Risk. Return and Sub-prime Mortages
Risk and reward vary directly. If reward goes up, risk also goes up. This simple financial fact from economics 101 would be a good thing to remember, especially for those people who have invested in securities backed by sub-prime mortgages. the risk of course is that you will not get the return you seek and/or you will loose all the money you have invested. Big duh, people.
Investors don’t want to loose a rate of return they were counting on from sub-prime mortgages, so I understand why they are opposed to the plan offered by the US Treasury to get a grip on the sub-prime problem. I understand that it is just good business to give ground grudgingly when you have to give up money. But, here is the deal, you investment was riskier than you anticipated. Key words being “you anticipated.” I know it’s a big hit to the ego. Even with your Ivy League Economics degree and the high six figure salary and seven figure bonus, you got shucked by the market.
Here is a little lesson on risk that they don’t teach in the B Schools, but you might pick up at General Electric. In the ’70’s and ’80’s if you submitted a budget for a project and it was approved the powers that be generally added 25% to the budget for things that you didn’t know you didn’t know about. Experience had told managers at GE that on average the risk associated with a project was 25% more than they could identify.
Second lesson on risk from a venture capitalist I know. After you have made your forecasts, double the investment needed to make the venture go; cut the return in half; if you can live with the invest at that point, then go ahead. Again this is an attempt to quantify the risk we cannot identify.
Risk is always present. If there is more than we think there should be, well life is dangerous. Get a helmet.