Why does everybody start talking about systemic risk, after a crisis has already started? If we define a systemic risk event as something large enough to affect the entire global financial and economic system, then you would think that the best time for investors to be told about these terrible events is before they occur. But that’s not the way it works now. The way it works now is that the large institutions which are in the business of managing our money charge us handsomely for advice that often describes dangerous events to us only after the bulk of their effects have been felt. Then all the discussion is focused on whether it is over or not, and if not, how bad it will get.
Is it because they’re not smart enough to see things coming? Not according to them. Several months ago I was on the phone with the managers of a very, very large international bond fund. They wanted me to support the recommendation of the staff of an investment committee, on which I sit, to put a lot of money under their care. Their performance had been poor lately, but as a long-term investor, I didn’t hold that against them. I wanted to know how they thought, especially about risk.
But no matter what question I asked them about their way of thinking they always seemed to give an answer in terms of the intelligence, resume, or academic qualifications of their analysts. So and so studied under Barry Eichengreen at UCLA; this guy has been analyzing bonds for X years; this other guy has lived in South America analyzing bonds for his whole career, etc. Well that’s nice. Smart is better than dumb, but right is better than smart, and right is largely a matter of fundamental principles.
After two or three iterations, I finally was able to talk to one of the fund’s super-star analysts, and we talked about risk in Europe. Greece, he told me, was actually not as risky as some of the other peripheral countries we had discussed. Why? Because their political instability risk factor is based partly on income inequality and Greece’s income inequality had been dropping. But why, I asked, did Greece have more income equality than they previously had? Because their economy was in a tailspin and economic contraction almost always affects people at the top more than people at the bottom. And people at the bottom, the analyst told me, did not sink very much during the recession because Greece has a very large social welfare system.