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Political Risk

Managing Risk in the Coming Recession

Daniel Wagner | September 11, 2015

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As if a reminder were needed, a variety of asset classes are once again frothy and it feels a lot like 2008. Just 7 years ago, the markets were partying like there was no tomorrow—ignoring the bubbles that had developed, having failed to learn lessons from the plethora of previous financial crises, and pretending that if they just kept saying everything was fine long enough, everything would indeed be just fine. Yet, after all that has happened, it appears that investors, lenders, and the markets have learned little. August's mini-China crisis is ample evidence of that. It is just a matter of time until the next market crash, recession, or financial crisis emerges.

While Wall Street's natural inclination is to cheer the ongoing evisceration of Dodd-Frank, it should know that it is in the Street's own interest to have legal boundaries in place to prevent financial institutions from succumbing to their historical propensity toward greed and excess. How can the repeal of Dodd-Frank and a return to the days of boundless excess be in Wall Street's—or the country's—long-term interest?

Four basic ingredients were required to enable the Great Recession to occur: greed, lax risk management, inadequate regulatory enforcement, and short memories. Greed certainly hasn't disappeared and, as is abundantly clear, people still have short memories. Although risk management procedures and regulatory enforcement mechanisms have definitely improved, the propensity to water them down has gained momentum as time has passed. So, the stage would appear to be set for a recurrence of the precursors that led to the Great Recession, and the plethora of financial crises before it.

Overdue for a Recession

According to the National Bureau of Economic Research, which tracks recessions on a monthly basis going back to 1854, the United States is already overdue for another recession. Between 1854 and 1919, there were 16 economic cycles, the average recession lasted 22 months, and the average economic expansion was 27 months. From 1919 to 1945, there were 6 cycles, recessions lasted an average of 18 months, and expansions for 35 months. And, the period from 1945 to 2001 saw 10 cycles, recessions lasted an average 10 months, and expansions an average of 57 months. So, recessions got shorter and expansion periods longer over time.

Since the third quarter of 2009, the US economy has expanded for 21 of the past 23 quarters, and is poised to continue the trend through 2015. Given that the US economy is once again the de facto engine of the global economy (given China's slowdown), far outpacing Europe and most other developed economies, there would appear to be little reason to believe that there are two consecutive quarters of negative growth or real GDP are in our near-term future (which would constitute the beginning of a recession).

If we assume that the final two quarters of 2015 will see positive growth, the most realistic prospect for the onset of a new recession will be in 2016, meaning that the current period of economic recovery will have lasted a minimum of 72 months (6 years). By post-war standards, by that time, the United States will have been overdue for another recession by 2 years. As things look now, it certainly appears possible, perhaps even probable, that a recession will either begin, or be well under way, in conjunction with the US presidential election.

Managing Post-Recession Risk

This time, we don't have the traditional tools in our toolkit that allow us to combat the next recession. The Fed can only lower rates as much as it may raise them in the interim, and the printing of money can only go on for so much longer. So, risk managers must expect that it is possible that the next recession will be more severe than would otherwise be necessary, and must take precautions to help ensure that their firms are not more adversely impacted than necessary in the process. Here are some ideas for how to soften the blow:

  1. Decision making: Revise internal processes to allow for more nimble and faster decision making. This can make a real difference when times get tough.
  2. Prioritize initiatives: Put costly and/or time consuming initiatives on the back burner until such time as circumstances allow them to be put back on the front burner.
  3. Maintain flexibility: In order to enhance responsiveness to fast-moving conditions, enhance the company's flexibility to respond so that risk may be reduced and costs contained in the process.
  4. Review your business continuity plans: Are they current, and are they appropriate for present and future events? If not, modify them.
  5. Manage your costs: Increased pressure on budgets will make it all the more important to select lower cost inputs and service providers. Shift the mix as quickly as possible.
  6. Alternative suppliers: Should a critical supplier be negatively impacted by the recession or unable to adequately supply your business, do you have alternatives?
  7. Key person insurance: Does your firm have key person insurance in place should one or more people critical to the operation of the firm be made redundant?

There are of course as host of other considerations that can make the difference between success and failure, or even survival, in times of recession. The job of the risk manager becomes even more critical in times of adversity. Thinking ahead and anticipating risks, needs, and required outcomes is not only desirable, but essential.

History tells us that 2016 will see a recession. Governments' ability to manage it through traditional monetary means will be limited, which implies that the recession could be worse than anticipated. That it may coincide with the US presidential election implies that policymakers will want to try to soften the blow through extraordinary means, such a fiscal policy measures. Given the way Washington tends to work, risk managers are likely to derive little comfort from any initiatives that may be undertaken, however, which are in any event likely to take months to put into effect. That means that risk managers will be on their own—at least out the outset. Better buckle your seatbelts.

Daniel Wagner is CEO of Country Risk Solutions and author of the book "Managing Country Risk".

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