December 17, 2018 Was a Bad Day for Risk Management
Bitcoin hit an annual low of $3,125.
Newbury College in Boston announced it will close its doors.
The U.S. stock market dropped by two percent, bringing the market to its worst December since the depths of the Great Depression.
These events highlight risk in three areas — cyber risk, higher education and money management.
In a 2017 Risk and Insurance® Risk Insider piece, I described 17-year old Dominik, the prodigy son of close friends. He owned a bitcoin worth, at the time, $2,650. I described the complexity of his investment, including the password on his “wallet.” As best I remember it, the code was 2BF46KW3EM539QZG46NX93. I could be wrong.
When the bitcoin reached its historic high exactly one year ago on December 17, 2017, his investment was worth $20,000. I hope he sold it, but I’m cautious about asking. Maybe he still has it. Who knows what it will be worth by the time you read this?
On May 17, I described the abrupt closing of Mount Ida College located 4.6 miles away from Newbury College. Last summer, the admissions office at Newbury aggressively recruited Mount Ida students and some transferred to Newbury. Now they will have to transfer again if they do not graduate by May 2019.
On December 18, financial analysts reported that U.S. stocks had their worst month of December since the year 1931. In December 2018, General Electric cut its celebrated annual dividend from just under a dollar down to exactly four cents.
Cryptocurrencies, higher education and stock markets offer lessons in risk management.
Cryptocurrencies are a mechanism for gambling. Bitcoins and the 1,700 other artificial currencies suffer massive swings in value. Who knows what will happen next?
Choosing a college resembles purchasing an automobile. It starts with a list price. The dealer tells you the car costs $36,000 but, for you, a special deal. $32,500 if you sign immediately on the dotted line.
If you resist, the dealer might provide an invoice showing he paid $33,000 for the car. The dealership is losing $500 on the sale. If it’s losing money on cars that are sold, how can the dealer stay in business? Don’t ask.
The same marketing behavior occurs with colleges and universities. First, we start with the list price. Is Hobart and William Smith College worth $65,000 a year? Or, if your family will move to a remote area of upstate New York, is it worth commuting from home so you pay only $51,000 for tuition?
Would it be better to attend Brigham Young University where annual tuition is $12,000? Not to mention the opportunity to convert to the Mormon religion, a status that reduces annual tuition to $6,000.
Cryptocurrencies, college tuition, and common stock may seem like odd subjects to link together in a single discussion. Not at all. The common thread is the need for people to recognize rising uncertainty in their lives.
If you are a New York resident from a low-income family, you can do pretty well without moving to Utah or changing religion. Public colleges in New York state are tuition-free if your family’s annual income is $110,000 or less.
Read the fine print. Fees and ancillary expenses cost thousands of dollars a year. If you graduate from college and immediately move out of New York state, the “free-tuition” scholarship converts into a student loan.
Now for the risk management part of the story. Forget about the list price. Many schools discount with the mentality of a fire-sale. It is commonplace for private colleges and universities to offer a 50 percent reduction in tuition through “scholarships” or other aid.
The $36,000 car costs $32,000. The $50,000 tuition costs $25,000. Even public colleges may offer discounts to attract out-of-state or international students.
Volatility in stock prices completes the picture. It highlights broader and more consequential risks that pose increasing uncertainty for all of us.
Cryptocurrencies, college tuition and common stock may seem like odd subjects to link together in a single discussion. Not at all. The common thread is the need for people to recognize rising uncertainty in their lives. Negative consequences affect investors as well as borrowers, organizations as well as individuals, pundits as well as the naïve or innocent.
The difficulty arises from deciding how we approach risk. When bitcoins were rising, people were excited about the upside. When student loans offset rising tuition costs, parents and students were sucked into borrow-now, pay-later schemes. When stocks reached unsustainable levels based on fundamental factors, people bid them up further.
- At their peak, bitcoins had a total value of $340 billion. Today, the number is $50 billion. Somebody lost a lot of money.
- At the current time, student debt is $1.48 trillion. A lot of young people hocked their future to pay off student loans.
- Volatility in the stock market is undermining long-term assumptions about the risk of running out of money in retirement planning.
Risk managers, and the people who want to behave like them, need to remember the canary in the underground coal mine. Hung in a cage deep in the earth, the bird died if oxygen levels started to run low. The death of the bird was a sign that it was time to get out of the mine.
Were the events of December 17, 2018 a canary in the risk management world? Time will tell. &