September 26, 2015

Globalizing the conclusions of members of mutual admiration clubs, like the Basel Committee’s, is a huge systemic risk.

Sir, I refer to Gillian Tett’s interesting discussion of Paula Jarzabkowski’s “Making a Market for Acts of God” “The doublethink insurance club”, September 26.

Tett writes: “insurance executives …love to talk about how they are now using diversified strategies that bundle different risks together, and price this according to a global pattern of supply and demand – or a “market”… But there is a rub. As consolidation has taken hold, this has cut sharply the number of players who handle reinsurance products – And [so] while the insurance companies say they want to “diversify” their risks, they are all doing this in exactly the same way –which produces less, not more, diversity.”

Indeed that of diversifying more and more in ever fewer and fewer diversified ways is a clear and present danger in days of increased globalization. The following is what I had to say on that subject in April 2003 at the World Bank, as an Executive Director:

“Ages ago, when information was less available and moved at a slower pace, the market consisted of a myriad of individual agents acting on limited information basis. Nowadays, when information is just too voluminous and fast to handle, market or authorities have decided to delegate the evaluation of it into the hands of much fewer players such as the credit rating agencies. This will, almost by definition, introduce systemic risks in the market and we are already able to discern some of the victims, although they is just the tip of an iceberg… A mixture of thousand solutions, many of them inadequate, may lead to a flexible world that can bend with the storms. A world obsessed with Best Practices may calcify its structure and break with any small wind.”

Tett writes “this project touches on a point that matters beyond the insurance world: namely we all have an amazing tendency to fool ourselves… insurance brokers…they are so clubby that they are susceptible to both groupthink and doublethink – and an inability to see the contradictions that underpin their world.”

And if that goes for insurance brokers, then think of what a mutual admiration club of regulators could come up with, when trying to impose the same one and only set of regulations on the banks of the world. Holy moly! Just for a starter, when setting the capital requirements needed to partly cover unexpected Acts of God losses, without blinking, they decided to use the human perceptions of the expected losses… and no member of the Basel Committee club objected... naturally... members are not supposed to do that.