Latent Hazards

Short-termism and over optimism is dangerous.

When our political masters deal with the big ticket risks we face and formulate new legislation or ways to deal with the risks, they would do well to look carefully at the business models of Lloyd's and our successful UK insurance industry.

There are risks which are capable of being assessed in terms of: the likelihood of a loss or bad event happening, and the size of the pay-out. These are the bread and butter of the insurance industry. Where the risks and / or the pay-outs increase the insurance industry simply jacks up their insurance premiums. The focus then moves on to how the rate of claims and pay-outs can be reduced. The motor industry is a good example. The introduction of seat belts, breathalyzers, no claims bonuses, MOTs have all helped reduce risks and insurance premiums. Prevention saves money, frequently costs not a lot, but the beneficial effects may take many years to show through, so the action is put to one side (e.g. tackling the causes of obesity).

Then there are the big ticket items, the catastrophes, where the likelihood of the disaster happening is very small, but if the event were to occur the pay-out would be massive. The long financial tail of these potentially large liabilities in practice are reinsured.

It is the management of the risks where when things go wrong; the potential pay-out is simply too big, the economic damage is too large, or the social costs are too high, which politicians seem to misjudge. And they do not have the luxury of reinsurance. Perhaps it is the 5 yearly political cycle that makes politicians focus on the short term and do little about reducing or mitigating the big risks.

Things which could go wrong big time, and cause the country massive damage, but where the likelihood is very small are seemingly put on "the to do list". Examples of "we know there is a problem, we will sort it out later" seem to be:

=> UK energy shortfall
=> Flooding of London and other key areas
=> Nuclear waste

Five years ago the country's finances were strong and the costs of large disasters / set-backs could be taken onboard. But times have changed. Now public finances are stretched to the limit and it would be difficult to find the money to meet the financial cost of a catastrophe.

To hope very bad things will not happen and therefore do little about them is short-sighted and risky, even foolhardy. Perhaps there is much activity going on behind closed doors? It is hard to tell, but I don't see signs of this happening in a serious way.

Then there is: "we will cut the budgets, but we won't undertake a review to determine what is a must have and what is a luxury".

A significant reduction in the unit of resource has occurred in many areas, for example:

=> Armed forces
=> Universities

It is much trumpeted that the overall spend has increased year on year. This is true, but the volume of activity undertaken has increased at a faster rate. So in reality there has been a significant reduction in the unit of resource.

The position is made worse due to the difference in the inflation rate for individual citizens and those receiving the funding. I have seen it reported that the cost of keeping our service men and women properly equipped and supported rises at 3% above the rate of inflation. Contrast this with a funding rise of 0.5% per annum. At the end of a 12 year period this results in an effective cut of over 30% in terms of what is being paid as against what should be paid for the armed forces to financially stand still.

In contrast the unit of resource at the NHS has increased significantly, but this we have to ring fence!?!

It is all down to the allocation of scarce resources. Ring fencing causes financial distortions. How for example is body armour to be ranked against fertility clinics, or sending out leaflets on stress? There are a large number of must haves, lots of we need this in a civilized society, but over the years there are many, many things that have crept into the public spending which are luxuries or beyond what we can afford.

One hopes that the new Government will take an informed and longer term view. And will identify the "we must have it" and the "it is essential to our long term success", and the "we don't need it and can't afford it".

Am I right in believing that politicians are increasingly driven by short-termism?


For a crime thriller with political intrigue visit: www.latenthazard.com

PSNCR, It got me thinking...

Whilst working on the plot of my next book, I had a phone call from a friend who was writing a follow up article on the EU and the single currency. Would Greece have got into such a mess if they had stayed out of the Euro? He asked. It got me thinking (at a tangent).

The UK's Public Sector Net Cash Requirement (PSNCR) is out of control and little is being done to stop the spiraling size of this liability which will fetter our next generation. Investing for growth has merit, but how much of the massive Government spending is in reality targeted on growth? And in contradiction our universities are having their budgets cut and they are the educators of the next generation of wealth creators... The UK is sitting on a knife-edge.

In the investment markets it is important to understand what the perceived view is, and to work out what will influence it, and change it. The markets are full of analysts with great looking CVs (BScs, MBAs, PhDs, CFAs, etc) and an ability to put forward their views in well thought through terms (usually). They understand the risk / reward trade-offs and how to play the markets to their advantage.

Why then do so many politicians play catch-up? 

And why is there so little debate on the sererity of the looming credit crunch which has the wherewithal to impoverish the next generation?  PIMCO, whose assets under management, have just topped $1,000 billion, have recently estimated the UK's public and private debt at 466% of GDP. (as I commented on in http://www.ebooktumble.com/latenthazard.html). PIMCO has decsribed UK gilts as a must avoid... and resting on a bed of nitroglycerine.

We can't spin ourselves out of this one. 

At what point will our politicians wise up and realise that the perceived view is changing and the reality is that they have to start doing something meaningful now, whilst they can. If it remains all talk, bluster and spin, they face the prospect of being overtaken by events. The risk is that a tipping point will be reached beyond which is a financial hell. 

In this after world, we (the UK) will still need to borrow large amounts of money, but investors won't want to lend to us, unless it is at (very) high rates of interest. Perhaps the politicians should ask the finance director of a small or medium sized company what it is like dealing with banks in the current economic environment - will they lend? may be, and if they do, the interest rate will be exorbitant.  Leaving the hard decisions to much later in the year is starting to look very self-interested. In short the ability to finance growth could become a secondary issue. The main issue could simply become - how do we stay afloat?

We need a new Government with a mandate to do what it takes to stop our borrowings and our economy from going totally off the rails. 

Imagine what the Greek Prime Minister would be doing if he was currently in the middle of a General Election...

What ever the outcome, we need to get the General Election out of the way as quickly as possible, so that our politicians can then place the country at the top of their priorities. The alternative is delay, and then facing the priority of getting re-elected, while sterling and gilts get hammered. 

Quantitative easing has bought the Government valuable time, it would be a shame if it was all in vain.