Some Comments on Financial Risks - eVECTOR January 2008

Writing a little over a year ago in eVector, we drew attention to several of the financial and other risks and uncertainties inherent in the prevailing global situation. Commenting upon the Chancellor of the Exchequer’s recently published Pre-Budget report, we highlighted the fact that the Chancellor’s projections for government revenue and expenditure for the fiscal year 2007/2008 onwards “were based on some ‘comfortable’ assumptions regarding the global economy and UK growth performance.” We made the point that other scenarios were equally plausible; and that the implications of these should warrant careful consideration, not only by the Chancellor, but also by those companies and organisations that might be affected by significantly different outcomes.

The events of recent months have brought such risks into stark focus, including those of global trade and financial imbalances (subsequently flagged by the FSA in its Financial Risk Outlook 2007), the level and profile of consumer borrowing, particularly in the USA and UK, and some of the accompanying increases in asset prices. Rising concern in the summer over the US sub-prime debt problems has progressively increased, in turn leading to a crisis in wholesale credit markets, mounting fears over the financial health of US “monocline” insurers with accompanying implications for associated bond ratings and valuations, and the growing possibility of a US recession, together culminating in the recent extreme turbulence and falls in global stock markets and the sudden 75 basis point cut in interest rates by the US Fed. How far the difficulties at SocGen may have contributed to the market volatility that preceded the action by the Fed will remain unknown.

The jury is still out on where we go from here, but clearly the level of uncertainty is mounting. George Soros has alluded to parallels with the situation in the 1930’s, while the new head of the IMF has called for fiscal as well as monetary stimulus to head off recession risks.

While the lead-time available for effective contingency planning to cope with the turbulence and risk that may lie ahead over the coming months may have shortened dramatically for individual companies, a degree of preparedness is better than none. The use of scenarios as a tool to aid quick contingency planning in times of such uncertainty can be extremely valuable and is a task in which SAMI is well equipped to assist.

SAMI Consulting

January 2008