Risk aversion on the wane, for now

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World stocks tumble on credit worries

Beijing: Call them resigned or defeatist, but two leading risk managers are already sure of one lesson from the crisis ravaging the global financial system: in one way or another, it's happened before and it'll happen again.”For at least 10 to 15 years, people will remember this very painful experience, take it to heart and balance risk versus return more realistically,” said David Rowe, London-based executive vice president for SunGard, a provider of financial software.

“But I say to my younger colleagues: don't assume this is the last one. If you're young enough you'll see the next one,” said Rowe, who used to oversee market risk at Bank of America. Leaders of the Group of 20 developed and emerging economies have ordered financial supervisors to conduct a root-and-branch review of the shortcomings in regulation and oversight that spawned the credit crisis and still-deepening global slump.

Speaking on a recent visit to Beijing, Rowe saw no need for supervisors to become heavy-handed. But, he said, they should require banks to demonstrate they have the capacity to process their trades from start to finish and value them daily.

“And they should say 'if you can't show us, we'll get real tough',” Rowe said. “It would slow the pace of innovation to some significant extent, but it wouldn't completely handcuff the process.”

Even then, Rowe said the best pricing and risk management tools struggle to capture “tail risk” -- statistically improbable confluences of events that have materialized with alarming frequency during the crisis, bringing many banks to their knees.

“People have been too inclined to put complete faith in the scientific certainty of the numbers that come out of all these complicated systems and abandon a certain amount of common sense,” Rowe said.

“Part of the problem is not derivatives or risk systems. It's human psychology at fault here. We've met the enemy and it's us.” Nikolaus von Bomhard, the chairman of Munich Re, the world's largest reinsurer, thinks he may have already spotted the next market land mine: before long, the availability of too much cheap cash will once more cause risk to be underpriced. The appetite for risk may have faded for now, but von Bomhard said he suspected this was just a fad.

“Excess liquidity will sooner or later become an issue again,” he said in an interview at the weekend.