New World of Financial Risk. Essay

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Second and third supporting opinions center on the improvement of the financial system. The current Administration will be able to develop better systems to manage risk across the financial system. In this will be the development of better ways to identify risk. This will lead to a more robust and more transparent system, when it all comes together (Johnson & Kwak, 2009). A complementary component of the healthier system is increased disclosure.

Johnson and Kwak (2009) use this anticipated increased disclosure as their third supporting opinion. They theorize that increased disclosure requirements will be developed for off-balance sheet exposures, including items like structured investment vehicles. Hedge funds will require some measure of disclosure as well. Each of these should help revitalize the financial system and prevent similar problems from occurring in the future.

Three Opposing Opinions/Reasons:

The three opposing opinions to Johnson and Kwak's (2009) theory that the United States will be able to overcome the new financial risks begin with examples of the struggles in implementing similar programs, specifically nationalization, in other countries as well as a note that sovereign debt may be exceeding expectations. "CDS spreads on U.S. sovereign (U.S. Treasury) debt had climbed from 6 basis points at the end of April to almost 40 basis points in November." Other countries have had it worse though, including the financial collapse of Iceland, and troubles in countries like Greece and Ireland. Although not the economic size of the U.S., these countries could demonstrate the potential hazards of America nationalizing beyond its true means.

Johnson and Kwak (2009) also note that a resurgence of political risk is a possibility, as a second opposing factor.

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Unpleasant political consequences can be triggered by financial crises and recessions. As the authors call it, 'old-fashioned protectionism' could come into play. In this instance, the U.S. could favor Americans over foreign creditors. This could wreak further havoc in an increasingly globalized economy.

Lastly, as a third opposing factor, the house of cards that was lending may not be finished falling, according to Johnson and Kwak (2009). As noted earlier, sub-prime mortgages are continuing to fall in value. Auto loans, credit cards, prime mortgages, commercial mortgages, mortgage-backed securities, and corporate debt are all areas where banks are expected to take writedowns. Recapitalization, in the first round, is likely not to be enough to sustain them. Banks like Citigroup already are in need of fresh bailout funds.

Summary:

Johnson and Kwak (2009) explore the causes of the new world of financial risk, as well as the anticipated fixes to the economic mess America is in. Although focusing on the potential upside of an increasingly healthier financial system, there are potential risks that may not make the road to recovery an easy one. More conservative financing institutions, increased transparency, improved models, and increased disclosure are all positive outcomes from the situation that should help investors and institutions more effectively manage risk. However, there are potential challenges, including: a finite amount of nationalization that can occur, political triggers, and continued writedowns that may require additional bailouts, to a renewed financial system. Even if recovery goes smoothly, it will be a long process, in which businesses will have to learn to operate on reduced credit and will likely see increased costs of doing business, due to increased.....

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