August 21, 2012

Risk-adverseness is also the subject of fashion.

Sir, John Kay asked “Why do we need to pay billions of pounds for big projects” August 21 and I suddenly remembered an anecdote, from some decades ago, which might illustrate one of the causes. 

In Venezuela, after a devaluation of its currency, the Bolivar, I witnessed amazed a CFO of a big multinational covering his company’s Bolivar positions by buying a swap at an absolutely absurd high price, and which de facto guaranteed a much larger loss that anything that could happen leaving that position un-hedged. I asked him why, and this is what he answered: 

“Per I know this is utterly silly, but you have to understand me, if I spend millions of dollars covering this exposure, and that would result in a huge waste of resources, nothing will happen to me, but, if I lose one single dollar, because of a non-hedged FX position, I am out!” 

In a similar way, if a bureaucrat spends millions of dollars more in order to have a reputable name carry out the works nothing happens, but one dollar of loss suffered in the hands of an unknown, that can bring him down… and the “reputable” make it of course their business for this to be well known. 

So you see, not all same risks are equal, even when measured in dollars, or pounds. Risk-adverseness is also the subject of fashion. 

Look at bank regulators, if banks go down, they feel responsible, but, if the economy tanks because of how they try to avoid bank failures, that doesn’t seem to bother them.