Thor vs. Zeus or why there is no rush for Germany to bail out Greece

A lesson learned from the financial crisis is that the life insurance and wealth management industries are heavily dependant on the general state of the economy. Therefore it is important for insurers to understand what exogenous and endogenous factors can impact their business: The current challenge faced by the EURO zone and the EURO currency following the Greek unsustainable financial situation is an interesting example of a single event influencing insurers. At the very beginning of the Greek crisis, nobody would have expected it to last so long. According to financial experts, the EURO zone countries had not interest in letting the situation worsen. But interestingly, Greece is still in danger and so far, nothing concrete has been decided by any of the parties potentially involved in a rescue plan and notably Germany. According to me, there is a good reason for that. Germany has always been complaining about the strength of the EURO currency. Indeed, a strong European currency penalizes German exports and therefore the whole German economy. It is important to recall that Germany counts more than any other European countries on exports to grow its economy. In consequence, Germany has an interest in letting the Greek situation worsen and letting the European currency get weaker and weaker. Of course this is a dangerous game but Germany seems to have all the necessary cards in hand and by the end of the game, there will certainly be a plan to save Greece from bankruptcy. It is a war of a new age, whose main characters are barbarian and mythological gods: Thor vs. Zeus! But it is more importantly a political battle, whose objective is to determine what is the long-term vision of the European construction. In the meantime, insurers will have to analyze how the Greek case may impact their business and notably their asset allocation strategy and adapt…

Attacking Business Complexity

This week, Celent is pleased to feature an article from guest contributor, John Boochever, who leads Oliver Wyman’s Global practice focused on strategic IT and operational issues across financial sectors. For senior executives facing the turbulence of today’s financial crisis, reducing the cost base of their business operations now sits squarely at the top of the agenda. After decades of product and service variation, channel diversification, geographic and operational expansion, all supported by layers upon layers of technology, many institutions are finally compelled to deal with a fundamental reality: their businesses are overly complex for the value they generate. Not only is this excess not valued by customers, it actually impedes value delivery by limiting the sales force’s ability to respond, increasing service and fulfillment costs, compounding operational risk, and making the organization more unwieldy to manage. The siren call for a simpler “core business” approach, incorporating elements of modular design and industrial engineering is being heard across the industry. But when senior executives take the first steps toward “dialing down” complexity, they rapidly come up against three immutable features that overshadow their ability to make change in their environment: Complexity is structural, deeply embedded in the business and operating models of their institutions. Poorly understood network effects across functions and businesses create linkages and interdependencies that compound complexity. There is a general lack of transparency of the features of complexity required to generate value versus those that do not. Eliminating complexity requires a “front-to-back” approach that identifies and addresses the root causes of complexity and all of its network effects. As an example, “eliminating 20% of non-profitable products” has limited impact if it is not followed through with a systemic simplification of the supporting operations and IT infrastructure. By the same token, introducing new middleware to make the IT architecture more “service oriented” is a waste of investment if the institution’s operating model is not built around modular services at all. Financial institutions have to not just cut but eradicate complexity to regain their focus and flexibility, and sustain efficiency. The long-term rewards of eliminating complexity include a radically simplified operating model, an improved client experience and a dramatically reduced cost structure. John Boochever leads Oliver Wyman’s Global practice focused on strategic IT and operational issues across financial sectors, and can be reached at john.boochever@oliverwyman.com.

The consequences of printing money

When reading recent financial analysts’ comments and listening to politicians’ opinions around the world, it seems that the worst of the financial crisis and the economic downturn is behind us. Of course, nobody forgets that the international financial system was about to collapse in October last year but according to the most powerful US policymakers, the world economy will be probably growing again at some point between Q4 2009 and Q2 2010. Some indicators tend to confirm this statement, the first one being the impressive rebound of equity markets around the world. For instance, the S&P 500 has gained a bit less than 30% since it reached its lowest level back in the beginning of March 2009. In other words, most economists, finance professionals and politicians are confident that the urgent measures implemented last year in order to tackle the financial crisis were just the perfect ones. The constant injection of new liquidity into the financial system during the past 18 months, the multiple bail-out plans as well as the low interest rate policy were the necessary ingredients of a miraculous cocktail to save the financial industry and help the economy recover fast. At least, it is what policymakers are now claiming. After a difficult period in all fronts, it seems that the period of self-congratulations has come and that the last 18 months period was just a bad dream we must forget as quickly as possible. Personally, I am not so optimistic and I think there is still plenty to worry about. In a report published in December 2008 called “Flawed Assumptions about the Credit Crisis: A Critical Examination of US Policymakers“, Celent reviewed the credit market in the light of figures provided by the Fed and other central banks in Europe and Japan. More than questioning if there is really a credit crisis, what appears to me to be an issue of high importance for the future is the money aggregate in circulation in the economy (click to enlarge): Economies worldwide are struggling and have been experiencing an important slow down in terms of GDP recently. In Europe for instance, certain countries have double-digit GDP decrease rates resulting in higher unemployement and lower investments. On the other hand, beside this tough and cruel reality, there is a huge amount of money available to spend and to invest. What a strange and unsound equilibrium! As a result, we might end up with a period of high inflation, which will require specific actions in the short term on interest rates by central bankers. Taking into consideration the sudden and drastic slow down of GDPs around the world coupled with the equally sudden and unprecedented increase of money supply (as depicted in the figure above), the financial crisis might have been the earthquake, whose tsunami could be a certain form of hyper-inflation. In the long run, the world leaders will have to address the real cause of the problem: the definition of a new international monetary system. But by now, I really believe it is not the right time for self-congratulations!

Back to the future…

The major international equity indexes have lost ground this week, dropping by 3 to 4% in average. It appears that the recent numbers issued by companies have increased the global fear of a deepening recession. Despite a clear sign of confidence regarding its own future provided by Munich Re last week and notably its decision to keep its dividend per share stable, investors prefer giving more importance to the bad side of the coin for instance the disappointing Swiss Re numbers. The big giants have adopted different strategies and it seems that the German company is weathering the storm better. In the banking sector, the two biggest Swiss banks CREDIT SUISSE and UBS have announced billions of losses for 2008 but both companies see improvements ahead and expect good news already in Q1 2009.

Even though the overall environment doesn’t look great, I’ve got the feeling we are entering a phase of exacerbated pessimism in opposition to the irrational exuberance described by Alan Greenspan when he was talking at the Annual Dinner and Francis Boyer Lecture of The American Enterprise Institute for Public Policy Research in Washington in December 1996. Are financial markets so emotional that they exaggerate all kinds of perceptions in the highs as well as in the lows? According to me, there are clear signs of over-reaction or anticipation resulting in above-average volatility on the equity markets, which adds more uncertainty for the future of the insurance and the banking industry. That being said, the economical slowdown is a necessary cure to get back to basics. Then, we will enter into a sound prosperity for a while before diving in some kind of amnesia and enter a new exaggeration phase. The economy and especially the financial industry need bubbles to surf on but now it’s time to rest a bit before finding the next one…