Systemic Risk – Challenging Assumptions

Risk managers should contribute to long range planning and analysis. They can cause planners and modellers to recast their assumptions. In a recent workshop, participants and I were discussing risk assessment of the firm’s strategic plan, and considered wider systemic risk and emerging risk, that could undermine the organization.

On the issue of strategic risk, I first draw the reader’s attention to my 6-part series in which I discussed high quality risk assessment and future scenarios; strategic identity; stakeholders; and environmental scan. The essential point in that series is that risk assessment should be part of a complete research and planning process, including methods to deal with “black swan” risks and high uncertainty.

In this post, I want to elaborate on the idea of risk managers questioning assumptions that typically go unchallenged.

Information Sources

Consider information sources. It should be axiomatic that information sources are biased, whether academic, government, corporate or conventional corporate media. The fact is that a system of values and unspoken assumptions is inherent in power structures; this compromises the quality of the forecasts and data they give.

An example commonly discussed online is the US Bureau of Labor Statistics versus critic John William’s shadowstats web site. Williams makes the argument that official estimates of inflation, for example, are misleading, since they no longer incorporate food and fuel costs; similarly, reporting of unemployment levels is faulty. Now, I recently read a severe critique of Williams by M. Stathis, author of America’s Financial Apocalypse. He said that Williams’ prediction of hyperinflation, for example, is misguided. Yet he did not disprove William’s alternative presentation of economic trends.

The lesson, therefore, is to question our habitual sources of information and the unspoken assumptions that inform them. We don’t want a repeat of 2008, where some risk managers relied on narrowly conceived models and did not consider the wider context. Consider the sharp divergence in opinion now evident regarding the economy.

Economic Ruin

Some argue that an economic collapse is inevitable and even imminent, that is, certain to occur within the next few years. The chief cause is the unsustainable level of debt,  including government, corporate and household. Price inflation and unemployment are proceeding by stealth. Market bubbles spurred by stimulus have successively shorter lives, portending an eventual crisis in confidence. Some trigger event could cause a series of defaults, a massive unwinding and sell-off. Proponents of this view point out that fiat currencies always, eventually, revert to their intrinsic value of zero. Manipulation of capital markets create windfalls for insiders, and are destroying the means to a productive economy. Quantitative easing devalues the currency, while independent trade arrangements among various global partners are undermining the US dollar as universal reserve currency. The political ramifications, as predicted in a 1959 interview by Ayn Rand – whose ideas are enjoying a resurgence of popularity – are not lost even on mainstream commentators: the US is realizing collectivism and the attendant loss of civil liberties.

Alternative Views

The counter-argument maintains that the US economy is extraordinarily powerful and is unlikely to fail. The institutions of the US polity, including the Fed and military, make it so. Inflation is not a concern and stock market gains evince economic recuperation. Moreover, low cost shale oil -based energy and business friendly locales are seeing a repatriation of industry to the West and a recovery.

A mixed view acknowledges the recovery phenomenon, but maintains that it is localized, and that shale oil is highly debt-financed. Erosion of economic fundamentals is continuing, but the institutional fixes will hold it together indefinitely, resulting in a long term stagnation-inflation.

Challenging Ingrained Assumptions – Risk Managers’ Evolving Role

It is not necessary to prove one view or the other. Rather than espousing one fixed view of the future as the official forecast, it is possible to build divergent pictures of the future. Then, the main features of the strategic plan can be evaluated for risk within each potential scenario. That is far better than to leave such fundamental shifts in the economic landscape unexamined.

There are other ways to challenge key assumptions. Goals and objectives, after all, are not permanent fixtures — they are merely the means to a desired future state. Organizations can be undermined by radical changes in stakeholders, competition and markets, calling for a review of the firm’s strategies. Hidden assets and the firm’s ability to innovate will come under scrutiny. To evolve with a changing environment could even require a redefinition of values, identity and mission.

Progressive risk managers have been aspiring to get a seat at the planning table.  As the role of risk managers evolves, risk assessment has come to signify a critical assessment of the organization’s habitual worldview that sets its direction.

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