What is Systemic risk? (also known as Systematic risk)
The risk that a breakdown of the American or global financial system will cause panic selling and major losses for investors, no matter type of investments they hold.
How this risk plays out in the real world
Nov 04, 2014: A Recent Surge of Leveraged Loans Rattles Regulators
Nov 03, 2014: MetLife to meet skeptical regulators in bid to escape rules
Oct 15, 2014: Systemic risks in the market on the rise, says Iosco economist
Oct 14, 2014: Too-big-to-fail banks face capital gap of up to $870 billion
Aug 21, 2014: G20 edging towards deal on ‘bail-in’ bond cushion for banks
Oct 09, 2013: No way to hedge against US default: Kyle Bass
Sep 13, 2012: Systemic risk panel needs to be more accountable, transparent: GAO
Oct 11, 2011: Trichet sees systemic threat, wants Europe banks funded
May 06, 2010: Credit Markets Seize as Issuers ‘Sit Tight’ on Greek Contagion
Nov 19, 2008: Stocks Drop Sharply and Credit Markets Seize Up
Connection to other risks
This risk is related to economic risk. Normally, countries move back and forth between periods of economic growth and contraction (ie: recession). But, what if a country’s economy is in such bad shape that it can’t pull itself out of recession? What if its debts are enormous, its unemployment rate high, and its banks on shaking footing due to borrowers not being able to pay? The basic systems in the country may ultimately fail.
How investors can manage Systemic risk
- Invest in assets deemed by the investing community to be the ultimate places to run for safety. Currently, that is U.S. Treasury bonds. However, this may be the world’s biggest trap because the U.S. has its own major problems and so many people have already run for safety by purchasing these bonds that they are very overpriced.
- Keep a significant portion of your money on the sidelines (ie: in cash). When panics start and people see the value of their investments plunge, they hit the “Sell” button ASAP and ask questions later. The money you have on the sidelines is not vulnerable to panic.
A final word
People with money invested during the period from 2007 to 2009 know too well how much damage a systemic failure can cause. During that time, major banks failed and the global financial and credit system froze up. It took an intervention by the US Federal Reserve Bank, which lent trillions of dollars to businesses and governments around the world, to get the credit markets unstuck.
The 2007 to 2009 financial meltdown caught our elected officials so off-guard that the Dodd-Frank reform bill passed in response called for the creation of the Financial Stability Oversight Council (FSOC). The Council’s purpose is to overlook the financial system and address threats before they can cause another systemic failure. The problem with the FSOC is that it is staffed with the heads of other regulatory agencies which did nothing to stop the irresponsible lending that lead to the crash.