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 the type of investments they hold.

How this risk plays out in the real world

Sep 16, 2021: How China Evergrande’s debt troubles pose a systemic risk
Sep 08, 2021: ‘Financial Armageddon.’ What’s at stake if the debt limit isn’t raised
Apr 06, 2020: The Fed Has Averted A Systemic Financial Crisis—For Now. Here are 3 Areas To Monitor
Oct 09, 2018: Global financial stability risks rising with trade tensions, IMF says
Oct 30, 2017: When Does Consumer Debt Become a Systemic Risk?
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
Sep 29, 2008: Stocks Take Record Tumble, Down 777 Points

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 shaky footing due to borrowers not being able to pay? The basic systems in the country may ultimately collapse.

How investors can manage Systemic risk

  1. Invest in assets deemed by the investing community to be the ultimate places to run for safety. Currently, that is U.S. Treasury bonds. The U.S. issues these bonds when it borrows money, so bond investors are lending their money to the United States. The United States has world’s largest economy and the U.S. dollar is the most respected currency.
  2. Keep a significant portion of your money on the sidelines (ie: in cash) if you believe risks to the system are rising to extreme levels. If  systems begin to fail and panic selling sets in, your cash is safe from any meltdown.

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 2010 Dodd-Frank reform bill passed in response to the bursting of the housing bubble and subsequent Great Recession 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.

However, because of the concerns that the empowered government agencies have allowed years to pass without making the difficult decisions necessary to rein in profitable but risky activities of the financial industry, the private sector has formed its own organization, The Systemic Risk Council, to highlight risks to the financial system and to urge that they be addressed.