Systemic or Idiosyncratic: “Let’s Call The Whole Thing Off!”

[Teach]

In recent days, I’ve heard the question posed several times, “Is it systemic or idiosyncratic"? That is, the current state of our banking system.

This all reminds me (I’m an old-movie buff) of the 1937 movie, “Shall We Dance," that starred Fred Astaire and Ginger Rogers. In one scene (I read that it took 150 “takes”), Astaire and Rogers are roller skating through a park when they eventually plop themselves down on a park bench. It’s then that Astaire sings the George and Ira Gershwin song, “Let’s Call The Whole Thing Off.” You may remember the lyrics. “...You say knee-thr (neither) and I say nigh-thr (neither)…"

Currently, if someone were to doing a film on the current banking “crisis,” the depth of which we still do not fully know, the lyrics might sound like this: “You say systemic and I say idiosyncratic. You say “temic" and I say “cratic." (my neologisms). Systemic, idiosyncratic, ’temic’ ‘cratic’, let’s call the whole thing off." But can we?

At this juncture, let’s take a closer look of at those two polysyllabic words. Systemic implies a wide-spread, possibly global impact, whereas idiosyncratic has the connotation of being “localized.”

The Financial Stability Board (FSB) defines systemic risk (and I quote) as "the risk of disruption to the flow of financial services that is (i) caused by an impairment of all or parts of the financial system; and (ii) has the potential to have serious negative consequences for the real economy."

In our financial system, systematic risk is one that has the potential to impact our entire economic system, unlike the word idiosyncratic that implies the impact is “contained" to a single stock or industry. Examples of systemic risks include: natural disasters, weather events, inflation, changes in interest rates, war and even terrorism. Today, the potential for systemic risk lies in our banking sector.

Put another way, if you believe that the current banking “crisis" is an all-encompassing one that has the capability of impacting our entire society, then you believe it to be systemic.

On the other hand, what about idiosyncratic risk? Idiosyncratic risk is a type of investment risk that is endemic to an individual asset (like a particular company's stock), a group of assets (like a particular sector), or in some cases a very specific asset-class (like collateralized mortgage obligations).

When it comes to idiosyncratic behavior in an individual, it is said that Albert Einstein rarely wore socks. He also talked to his cat.

With regard to systemic risks, there can, and likely will be, a "domino effect." The expression “contagion” would be apt. There is also the possibility of a “herd mentality" that exacerbates the situation. In the current world, that "mentality" is the impact of social media.

Furthermore, in the health world, one could compare systemic to the potential spread of a communicable disease, i.e., Covid-19.

In concluding, how would one categorize our current banking “crisis." Systemic or idiosyncratic? That is open to debate. The answer may reveal itself in the days and weeks to come. If you view the current situation as possibly being systemic, you need only look “Across the Pond” at Credit Suisse, and now Deutsche Bank.

Finally, I ask, "Which one is it?” Not, as in the movie, the pronunciation of tomato and potato or, for that matter, neither and either. but systemic and idiosyncratic. Yet one thing we can’t do, as was suggested in that Fred Astaire-Ginger Rogers romantic-comedy: “…Call the whole thing off."