We’re all contractualists now…

The recent awarding of the 2016 Nobel Prize in Economic to two individuals for their work on contracts and how they affect the division of power in economic relationships, brought to mind the broader philosophical question of the how not just the wordings and forms of contracts matter, but also how they are created.

“And what, pray, is a “contractualist”; and what on earth has it to do with the world of (re)insurance?” you may well ask. Bear with us, as we take an excursus into the importance of trustworthiness- which is still a concept at the core of commercial and personal relationships and contracts of (re)insurance.

Most, if not all of us, would wish to be considered trustworthy, as well as moral beings. But what is moral, and how does it affect decision-making, or the perception of trustworthiness?

While philosophers may parse the concept into minute segments, there now tend (at least in Western philosophy and neuroscience) to be 3 main schools of thought about how an individual makes moral decisions and thus signals trustworthiness:

– Deontological: there is a set of rules that one cannot break (e.g., Thou shalt not bear false witness)
– Consequentialist: one ought to maximize the greatest good for the greatest number of people (as expounded by, inter alios, the Benthamite utilitarians)
– Contractualist: respecting and understanding the rights and duties of others (Do unto others as you would have them do unto you)

So, in the real world, why do nuances of moral behaviour matter? Why should one care about such matters in a system that tends to take profit maximization as the goal of a business, because that is “clearly the best outcome”.

It matters, because it turns out that people tend to trust most those who follow a contractualist approach: as social beings, we care about fairness, and the responsibilities and duties that we have to each other. Trying to “put one over” on someone does not go down well, whether in a social or business context.

Of course, because we are human, and thus emotionally and psychologically complex, we apply behaviours or thought processes that can encompass one or more of the 3 systems (unless we are narcissistic sociopaths) and these affect our decisions; but the contractualist approach seems to align more closely with how most people behave and expect to be treated.

Bringing all this back to the world of (re)insurance, terms such as “pactum meum dictum” and “uberrimae fidei” are considered truisms; and too obvious even to require explanation. Yet, we would argue that they are the distillation of a contractualist approach; and evidence of the fact that the industry does not seek simply to benefit from “filthy lucre”, but rather to provide a service to the societies in which operates, while deriving a fair return.

All this may sound a little too “soft” and “touchy feely” for some of our readers. We can almost hear the harrumphing! However, at Awbury we are firmly of the opinion that not only does a proper alignment of interests matter, but also that all parties should derive a clear benefit from any transaction or relationship. Ultimately, that engenders trust- and trust is what actually strengthens and builds a franchise and enables us to generate repeat and scalable business- which is more efficient and ultimately more profitable. [Yes, we do believe in the “P” word!]

And one final thought: there is also an Aretaic School, based upon Socratic concepts of the Good or Virtuous, but that is a topic for another day!

The Awbury Team

The Debt/Growth conundrum

As Friday’s “second flash crash” of the Pound Sterling (well, it was once considered “sterling”) demonstrates, we live in uncertain and volatile times. No matter what the actual cause of the event, it seems symptomatic of a greater malaise and sense of uncertainty afflicting the global economy, as existential gloom continues to outweigh animal spirits.

Ahead of its Annual Meetings, the IMF recently published its latest World Economic Outlook (WEO: http://www.imf.org/external/pubs/ft/weo/2016/02/), which reflects rising concern that globally the rate of growth in output is slowing, to 3.1% in 2016, with only a slight uptick to 3.4% forecast for 2017. Now, that rate of growth would be considered more than satisfactory in the US, the EU, Japan and the UK, but it reflects still subdued growth expectations in emerging and developing markets. Then couple that with the contents of its latest Fiscal Monitor (http://www.imf.org/external/pubs/ft/fm/2016/02/pdf/fm1602.pdf)
and one has reason to be concerned.

On the general economic side, there are the obvious concerns about slowdown in the PRC, the Brexit shock, a reverse in globalization and increasing anti-trade sentiments, as well as constrained demand, none of which is exactly news by now. However, it is Fiscal Monitor that should also be causing policy-makers sleepless nights, because it points out that, contrary to many people’s likely perception, the level of debt in the non-financial sector (general government, households, non-financial firms) is continuing to rise, and now stands at an all-time recorded high of 225% of global GDP.

More particularly, some two thirds, USD 100TN equivalent, is private sector debt, with its levels continuing to rise in many advanced as well as in key emerging market economies. Ironically, of course, ultra-low interest rates encourage the use of debt, but the continuing constraints on demand may well be reducing the rate of growth- in other words, it could be worse.

This level of debt matters for a number of reasons. Empirically, financial crises tend to be associated with excessive private debt, while high levels of public debt, coupled with fiscal weakness, tend to exacerbate the outcomes. If a government’s fiscal and budgetary position are already weak, it has fewer means at its disposal to manage the consequences of a financial crisis, because it cannot act counter-cyclically.

Ultimately, it is arguable that debt levels are still constraining growth, yet higher rates of growth are required if debt levels are to be reduced to more sustainable levels. ‘Tis indeed a puzzlement!

In reality, what the IMF is starting to emphasize is that debt which cannot be repaid, will not be repaid. The Japanese economy has suffered from the “zombiefication” of large sectors on its industry base, and there are signs of the same issue in other economies, such as that of Italy. This is not exactly a new concept. After all, the biblical Judaic concept of a periodic “Jubilee” year includes debt forgiveness as part of the required actions.

At Awbury, we study and try to understand these seemingly arcane and abstract issues because they actually matter in the real world. If a banking system has a burden of unproductive, non-performing loans that are not going to be serviced in full, or require time to be restructured, there are ways in which Awbury can provide mechanisms and techniques that help clients address the problem, and thus free up capital and resources for more productive and economically beneficial deployment.

The Awbury Team

Loose Lips Sink Ships…

The above is from a famous propaganda poster from World War II; but, no, this post is not about the travails of much of the global shipping industry, but about how the “velocity of distribution” of what passes for information can damage or destroy business franchises very quickly.

The recent travails of Deutsche Bank are a case in point. We shall not opine on the probability that the concerns expressed about the bank’s viability are valid. Rather, we shall make some observations about the dangers of recent events, and how one can become “collateral damage” because of issues that have nothing to do with one’s own business.

Start with the fact that, somehow, news of a supposed demand from the US Department of Justice (“DoJ”) to Deutsche Bank for a USD 14BN “settlement” was leaked to the media, whereas most US banks have been able to conduct such negotiations quietly and confidentially.

Consider also news of certain hedge fund supposedly withdrawing assets held by the bank; and that the bank’s shares sank to a 30-year (nominal) value, such that their “optionality” became clear, as their market price whipsawed on every scrap of information.

The German Federal government has to issue a denial that it is planning a rescue of the bank; while its CEO is adamant that it does not need additional capital and has more than ample liquidity. Even the IMF had been seen as labelling Deutsche Bank as the world’s “most systemically risky” bank.

Of course, it is a truism that, as (still) highly leveraged entities, banks are inherently vulnerable to a loss of confidence and a “run”, leading to a closing of the doors (literally and electronically) as they become unable to generate liquidity sufficiently quickly to meet obligations when due.

Stir all this together with the bank’s acknowledged difficulties in adjusting its cost base to a world of constrained margins and its continuing struggle to generate sustainable profits and one has the recipe for the sort of frenzy that has taken place recently.

One can certainly make a case for Deutsche Bank being yet another victim of the US’s electoral cycle and dysfunctional and often politicized regulatory and enforcement system, as well as the probability that certain investors (or, rather, speculators) were “talking their own book”; but that does not change the fact that a global bank, with a storied name (it is Deutsche Bank, after all), is perceived at least in some quarters (some 8 years after the crescendo of the Great Financial Crisis) as being on the brink of, at best, a further re-structuring.

Any why is that so?

It is arguable that a significant reason is the fact that “information” flows at the speed of the byte, which has the tendency to cause those who read or see it to act before they think (or algorithms to trigger), and worry about the veracity or relevance of the “information” afterwards. In the meantime, individuals, institutions and even countries have to deal with the consequences of ignorance, mendacity, negligence and greed.

At Awbury, we would never argue that there should be constraints on the concept of free speech, nor on the distribution of information. However, we do believe that, while one has to be nimble and adaptive in light of new information, one should also take the time and intellectual effort to analyze and understand its veracity, relevance and potential impact.

And we are very discrete!

The Awbury Team