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?
This entry was posted on December 18, 2009 at 2:46 pm and is filed under Asset Liability Management, Interest Rate Risk, Options, Reputation Risk, Risk, Risk Management. You can subscribe via RSS 2.0 feed to this post's comments.
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