Peter L. Bernstein on risk

A V Rajwade: When risk becomes uncertainty - III

Some instruments are so complex that it can take investment banks' computers entire weekends to value them!

Even as a measure of calm has returned to the financial markets, cautions are being sounded. The president of the Bundesbank described the events as “a classic bank run” — but on a different class of financial intermediaries like hedge funds, conduits, SIVs and SIV-lites. In the US, the number of foreclosures in the current year is expected to go up to 2 million, up from 1.2 million last year. This means that one of every sixty house-owners will be thrown out of his/her house, a rate not seen since the Great Depression of the 1930s. And, this is not the end: as many as 2.5 million adjustable rate mortgages (ARMs), where the initial rate was kept low to attract the borrower, are due for re-pricing next year. Quite often, a fall in home prices has been followed by recession. Could we see history repeating itself this year? There are some signs: US car sales in August showed a fall.

Full Article

In Nature’s Casino

It was Aug. 24, 2005, and New Orleans was still charming. Tropical Depression 12 was spinning from the Bahamas toward Florida, but the chances of an American city’s being destroyed by nature were remote, even for one below sea level. An entire industry of weather bookies — scientists who calculate the likelihood of various natural disasters — had in effect set the odds: a storm that destroys $70 billion of insured property should strike the United States only once every 100 years. New Orleanians had made an art form of ignoring threats far more likely than this; indeed, their carelessness was a big reason they were supposedly more charming than other Americans. And it was true: New Orleanians found pleasure even in oblivion. But in their blindness to certain threats, they could not have been more typically American. From Miami to San Francisco, the nation’s priciest real estate now faced beaches and straddled fault lines; its most vibrant cities occupied its most hazardous land. If, after World War II, you had set out to redistribute wealth to maximize the sums that might be lost to nature, you couldn’t have done much better than Americans had done. And virtually no one — not even the weather bookies — fully understood the true odds.

Full Article