transparency must flow from the seat of power.

In a transparent parliament the opinions of all MPs on the big issues, including on bank transparency, are ranked live online for all to see. This will happen when politicians vote in their dome of conscience, launched in parliament in 2002.

Published version- AFR- 2 Feb 2009

CEO pay

Published in Crikey

Why is public company CEO remuneration out of control? Political leaders are paid a tiny fraction in comparison, as are top managers in the non-profit sector. We are told it’s necessary to compete in the international CEO market. Just how efficient is this CEO market?
The listed companies managed by the CEOs compete for capital in the global equities markets. This is free market capitalism at its best — competition regulated for transparency and fair play. It’s the most efficient mechanism known for setting the fair market value of a company. Yet the market for public company CEOs the world over operates more like a rigged market. Shareholders get a non-binding vote on a deal already done by the board behind closed doors. A choice between one and none is not a choice. And it’s not a real vote in more ways than one.

The democracy of the parliament killed off real democracy in the equities markets with compulsory super. The financial institutions dominated by the super funds control the voting rights. Vast amounts of capital are transferred from ordinary workers to the super funds along with their voting rights. How many super funds ask their members how they should vote with their capital? Those with super can answer. However diligent the super funds may be they have failed on the CEO pay issue. The outrage at CEO pay is coming from the ordinary worker, forced to hand over capital along with their voting rights.

An enlightened board could set an example by inviting anyone with a published biography and asking price to nominate for CEO then invite shareholders to participate in a secure preferential vote. No vote is wasted and a fair market result is guaranteed. Dissatisfied shareholders might call for competitive offers and a vote on the entire board plus CEO team.

However it will not be a fair vote until the superannuants are all invited to vote their share of the capital — a kind of reverse proxy back to the real owners. When offered a choice the vast majority of people choose online voting over paper voting. Online direct voting is already common place in the non profit sector. It’s vastly more secure with an audit trail, flexible, convenient, green and much cheaper than paper voting. Yet it’s rare for public company boards to offer direct voting even by paper. It’s entirely practical to offer superannuants an online vote on the relative portion of their shares. Technically it’s a straightforward application of existing well seasoned technology.

Bank risk transparency wanted

Published in The Australian Fiancial Review

The November Group of 20 industrialised nations summit produced a communique that includes 47 action items aimed at improving early warning systems in the global banking system (“G20 backs new growth push”, November 17) Apparently not included is the single most effective, practical and inexspensive transparency measure possible. World leaders should demand nothing less than a permanent bank watch website where all banks in the world must report daily their exposure to wide-ranging movements in all the economic variables to which they are exposed.

This transparency measure will forever immunise  the global banking system against excessive risk taking in the most effective way possible. Such a website could easily produce and display net market risks across regions and banking sectors.

The first step involves agreement on a sensible standard for measuring the various risk components.

No astute risk engineer or scientist in the finance industry or academia will doubt the effectiveness of this transparency measure. True risk transparency will enable the market to self-regulate risk taking continuously. Excessive risk taking will be quarantined automatically.
preventing systemic failure.

It will be interesting to hear any objections. Which bank will admit it cannot produce this data? Is any bank now claiming the right to speculate in darkness? Has any regulator demonstrated it alone can be trusted to control bank risk?

Published version - AFR - 21 Nov 2008

PM could flag website to fix risk holes

Published in The Australian Financial Review

In “Bad risk mismanagement, not VaR” (Letter, October 23) Frank Ashe defends the banking industry risk measure standard VaR (Value at Risk) and blames the crisis on bad risk management. He then lists a comedy of risk management errors behind the UBS $US37 billion debacle. I doubt the same comedy of errors explains the silence of all bank boards, regulators and academics before the risk bomb exploded.

Published cartoon - AFR - 27 Oct 2008

Of course it was bad risk management. Risk management has three aspects, 1. risk measurement, 2. risk reshaping and 3. getting the first two right. Frank Ashe’s list of UBS errors fits nicely into point 3. Had the UBS risks been measured properly and transparent their massive risks would not have survived long enough to be mis-managed. At least one of the UBS board, its shareholders or its regulators would have moved like lightning to close the risk holes.

This is why I say the real root cause of the banking crisis was poor risk measurement, VaR. It’s the reason why bankers, regulators, investors, analysts and academics were caught out en masse and silent before the risk bomb exploded. The risks were not seen because the industry risk standard VaR hides catastrophic risks. Imagine cars built with speed meters that show variable measures for the same speed and never a speed over 60 KPH. The law on speed limit would be meaningless. VaR is the variable risk meter for banks. Two banks can report the same VaR – one may be safe, the other destined to crash.

I invite Prime Minister Kevin Rudd to take to the November 15 G-20 financial summit the idea from Australia that a website be established where all banks must report daily their exposure to wide ranging movements in all the economic variables to which they are exposed. The academics might like to show how such a website would have appeared over the last decade, including the VaR measures as a comparison. Add to this a permanent online global opinion market that harvests ideas from risk experts and ranks them live with democratic voting for all to see.

Published version – AFR – 27 Oct 2008

Bankers, regulators caught out

Published in The Australian Financial Review

As author of the book Risk Mechanics, financial derivatives, finding and fixing risk holes, and a long term critic of VaR (Value at Risk), I view it as a very positive sign that a debate is emerging on the way banks measure and report risks. Failures of risk measurement and reporting are the real root cause of the banking crisis. In “Risk measure’s complex frame” (letters October 20) Frank Ashe defends the role of VaR as a risk measure while acknowledging VaR has shortcomings that need to be augumented by stress testing.

So why were so many conservative bankers and regulators caught out by the explosion of a massive risk bomb? The only possible explanation is that the risk stakeholders, regulators and academics believed the risks were known and not extreme. Nothing else can explain the number of conservative institutions that invested heavily in the risky subprime instruments or the silence of regulators and others before the risk bomb exploded. The few whistle blowers were ignored.

The risk bomb was created by Wall Street investment bankers because, as a risk measure, VaR thinking dominated over rigourous stress testing. VaR is the perfect risk measure if the objective is to make risky investments look safe, hide the potential for catastrophic loss and give the illusion that capital requirements are far below that needed to match the real exposure. Senior managers, investors and regulators alike felt relaxed and comfortable with a risk measurement process with a name like “Value at Risk” unaware that the actual value at risk may be vastly greater than indicated.

An engineer would never build a structure based on a risk measure that emulated the simplistic single statistic, naive risk measure of VaR. Robust stress testing might appear more complex and less elegant. However it ensures that all unacceptable risks are seen and therefore avoided or reshaped. VaR failed absolutely. It’s part of the history of Wall Street banks. It deserves no place in the future.

Published version - AFR - 21 Oct 2008

Risk measure failed

Published in The Australian Financial Review

The federal government has moved to guarantee bank deposits with tax payer resources. What is the Government going to do about the failed banking industry risk measurement standard with the highly misleading name, Value at Risk (VaR)?  This is the real root cause of the systematic banking failures emanating from Wall Street.
 

Published version- AFR - 15 Oct 2008

Why were voices of reason on risk ignored in the US?

Published in The Australian Financial Review

Many myths are circulating about the root cause of the crisis in financial markets created by Wall Street. The root cause was none of securitization, the housing price collapse, predatory lending, free markets, short selling, innovation or borrowing short lending long. Not even greed, regulation or lack of it was the direct cause. Sound risk management can cope with all these simultaneously.

Risk management relies on accurate measurement of risk. If the risk is not measured and seen it cannot be managed. The root cause of this crisis was announced in 1996 in a report published in Euromoney’s Corporate Finance. The report exposed a devastating flaw in a risk measurement method called VaR (Value at Risk) imposed on the financial markets by Wall Street. I was the report’s author. It warned that widespread reliance on VaR left the financial markets exposed to a risk Tunguska, as I called it. Named after a massive aerial explosion 8km above Eastern Siberia on June 30, 1908 which devastated 500,000 acres. My point was to emphasis the seriousness of the problem, now exploded closer to home in 2008. I published many other papers in the 90s on the same theme including the book Risk Mechanics, finding and fixing risk holes.

VaR hides the many complexities of market risk. In particular, it ignores elements of risk associated with catastrophic loss. Yet, in the 1990s, Wall Street “rocket scientists” aggressively marketed VaR establishing it as the accepted standard of market risk measurement.

Imagine a fruit and veg trader from main street attempting to value a concealed bag of fruit and veg by its weight only. He has no idea if the bag contains potatoes, a mixed bag or bad apples. The single statistic of weight alone does not enable the fruit and veg trader to price the bag or understand the risk of holding it. Yet VaR is every bit as naive as the fruit and veg trader attempting to value his investment on weight alone. Less is not always more.

A long term solution to this crisis must answer why so many investment banker “rocket scientists” embraced a risk measurement method as naive as VaR. Why were voices of reason ignored? Whatever the motive, the rise of VaR made it easy to sell financial instruments with catastrophic elements in their payoffs. Promoters of these instruments are rewarded on a time scale much shorter than the expected time scale of these catastrophes.

Senior managers and regulators felt relaxed and comfortable with a risk measurement process with a name like “Value at Risk”. As the volume of financial instruments with hidden but massive risk holes ballooned the day of reckoning in the financial markets, the risk Tunguska, was inevitable.

Published version - AFR - 6 Oct 2008

Value_At_Risk – Var Is a Dangerous Technique

Published in Euromoney’s Corporate Finance 1996 by Ralph McKay & T Erle Keefer

A means of representing risk as a single statistic is very appealing- and highly flawed, argue Ralph McKay and T Erle Keefer of consultancy Risk Technology. The value-at-risk method can conceal large risk holes, is insensitive to the possibility of catastrophic market events and ignores risk reshaping difficulties.

Value-at-risk and its new incarnations represent a form of risk appeasement. It ignores the real market risk problems. It is fashioned to impart a feeling of security to the people that it is supposed to give comfort to – central bankers, directors of banks and financial institutions, regulators and politicians. Objective scrutiny exposes this as unwarranted.

Given the notorious billion-dollar derivatives losses and absence of senior supervision, the clamour for a simplified risk measure such as value-at-risk is understandable. And the arrival of value-at-risk has served positively to focus attention on the need for risk measurement.

What is wrong with value-at-risk? Popular, broadly accepted definitions eschew too much essential information. They represent market risks as a single statistic. This single statistic is appealing and easy to explain. Unfortunately, it is even easier to use it to hide large risk holes. Managers consequently oblivious to the actual risk can increase systemic risk of derivatives bungles.

The manager presented with a value-at-risk number is like a fruit and vegetable trader who has a basket of fruit to sell but knows only the weight of the basket. He, along with the rest of the market-place, does not know from this single parameter whether the basket contains potatoes, mangoes, a mixed bag or bad apples. Thus he cannot determine what price to ask – he cannot assess the risk. To the fruit and veg trader, weight is not a market risk measure. Similarly, on a detailed analysis conventional values-at-risk are barely worthy of being treated as a measure of market risk.

Beware Tunguska Events

Even as a simple measure of risk, value-at-risk is highly exposed to criticism. Values-at-risk assume well-behaved markets but ignore the impact of real worry, the financial markets’ Tunguska events , such as the stock market crash of October 1987.

Derivative markets are very young. There is little data from which to predict the frequency of market crashes – that is the size and frequency of so-called outliers. But the limited data that exists is alarming and the only prudent approach is to assume that the big crashes have not happened yet. A prudent risk measurement must highlight exposure to the totally unexpected – because, in truth, it should be expected.
The value-at-risk concept of measuring risk in terms of a 99% probability of market movements is dangerous and misleading. For example, portfolios with deep out-of-the-money short option positions frequently show little sensitivity to the 99% movement. However, for even larger movements they may incur accelerating losses. Values-at-risk can be blind to this form of market jump risk.

Value-at-risk relies heavily on past statistics as a guide to the future. Another example of this is the actual or implied use of correlations between different markets and risk diversification. Negative correlations produce cancelling risks in the value-at—risk. Most of the time, diversification helps to minimize losses. However, when the security of diversification distracts attention from absolute protection risk management practice – as value-at-risk appears to be doing now its effect can be destructive in the medium to long term. This is because correlation and diversification assumptions can prove inadequate when the risk Tunguskas hit.

An absolute risk measure seeks to protect wealth in a defined manner regardless of the probability of adverse market movement. For example, the maximum wealth loss may be limited to an acceptable level. Compared with the value-at-risk 99% probability-type protection, outcomes between OK and destruction may be different when a Tunguska hits.

Risk reshaping

Quality risk management is only half the story; risk reshaping is its complement. For example, two portfolios may have identical value-at-risk numbers. However, the risk may be eliminated easily in one of the portfolios, whereas the other may be difficult to modify because of the bumps-to-the-risk-carpet problem. That is, attempts to control one aspect of the market risk may worsen other aspects.

The value-at-risk statistic ignores these risk-reshaping difficulties. Frequently, such complexities of risk reshaping may be the real risk problem, even though value-at-risk numbers may appear benign. Value-at-risk hides all information required to assess reshaping risk. Using the value-at-risk, it is impossible to determine which transactions are required to reshape market risks.

A single risk number ignores market asymmetry. A portfolio may be more exposed to loss than profit, but this cannot be known from the value-at-risk number. Its limitations extend to overall trading philosophy.

Value-at-risk tends to give validity to the popular notion that financial institutions make money by incurring market risks. The more risk, the higher the potential returns. This is a myth. The target value—at-risk number should be zero. All risks should be fully hedged — particularly in zero-sum markets. The objective should be to eliminate market risk, leaving only counterparty and operational risks to worry about.

This is the case when a bank sees itself as a manufacturer of financial instruments. Such a manufacturer may not be able to achieve the ideal zero-risk position at all times, but how many senior bankers hold the misguided belief that a zero value-at-risk means zero profit?

The underlying reality is that market risk management is a complex problem. It is dangerous to oversimplify the issues. An effective set of risk numbers should indicate the present value change in the portfolio in response to all economic parameters affecting the portfolio, whether correlated on not, and indicate exposure to both small and and very large moves. If the portfolio is properly hedged, the exposure to a very large market jump may be the same as the exposure to smaller moves — zero.■

The ‘Tunguska event was a large mysterious aerial explosion in Siberia at 7.40am on June 30 1908. It devastated 500,000 acres. It is thought to have been caused by a comet. June 30 remains the financial day of reckoning for many companies.

Published version – Euromoney’s Corporate Finance – 1996

Risking Super

Published in The Australian Financial Review

Published version - AFR - 5 May 1995

In favour of floating versus fixed

Published in The Australian Financial Review

Published version – AFR – 28 Apr 1995

Published in The Australian Fiancial Review

The reshaping of risk

Published in The Australian Financial Review

Published version - AFR - 7 Mar 1995

Published version - AFR - 15 Mar 1995

ASPRIN criticism aimed to inform

Published in The Australian Financial Review

Published version - AFR - 1 Dec 1986

ASPRINS maybe a headache – includes 2 replies

Published in The Australian Financial Reveiw

Published version - AFR - 17 Nov 1986

Two replies to the above letter:

Published version of reply (1) to letter published 17 Nov- AFR - 21Nov1986

Published version of reply (2) to letter published 17 Nov- AFR - 21Nov1986

lenders Ignore clients’ risk

Published in The Australian Financial Review

Published version - AFR - 19 Sep1986