April 23, 2007

The pastor risk is the risk that investors just share into blissful ignorance.

Sir, Wolfgang Münchau is correct when saying “A risk shared may be more risky, not less”, April 23. As arguments he presents, first the deceased US economist Hyman Minsky’s general pessimism (or may we dare say realism) that instability is an inherent part of the system, and then Raghuram Rajan’s, former director of research at IMF, who argues along the line that the investor’s increased willingness to invest in “tail risk” and their “herd” mentality could lead to a catastrophic meltdown.

I myself have been writing and warning on these specific issues for a long time, though mostly on the risk present in assigning too much market decision power to very few credit rating agencies and which introduces not a herd but a “systemic pastor” risk.

For instance in the ongoing subprime mortgages debacle, the distance between the borrower and the final lender increased too much, just because everyone counted on others to be able to provide sufficient oversight. When we now start seeing how credit rating agencies rated without even sending a team to walk the streets in order to sample how those subprime mortgages originated, we should be able to conclude that the investors besides sharing risks, were also sharing blissful ignorance.