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What Are the Greatest Risks?

Posted by Larry Doyle on December 12, 2011 10:41 AM |

In the midst of all the research and analysis put forth by virtually every entity within the financial services industry, I VERY rarely see any mention of what I deem to be the two greatest risks that individual investors face each and every day.

We are fed and can read volumes about a wide array of risks, including market risk, interest rate risk, credit risk, currency risk, prepayment risk, volatility risk, and liquidity risk. While overwhelmed by analysis on these risks, my ‘sense on cents‘ leads me to focus primarily on the two greatest risks of all.

What are these risks and why is it that those within the financial services industry do not highlight them?

1. Greatest Risk of all is REPUTATION RISK!! Whether for individuals, small businesses, large corporations, or any other entity, the chance of developing and dealing with a tarnished reputation is the greatest risk by far in our marketplace. Just ask Penn State.

Wall Street, broadly speaking, will spend endless amounts of dollars and time in fending off the stench and degradation of a tarnished reputation. These dollars are directed toward Washington and marketing for purposes of influencing legislation and regulation that would otherwise protect investors. That said, Americans are just now beginning to appreciate the fact that reputation risk has been mispriced egregiously for a protracted period. The declining trading volumes across most market segments are an indication that reputation risk is being repriced.

1A. The next greatest risk – and a close cousin to reputation risk – is counterparty credit risk. This risk has also been massively mispriced for an extended period. Counterparty credit risk addresses the ability of the entity with whom you engage to perform and deliver on its obligations. How often have you received any information from brokers, money managers, financial planners, or other intermediaries with whom you interact on this risk? I am guessing not all that often.

Counterparty credit risk goes straight to confidence. Do you think shareholders, creditors, and customers of Lehman Brothers, Madoff, Stanford Financial, MF Global, AIG, et al wished that they had properly understood and addressed this counterparty credit risk in the midst of doing business with these firms? You think? Again, the industry works hard at disguising and mispricing this risk.

What are investors to do in the face of these greatest of risks?

Be exceptionally careful and inquisitive in understanding the individuals and firms whom you engage, or in other words as Sense on Cents is wont to say . . .

NAVIGATE ACCORDINGLY!

Larry Doyle

Isn’t it time to  subscribe to all my work via e-mailRSS feed, on Twitter or Facebook? Do your friends, family, and colleagues a favor and get them to do the same. Thanks!

I have no affiliation or business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets, our economy, and our political realm so that meaningful investor confidence and investor protection can be achieved.

  • Peter S.

    The language of “neither admit nor deny,” found in many securities settlements, sole function is to stave off reputational risk. Unfortunately it is not a company that commits the offenses – it is individual within the company who commit the act. The language is a win, win, win, for the regulator, the company, and the individuals who commit the offense.

    Ultimately, it is a lose, lose, lose – for justice, for the victims harmed (restitution almost always amount to pennies on the dollar), and to the future victims of those individual guilty who escape being exposed only to offend again.

  • coe

    Perhaps you might add one more log to the fire, LD…I think another risk, and one that sneaks up on the Capital Markets and the global economy with no warning and no defense, is that of the law of “unintended consequences”, as you put it…it happens everywhere in life, but it seems to be part of the daily landscape in these volatile and challenging times – from new Penn State committed players walking away because of the abuse scandal, to investors punishing the currencies of other boutique firms in the wake of the MF Global travesty, and countless other examples, these “unintended consequences” have become a more important part of the human condition….sure, the broad category is an “effect” of the byplay of other factors, but on the financial scene, especially in these times of global distress, economic weakness, and (here we go again) mediocre leadership, it just seems to me the risk of “unintended consequences” is particularly high…I’m not advocating that investors should sit it out, but one really has to think outside of the box to try to get ones’ arms around what could go so very wrong…btw, great comment from Peter S above

  • G-man

    Thanks.

    Both these risks are a function of the greatest economic risk facing our country right now, which is legislative risk.

    Our “public servants” in office have f*&^#ed up so badly that we are saddled with inconsistent and corrupt interpretation/enforcement of the rule of law.

    What is the credit and reputation of our elected officials? As a society we get what we deserve and vote for unless we Occupy Washington.






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