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“A bigger problem for both investors and regulators has to do with risk itself. Outsiders–and perhaps even insiders–find it hard to judge whether Goldman’s business is sustainably good or has thrived thanks to a dose of unsustainable good luck and skill. In addition, the very improvements in risk management that have spread risk far and wide make it harder to know where risk is concentrated or how risks might combine to threaten the system’s overall health.
“So far central banks have concluded that the system is more robust than it was. But the trading models that have propelled Goldman will be tested one day. At worst, the bank itself–or, more likely, a second-tier rival or a hedge fund–might fall into the kind of dramatic spiral that killed off Long-Term Capital Management (LTCM), a hedge fund, in the late 1990s. Financial markets have always been subject to crises.
“Any crisis would affect Goldman, because it is so intertwined with the system. The bank says it keeps plenty of liquid reserves against the dread day. It might well profit from any crisis (it did from LTCM). But the chances are that some banks, somewhere, will get into serious trouble.
“If that happens, the losses of any bank will be for its shareholders; they should not expect any bail-out. The wider question has to do with systemic risk. If the much vaunted systems do not work, then the central banks will have to step in (as the Federal Reserve did with LTCM).” —The Economist, 4.26.06
Risk is tricky, and this story demonstrates that even the supposed experts, Goldman in this case, were still open to some serious consequences as demonstrated by recent events. While you and your portfolio are not an investment bank, you need to consider some of the same things with regards to your risk.
Do you really understand what you’re risking? Do you understand what your options are if there’s a crisis? Setting goals and making the time to adjust your levers can help you measure and balance your risk. If we’ve learned anything during the last year it’s that risk doesn’t take care of itself.
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