07.27.08
Oops, somebody just lost $ 6 billion dollars!
No, this is not an item on Societe General, although there are definitely similarities. Can you make a guess which company caught my attention? When you think of Kervel do you automatically make the association with Wurz?
This week started with hope for the financials beating expectations of analysts. But then Wachovia surprised everybody! A loss of $ 8.9 billion was reported. Well this in itself is hardly any news nowadays. The more disturbing in this article from Yahoo is not the loss itself. It is a short reference to a previous outlook from Wachovia itself. I had to look twice, but it really happened. Only three weeks ago the company expected a loss ranging from $ 2.2 to $ 2.8 billion. This outlook from Wachovia now signals severe problems for this bank.
I will explain why, but you can draw your own conclusions with the guided analysis from riskfriends. Just select Wachovia and look at the events as they unfold. Only three weeks ago, according to Yahoo, the expectation was a loss of $ 2.8 billion. Just before this announcement the CEO had to leave. Within a week, after surprising investors and analysts with really disappointing figures, the CFO stepped down. Can you guess why?
Who believes that Wachovia’s portfolio deteriorated within 3 weeks another $ 6 billion? The market is worsening and the number of loans that are noncollectable increase, but not at this speed.
One explanation could be that the CEO and CFO decided to represent the quality of the Wachovia portfolio as optimistic as possible, hoping that the market would quickly turn around. This would be a matter of changing variables in the models used to calculate the numbers of expected defaults. Another possible reason for this difference could be an inadequate information infrastructure that is unable to calculate the impact of market movements and internal operational data on a daily interval. This can happen when essential data is simply missing or the process of validating the credit risk models against the operational performance runs on a very low frequency. Or to put it different, the operational feedback in the risk models is not functioning. Perhaps Wachovia is experiencing difficulties with the integration of Golden West Financial. There are more scenario’s possible. The mistaken outlook makes Wachovia’s position in lawsuits extremely vulnerable.
I started with a reference to Wurtz and Kervel. Kervel did not profit from his actions that were targeted at repairing his mistakes unnoticed. I think it is very likely that a similar motive drove the Wachovia management. It is the kind of behavior you often see with investors. Trying to repair losses unnoticed hoping that a swift market change will cover up what went wrong. There are more ways to hide problems from the public and an independent investigation like the one performed at SocGen should give insight in what actually happened.
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07.12.08
Implementing enterprise risk management – part 1.
Implementing Enterprise Risk Management (ERM) is becoming one of the activities that gets more and more priority in the financial world. I will share my own experience with the implementation of ERM. The first part is about added value of ERM so you have some input if you think of trying to initiate a similar initiative in your own company.
ERM is primarily targeted at improving strategic and tactical decision making at senior management level. Your ambition should be obtaining support from your CEO and CRO, because that is the level that you need to service. Now is improving decision making not a very convenient argument to get warm support from senior management. So here are some other valid reasons:
- It will enable senior management to respond much quicker and with higher confidence to changing circumstances. Referring to the credit crisis can help here.
- It enables a company to present analists with reliable information regarding impact of changing (market) circumstances.
- It saves the CEO a lot of meetings with different risk specialists and thus time.
- It will enable a company to better profit from the opportunities that identified risks can bring.
- It strengthens the position of the CRO.
- It is likely to become a requirement to qualify for capital reduction from regulators anyway.
- Rating agencies are likely to include the maturity of ERM as one of the variables in their models.
- Within 2 years it will reduce risk management and control costs.
- It forces risk disciplines to work together and improve the quality and completeness of risk information. This results in less incident management, more often informed risk-reward decisions.
- It is more fun!
Now I do not advice you to use them all, just pick the ones that are the most compelling to your management and to the ERM champion.
What do you need to ask from your business sponsor? This depends on your ambition, but there are actually only three key success factors.
1. Immediate adoptation and support from senior management for the ERM initiative.
When you start, make sure that senior managements commits to putting the ERM monthly report on the agenda of their monthly meetings. Even when you feel that the initial product is not ready for publication. You need to do this to ensure that all departments will feel the pressure to deliver. I will come back to this in one of the following parts.
2. Assign the responsibility to deliver the ERM report to one department.
There should be no confusion who has the lead in the ERM initiative. Expect resistance from various departments. Ensure you have the backing of the sr. management team by means of a formal assignment. I think that ORM is preferable, because that is a risk discipline used to work with a broad variety of risks and therefore has the best mindset to facilitate this process.
3. Request the funds and resources to build the ERM information infrastructure.
An professional ERM environment cannot do without a solid information infrastructure. This is not an easy task, because it will take time, effort and perseverance to build this. Whatever you do, do not make the availability of the infrastructure a prerequisite for the ERM report.
To be continued …
07.10.08
Bankparade ultimate showing 375+ subprime events!
One year of subprime misery brought us a lot of business events. Enough events to detect patterns in chains of events. Too much events to remember by heart. Well follow this link and you find a pretty complete overview of more than 375 subprime events. You can select, sort, text search and view it in a graphical timeline. In other words you can analyze the credit crisis from different angles yourself. This overview will be kept as actual as possible and new events will be added within days from initial publication.
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07.09.08
SEC report, old news?
Today the SEC issued a report on the three major rating agencies. I understand the SEC has to obtain hard evidence before it can intervene. The rating agencies are willing to implement the SEC’s recommendations. This shows that they have realistic management. But really, this is all old news!
The investigation delivered a typical after the fact report. Those responsible for keeping an eye on the financial world should take responsibility too, because they also failed terribly.
If you look at the fundamental causes of the credit crisis it is not just a falling house price issue. It is also about financial institutions creating complex products. Products that receive a rating that creates value for the issuer. Ratings that convinced investors there was limited risk. Products that were exchanged in small and not very transparent markets. Products that were insured by companies that did not check adequately the underlying collateral’s nor validated the selling practices. Rating agencies as well as insures proved they didn’t understand the credit risks of these complex products. Bond and mortgage insurers failed in calculating the right premium for these risks. Also their insurance increased the illusion that investments carried limited risk and delivered high rewards. All these players in the subprime were profiting and it was in their interest that risk calculations had a favorable outcome. I’m not implying here that these players were deliberately influencing their risk calculations. At the minimum you can state that they overconfident presented their calculations to the market.Also after the fact rating agencies are now revisiting their models.
The regulators failed to see that the large players created an illusion and that everybody seemed to profit from it. Making money is what is expected from commercial companies, but regulators are payed by the government and their primary focus is to ensure financial markets are stable and free from manipulation. Who is looking at the performance of the regulator?
Their conclusions are hardly surprising and a little late. Already in October last year S&P was under fire as a result from conflict of interest. This year Moody blamed their mistaken ratings to errors in their computer models suggesting that we should blame their computers and not their modelers and the validation of their work.
When you take a look at the credit crisis interactive analysis here and select the rating agencies you can see for yourself their power and their failures.
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07.07.08
Big rewards at no risk!
Analyzing the credit crisis, you can do that interactively yourself here, shows that the most troubled companies all have been in the news with integrity issues.
Some financial institutions did fire risk managers or at least blamed their risk management department for the unforeseen impact of the crisis. Any risk manager should have had a strategy in place that manages situations in which market mechanisms stop functioning. Risk managers know that VaR calculations do not cover extreme events. In the past the LTCM case, an analysis can be found here, already showed that markets can stop functioning. The best risk management department off course predicts when such events are likely to happen and enable a company to profit from such events. It looks like only Goldman Sachs managed to do this.
But what to do when the CEO starts making decisions that are conflicting with business ethics and that increase legal risk? The credit crisis interactive analysis shows that integrity issues are the most threatening and most damaging problems for a company. Just take a look at the events at Bear Stearns and Countrywide or remember what happened at Enron. These type of problems are difficult to manage by a company’s internal function, whether it is risk, compliance, audit or the board of directors. The internal functions simply do not have the power nor the authority to withstand a CEO. The board of directors are often at too much distance to remain in touch with the operational reality and at the same time they are often to close at the personal level to remain independent. UBS recognized this, be it a little late.
The credit crisis will probably result in more legislation or more focus at Basel II pillar three. Shareholders and employees became victims from inadequate management. Senior management however often walked away with millions of dollars. Big reward at no risk!
Some examples:
- O’neal from Merrill Lynch rewarded with $160 million leaving his bank in real trouble.
- Groenink from ABNAMRO rewarded with $ 40 million leaving his bank to be split into 3 pieces.
- Charles Prince from Citi rewarded with almost $ 100 million
- Sullivan from AIG rewarded with $ 47 million severance package
- Angelo Mozilla to profit from sale to BofA.. estimations vary but are in the range of several tens of millions.
Today Yahoo! reports that Countrywide employees fear for their severance pay.When will the first employee out of a job due to failing management start a lawsuit demanding equal severance pays?
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