Does Bloomberg Understand Anything about Risk Management?

On December 18, Bloomberg posted a story about losses on interest rate swaps at Harvard.   The story says that in 2004, Harvard entered into long term swaps to lock in future rates for planned borrowing.  That seems like ok risk management.  But as it happened, interests did not rise, they fell.  So the hedge was not needed.  They type of hedging strategy that they chose had no initial cost.  The cost of risk management was incurred only if the hedged event did not happen.   If interest rated did risk, then the swaps would have resulted in a gain so that Harvard’s costs were limited to a predetermined amount.  If Interest rates fell, then Harvard would pay on the swaps, but save on the interest costs, bring the sum of interest paid on their borrowing and the swap payments to a fixed predetermined total in all cases.

However, Bloomberg chooses to say is this way:

Harvard was betting in 2004 that interest rates would rise by the time it needed to borrow.

The bulk of the story is about how Harvard lost their “bet” and how much money that they lost because they lost the “bet” when interest rates fell, and Harvard had to postpone their planned borrowing.

No wonder it is difficult for firms to disclose any information about actual risk management actions and plans.  If a reasonable, but not perfect risk management action is seen as a “bet”, rather than a move to stablize interest costs.

Every risk management action will have a cost.  Harvard’s real bad move, similar to the one by Soc Gen in January 2008, the choice to lock in losses, and at the worst time.  Interest rates cannot go below zero, so there is absolutely no reason to get out of those swaps, unless their cashflow was so, so poor that they had no way to pay the monthly interrest swap amount (even though they somehow had the cash to settle all of the swaps, presumably paying the present value of the long term swap amounts as viewed at a time ov very low interest rates).

Their other bad move was to fail to hedge the possibility that they would not even do the project and therefore not need the hedge.  To identify how to hedge that situation, they would have had to do some scenario testing of scenarios of extreme losses in their endownment that would have resulted in the situation that they now find themselves.  That analysis should have resulted in some far out of the money hedges on the investments in Harvard’s portfolio.  And the fact that much of their portfolio may be unhedegable should have been a warning about the wisdom of making forward committments like the swaps that presume that the endownment will not tank.

Seeing how wrongheaded the coverage of the transactions was, Harvard probably felt that they had long term reputational risk from paying the monthly payments.

Alternately, if as the article says, the swap markets are so much more liquid at periods for up to 3 years, they why didn’t they enter into trades to reverse the first 3 years of the payments?

No matter what the market says right this minute, I find it hard to believe that interest rates for Harvard will never again reach 4.72% that the swaps were locking in as the rate.

But that is not the point.  The point is that Bloomberg reports Risk Management as a “bet” implying that lack of risk management is not a “bet”.

But, how many companies are implicitly taking a “bet” that the future will never get worse than the present by not hedging anything?

Why is that NEVER a story?

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4 Comments on “Does Bloomberg Understand Anything about Risk Management?”


  1. […] Does Bloomberg Understand Anything about Risk Management? (December 2009)  Risk managers do not stand a chance if even the financial press characterized hedges as bets. […]


  2. I agree that the reporting is bad, but reading between the lines, it looks like it was bad risk management too. The article talks about the fact that they had to post collateral; the amount that they might have to post at any given time would be the present value of all of the future payments. This is a big liquidity risk, and the question is whether they were managing that liquidity risk. If not, then this a good example of bad risk management – they got rid of some of their risk (interest rate risk) via derivatives contracts, but they missed the new risks that they were taking on in the derivative (not dissimilar to Metallgesellschaft).

    I can imagine something like this happening: the reporter wants to write about this big loss at Harvard, and so he talked to some people who knew about it, and they told him that those were bad hedges, that it was poor risk management, and talked about the issues above. The reporter probably didn’t fully understand, so he defaulted back to the “lost money, bad bet” narrative.

  3. riskviews Says:

    Udaya,

    Thanks for your comment. I believe that Quantitative Risk Management, if done right, means that you do not believe that you CAN pick the best scenario and that you always must deal with the UNCERTAINTY that looking into the future ALWAYS entails.

    But for Quantitative Risk Management to be effective, both the risk managers and the regular managers need to all agree about this idea that you can NEVER KNOW THE FUTURE FOR CERTAIN.

    See my post ERM only has value to those who know that the future is uncertain. http://wp.me/pevO4-4B

  4. Udaya Adhikari Says:

    Do you think that Risk Management is a Process of fooling people with different technical words. Some time I feel when we do any analysis with a certain scenario…then if that scenario is not happened then its complete worthless. even if we do different number of scenarios , choosing a best scenario comes from best judgement. Does Quantitative Risk management solves the problem ??


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