President Obama spoke this week regarding the improving mood on Wall Street and offered that “Those on Wall Street cannot resume taking risks without regard for consequences, and expect that next time, American taxpayers will be there to break their fall.” I’m not quite sure what this means. Risk always comes with consequences. Granted, having the American taxpayer bail them out isn’t necessarily something one should take for granted, but if the United States is going to continue to grow, risks must be taken, yes?
In the current issue of The New York Times, Andrew Sorkin speaks about risk and offered that “Perhaps the greatest measure of risk — and in this context, let’s define it as systemic risk to the entire system — is one word: leverage.” Perhaps I’m thinking too semantically, but I wouldn’t characterize “leverage” as a “measure of risk,” let alone the “greatest measure of risk.”
And while I challenge some of what Sorkin offers, his thoughts on VaR are, as the Brits say, “spot on”: “VAR, by the way, is a horrible way to measure risk, as has been said again and again by economists, because it calculates the risk for only 99 percent of the time. As Mr. Johnson [a professor at MIT’s Sloan School of Management] says, “VAR misses everything that matters when it matters.” Indeed, the VAR metrics obviously missed what led to what now has been dubbed the Great Recession.”
It’s good to see that VaR continues to be scrutinized, even while it continues to be measured and reported: I guess some folks that any number is better than no number, but understanding the number, what it means, and its reliability are probably critically important aspects of any risk assessment. I will be addressing the pros and cons of risk in an upcoming NYSSA journal article.