The US sub prime crisis taught us that markets are integrated and risk is global.  The term used was “systemic risk” as the system was at risk and the economy came close to a melt down.

So, could the prolonged volcanic Eruption of Eyjafjallajokull in a remote part of Iceland provide a similar systemic risk and melt down (not literarily of course!) to some economies and business?

One of the effects, natural events can have is on the supply chain.  In a global distributed world, consumable goods are manufactured across the globe and shipped “just in time” to the distributors and manufacturers by air, water or on the ground.

Cargo flights being stranded for a prolonged period of time can have severe effects on sovereigns, business and financial markets.  

For exporting countries and businesses, an abrupt reduction in customer demand and the need for additional storage, that’s if the over capacity can be stored.

• For importers, the disruption to the manufacturing chain due to the lack of one component which can bring production to a halt or for chain stores unable to deliver fresh produce.  
• Airline companies to lose daily revenue, as do the support infrastructure companies delivering daily goods and services.  
• For insurances the risk of possible huge claims and payouts, if the event is covered.  
• Etc…

Media news provided the following examples during the recent volcanic eruption:     

• Hundreds of thousands of Kenyans working in agriculture, the country’s largest export sector, could face economic uncertainty because of the flight bans.
• Japanese car giant Nisan, says it is suspending several production lines due to shortage of part from Ireland.
• Refrigerated stores at Nairobi airport and on farms are completely full, whereby a huge amount of fresh flowers and vegetables destined for the European market is in danger of perishing.
•  The Airline Associated calculated combined Airline losses for 740m Euro in the first 5 days of Air travel ban. 

So, supply chain risk can be classified as another systemic risk, hard to measure or forecast and could severely impact in the short or longer term capital markets, securities portfolio’s, company profits or heavily geared organisations.

Bond markets react strongly to the fear of default, the uncertainty over the Eurozone and the unification.

But why not take a rational view and have a look at the actors at play. 

Europe is still in recession, has seen its currency appreciate against the dollar and sterling, not because of its strength but because of the weakness of the others which puts its economies and exports in a disadvantages position.

So from a political perspective why not extend the uncertainty over a rescue plan and let the currency depreciate further improving European Exports.    Investors are generally risk averse, work on the basis of mathematics and drop securities if risk levels have reached to high. 

Imagine the unthinkable and Greece defaults on its debt, what would be the implications for

•  The still fragile European banking structure      
•  The stability of the currency union
•  The implications for the other weaker members like Portugal, Spain and Ireland.
•  Future members deciding on rendering their central bank.  

 So if the stakes are so high, logically we can assume (though you never know i.e. Lehmans) that Europe will eventual provide the support needed but waits as long as possible using the Greek problems as the perfect opportunity. 

 So for those who have fears on Europe, Europe might still be “All for one, one for Europe”

But the question remains “Who’s to blame for all of this” ….

So many articles have been written about this, though by listing the main factors may be we can achieve a better perspective on what occurred.

The factors:

1.  Central bankers kept interest rates artificially low, believing they could sustain forever growth, creating a false economy.
2. Nobody wanted to believe that real estate prices where over priced and did not reflect the inflationary reality anymore as the home and value is a men’s pride and joy and the main topic in each family debate.   
3. Bankers believed that by securitising mortgages they were spreading the risk and were repackaging all what they could find, thereby few still understood what they were buying let alone measure the risk of it.
4. Rating agencies believed that their systems were fool proof and that they could accurately rate companies and assets alike even in troubled economic times.
5. Households believed that the good times could not end and overextended their credit to the maximum.  
6. Investors believed that once insured (through CDS contracts) that they could take on more risk and did not believe their counterparties could ever be on the brink of disaster.
7.  Finance in big corporate organisations was and still is perceived as a pure numbers game whereby risk measures such as “Var” are believed to be adequate enough to detect a changing global financial environment.
8. Politicians were far too occupied working on domestic problems and be re-elected, instead of monitoring how their banking system and corporate organisations became global in scale and for governments to look for ways on how to adapt to this changing environment, tax rules and other financial constraints.  
9. Free and self regulating markets was what finance professionals believed in,  maybe forgetting one of the basic principles called “Agency Theory”.

 But then came as what can be seen as the first trigger ….. the commodities and global fight for Energy and oil, pushing up the prices with the resulting high inflation.  Households felt the pinch in their pockets and the dices started rolling.  Real estate and securitised mortgages were the first to collapse and the foundation of our financial system on a global scale started shaking.

Well who is to blame …. Probably all of the players above … still, the name of the game is to point fingers at each other ….  So shall we ever learn or is this human nature or shall we put it down as behavioural Finance a science we still have to explore just like outer space.    

In this lecture, he discusses that the current capital system which was led by the US and UK, can no longer be left safely to their own devises and that free capital markets have become a scenario of the past.

Evaluating this lecture, two themes seem to emerge, which questions the future of capital markets as we know it, namely.

1. The credit crisis showed that free markets need to be regulated and that the finance “agency theory” can be seen at the core of the current problems.  Though note that the issue here is that regulation lies with the sovereign state and questions if we can build global regulations to sustain global capital markets.  Will China, India or other countries be prepared to adapt to global standardised regulations, will these regulations serve their economies the same way as they should for more western markets and western financial structures?
2. Our global world has become more risky (which investor at core do not like) due to increased global needs.   These can be summarised as :
   1. Natural Resources:  The search by governments for natural resources such as gas and oil to sustain their economies and future growth.
   2. Energy security:  the increasing need of energy by the consumers which is expected to be delivered by their sovereign states.

So can markets still be free if the sovereign states intervene either through protectionist measures to support their own economies or regulatory measures!

But, how does this relate to our current Finance theory, tools and techniques?

• Does EMH or the Efficient Market Hypothesis still hold?      
• Is the risk free rate still risk free, and will all sovereign states triumph in this new global order?
• Do we have to revise the equity risk premium up or down in the new global order and for which sovereign states?     

A lot of questions emerge on how finance theory will change from this new world order, one thing for certain is that more active research will be needed matching global trends with global issues to steer the organisation through changing markets.