On Thin Ice

Most people who know that they are walking on thin ice will proceed very slowly and carefully.

That is also the effect that we get when we fail to recognize losses. Everyone HOPES that things will turn out ok and either the losses will eventually emerge at a lower value (i.e. less loss) than expected or that while we defer recognition, other earnings will make up for the losses.

Loss recognition is an important step in getting off of the thin ice.  Firms need to have a disciplined loss recognition process so that they can avoid getting into the thin ice situation. 

One important concept in risk management was stated by Nassim Taleb in his “Black Swan Free World” piece – that failures should be frequent and small.  That principles applies to losses as well.  A good risk management program should encourage small and frequent losses. 

A firm that rarely recognizes losses is either (a) not taking any real amount of risk or (b) failing to recognize the losses that it has.

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