Mitigating “Margin Call” risks
By Dave Ingram and Max Rudolph The opinions expressed are their own.
The financial thriller, “Margin Call,” which opened in movie theaters on Friday, tells the story of a firm in the mold of a Bear Stearns or Lehman Brothers at the height of the financial crisis. The firm in the film is akin to real-life firms that seemingly discover too late their reliance on a culture built on growth at any cost and tainted models at the expense of risk management.
Movies are great teachers, helping everyone better understand complex situations that can be confusing even to experts. “Margin Call” does just this, by putting a spotlight on the crucial role that proactive and skeptical risk management (or lack thereof) plays, particularly in financial services. Although the Occupy Wall Street movement is still in its infancy, it demonstrates how ordinary people feel the impact of the financial industry’s actions – and mistakes. Likewise, the movie demonstrates how great an impact one firm’s actions can have on the entire financial industry, underscoring the importance of risk management in such an interconnected system.
Based on our experience as actuaries, focusing on identifying and mitigating risks, we’ve outlined what we believe are the most important lessons of both the film and financial crisis. Hopefully those who see this movie, and those who lived through the crisis, will heed them.
1. All models are wrong – communicating the pros and cons of results is right
Models come in many shapes and sizes. Mental models can be simple, like rules of thumb, or they can be incredibly complex, like those used to calculate the expected payouts of structured securities. Models, however, rarely evolve to become simpler. In financial services, for example, some models will try to reflect second order interactions, like how often savers ask for their money when interest rates rise, or how many homeowners will default or prepay their mortgages given economic circumstances. As these models become more complex, they become harder for those who did not create them to monitor. The key is learning where the shortcomings are, and not being afraid to communicate the results to decision makers.
Taiwan takes tough stance on corporate governance
By Patricia Lee
(Complinet) Taiwan’s Financial Supervisory Commission has stepped up enforcement of its corporate governance regulations by making it mandatory for listed firms and financial institutions to appoint independent directors and set up a remuneration committee. The latest regulations will carry a penalty in the event of any breaches, an FSC official told Complinet, speaking on condition of anonymity.
According to the FSC official, although the requirement to appoint independent directors was not entirely new, the commission’s latest move built on its existing corporate governance regulations. It further expands their reach to cover the entire spectrum of the financial services sector.
Securities investment trust enterprises and integrated securities firms which are not subsidiaries of a financial holding company, exchange- or over-the-counter-listed futures commission merchants, as well as exchange- or OTC-listed non-financial institutions each with a paid-in capital of at least NT$10 billion ($344.7 million), but not exceeding NT$50 billion ($1.7 billion), are the four additional types of firms in the financial sector now covered under the corporate governance regulations.
The FSC official said: “The fact that the corporate governance regulations now cover as many different types of companies within the financial sector including those with a paid-in capital of NT$10billion shows that the FSC is serious about raising the standards of corporate governance of financial institutions in addition to that for listed companies.”
The FSC’s move to make setting up a remuneration committee mandatory for firms listed on the Taiwan Stock Exchange or traded over-the-counter, underscores its commitment to strengthening corporate governance and risk management. According to a recent FSC statement, the new regulation set out requirements governing the composition of the committee, the scope of its powers, rules of procedure, professional qualifications, independence, and the exercise of its powers. “The purpose of the regulations is to ensure a sound remuneration system for companies’ board members, supervisors, and executive officers,” it said.
According to the FSC official, the damning exposé of some chief executives at top US banks on the brink of collapse during the financial crisis who continued to receive opulent pay packages was one of the drivers that prompted the Legislative Yuan to reassess remuneration in Taiwan. It started with a review of remuneration issues for board members and executive officers of listed firms.
COLUMN-Two paths to failure on Dodd-Frank
(Scott McCleskey is a managing editor for the ThomsonReuters Governance, Risk and Compliance unit. The views expressed are his own)
By Scott McCleskey
NEW YORK, Feb. 14 (Complinet) – With all the chest-thumping about U.S. financial reform last year, you would suppose that the regulatory authorities responsible for implementing the provisions of the Dodd-Frank Act would now have the political wind at their back.
This is particularly the case given the tight deadline for most of the provisions — on or before the July 21 anniversary of the Act’s enactment. You would be wrong. Both sides of the aisle in Congress have taken or threatened steps which only serve to undermine the process of regulatory reform and leave the market with all the costs and none of the benefits of reform. (more…)
U.S. financial regulation: Three things to watch, and two not to, in 2011 – Complinet column
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By Scott McCleskey, Complinet
The past year was a busy one for those interested in financial reform – you know, Dodd-Frank and all that. But the new year will be even more fateful in shaping the markets for decades to come. It is likely to be the most critical of the post-financial crisis period. The reason is that Dodd-Frank only gave the regulators their marching orders, and 2010 mostly saw just the preliminaries to the really tough regulation. It will be in 2011 that actual rules will be proposed, finalized and implemented – and all by mid-year, if deadlines are met. It will also be when the Republicans hit the beach in the House and attempt to moderate or reverse many of the reforms already underway.
There will be a tidal wave of Dodd-Frank work, and some areas of focus are already obvious. The launch and first steps of the Consumer Financial Protection Bureau will be one, and the rather iffy implementation of derivatives regulation will be another. These items have been and will continue to be covered by this organization and others. But there are other items largely outside the Dodd-Frank ecosystem which bear a close watch over the coming year – and there are also some receiving a lot of press lately which can be ignored. (more…)
Asia regulators say G20 reform driven by U.S., Europe
By Daisy Ku and Rachel Armstrong
HONG KONG, Nov 29 (Reuters) – The lack of a unified Asian voice in the Group of 20 leading economies means the United States and Europe are driving the overhaul of global financial regulation with several of the new rules posing significant challenges for emerging markets, regulators said in a regional summit on Monday.
The G20 has endorsed a series of major reforms to banking and financial market regulation, which the five Asian members of the group and Financial Stability Board members Hong Kong and Singapore have signed up to.
But Asian regulators say a number of these rules pose significant difficulties for their markets, while others don’t address the way the crisis hit their economies. This, they say, is partly due to the fact that the United States and Europe find it easier to arrive at a common approach to regulatory change.
“There isn’t a uniquely Asian voice and I think that’s a challenge,” Martin Wheatley, head of Hong Kong’s Securities and Futures Commission (SFC), told the Pan-Asian Regulatory Summit held by Thomson Reuters unit Complinet.
New rules on banking liquidity, part of the so-called Basel III framework, were highlighted as one area where the reforms hadn’t taken into account the size of some emerging markets’ debt capital markets.
“Asian countries are facing significant challenges in meeting these liquidity standards,” said Lee Jang Yung, senior deputy governor of South Korea’s Financial Supervisory Service.
ANALYSIS-Wall Street mounts campaign backlash against Democrats
By David Morgan
WASHINGTON, July 27 (Reuters) – Wall Street executives who endured two years of blame for the U.S. financial crisis and now face costly industry reforms are turning against Democrats by shifting campaign contributions to Republicans.
Long a reliable source of big contributions for Democratic coffers, financial institutions in New York, Chicago and San Francisco are dialing back donations and vowing to shun lawmakers who pushed for the toughest provisions as reform moved through Congress to President Barack Obama’s desk.
Financial executives say they were unfairly blamed for the worst recession since the 1930s so that Democrats could deliver politically motivated reforms to angry voters — reforms that will now cost firms billions of dollars in revenue.
“If you’re going to haul me out of the bar and beat me up in the street, don’t expect me to buy you a drink,” said a source involved in political spending decisions at one Wall Street firm.
Bad feelings may be mutual. Some financial industry donors say they have been asked not to attend fundraisers for Democratic lawmakers who fear association with Wall Street could cost them at the polls.
Since the House of Representatives approved its version of financial reform last December, top Wall Street firms have cut their contributions to Democratic candidates for the House and Senate by 7 percentage points.
Let’s see. If you don’t allow banks to slap surprise outsize overdraft fees, the banks won’t donate to the politicians.
So Banks put less in lawmakers pockets, and are mad they can remove fewer dollars from our checkbook.
Good.
Final text of Wall Street reform bill is posted by U.S. Congress
The House of Representatives Financial Services Committee has posted the text of the the Wall Street regulation overhaul agreed by U.S. House of Representatives and Senate negotiators on Friday. The bill is headed toward final congressional approval next week although implementation will be bogged down for months in regulatory rule-making.
Financial reform gives insurance a free ride
The following is a guest post by Marc Levinson, a senior fellow for international business at the Council on Foreign Relations. The following opinions expressed are his own.
In a critical area of the financial reform bill that’s about to pass, Congress has lost its nerve. As senators and representatives met Tuesday to agree on key details of the final bill, they voted to give the insurance industry a free ride – and did so in the name of consumer protection.
The conventional wisdom, much promoted on Capitol Hill, is that insurance was the shining star as a crisis wracked the financial sector in 2007 and 2008. Tough state regulation is said to have kept insurers robust as banks tottered, leaving no reason for federal intervention.
Unfortunately, this picture is far from true. The subprime crisis exposed poorly regulated insurers as major sources of risk, transmitting problems from one part of the financial sector to another.
Financial experts, as well as state regulators, have long insisted that insurance cannot give rise to systemic risk. Insurance policyholders, the reasoning goes, cannot line up to demand cash if a company runs into trouble. Unlike a bank, an insurer’s obligations are long-term, which is said to give regulators plenty of time to deal with problems and make sure consumers’ claims are paid.
When the crisis struck in 2007, however, the luxury of time proved to be an illusion. Instead, insurers helped spread the crisis in at least two ways.
One involved obscure companies known as bond insurers, which had provided guarantees against the default of some securities created from subprime mortgages. As increasing numbers of homeowners stopped making mortgage payments, some of the insured securities defaulted, dealing losses to the bond insurers.
Insurance companies hold a ton of corporate building real estate. Leave them alone. They have enough problems. We have launched a Facebook competitor at story+burn dotcom
“Don’t fight the Fed” gets new meaning in Senate debate
By Rachelle Younglai and Kristina Cooke
WASHINGTON/PHILADELPHIA, May 12 (Reuters) – The shaping of the U.S. financial reform bill has given a new meaning to the old market adage “Don’t Fight the Fed.”
Five months ago, many lawmakers wanted to confine the U.S. central bank to setting monetary policy and acting as a lender of last resort for banks.
Blaming the Fed for missing the warning signs in the run-up to the financial crisis, senators were preparing to step up their scrutiny of the central bank and strip its authority to examine and supervise all banks.
But fierce lobbying by regional Fed bank chiefs and hundreds of small commercial banks scattered across the country persuaded Congress otherwise.
In a lopsided 90-9 vote on Wednesday, senators approved an amendment to a regulatory reform bill that would preserve the Fed’s power over small state-chartered banks instead of moving them to another banking regulator.
It was the second time in as many days that the U.S. central bank scored at least a partial victory. On Tuesday, the Senate approved an amendment for a one-time audit of the Fed’s emergency lending during the latest financial crisis, though some senators had initially wanted to subject the central bank to repeated reviews.
from The Great Debate:
SEC’s case against Goldman highlights need for Wall Street reform
-- Ed Mierzwinski is the longtime consumer program director of U.S. PIRG, the federation of state Public Interest Research Groups. U.S. PIRG is a founding member of Americans for Financial Reform, an unprecedented coalition of over 250 labor, senior, civil rights, community and consumer organizations. --
Over 18 months ago, U.S. taxpayers bailed out the reckless Wall Street banks. Yet, despite widespread and overwhelmingly public support for Wall Street reform and dramatic House action in December, efforts to move a Wall Street bill through the Senate have been stalled for months by a phalanx of powerful Wall Street lobbyists. While we cannot count them out, because they’ve increased their lobby and campaign spending as we move toward the endgame, Banking Committee Chairman Chris Dodd’s (D-CT) coup in moving a strong bill closer to floor action gave us some wind in our sails.
Then, several events last week put an even bigger whirlwind behind our reform efforts.
The biggest was that on Friday the SEC filed fraud charges against Wall Street's high-flying Goldman Sachs and its bond salesman Fabrice Tourre. The SEC alleged that they had made "material misstatements and omissions in connection with a synthetic collateralized debt obligation marketed to investors" and that these CDOs (a type of derivative) had contributed to the enormity of the financial crisis. The SEC’s claim, if proven, essentially will translate to this: Goldman stacked the decks against investors. Fabrice Tourre (who is known as Fab) even sent one email (SEC complaint paragraph 18) that said:
"The whole building is about to collapse anytime now… Only potential survivor, the fabulous Fab... standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstruosities!!!”"
In Washington, you don't have to make this stuff up, it writes itself.
That same day, over at the Permanent Subcommittee on Investigations, Senator Carl Levin (D-MI) excoriated former Office of Thrift Supervision (OTS) boss John Reich for his mishandling of the Washington Mutual collapse (WashPost). Earlier in the week, he had done the same with the executives of the failed bank. In his statement announcing the hearings, Levin was succinct: “The recent financial crisis was not a natural disaster; it was a man-made economic assault.” Consumers were sold predatory, unsustainable loans, by WaMu, Countrywide and many, many others.
You have to police money. What you are saying is just not true. The SEC and financial oversight was let go over the last 10-15 years (both political parties responsible) Lacking oversight and enforcement of mis conduct (rating agencis..insurance ..bank reserves) the mushroom cloud got bigger and bigger. Especially when no one was paying close attention to the explosive growth of the synthetic CDO market. When investment banks realized the profitability of that type of trading, geez, raise capital for a young company, underwrite bonds?? How boring! They then had access to bank assets, and the all time favorite Mortgages!! Securtiize, get you underwriting fee, flip the paper to the Hedge fund, flip it back and let the last one holding the bag loose. As it turns out they were all holding a smelly bag that is now stinking up the federal reserve.Did you ever think the more mortgages that were underwritten, they more they could securitize?? And lastly you have to review trades, and pricing (Madoff??) The principles that were set in the 1930′s and the agencies that were created is what made our markets most admired world wide. Do you think Bankers want to walk away from that money machine and go back to lending?? And on a final note, borrowing cost will naturally go up for interest rates are at 30 year lows, and taxes are naturally going up next year for the tax cuts had an expiration date.
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“All models are wrong – some are useful” Any attempt to improve on the poetry of George Box (or W.E. Deming?) is fraught with risk and tends to discredit the risk manager.
One additional suggestion: It may be risky to lure readers with a movie-review expectation if you intend to abruptly turn preachy. This is considered bad form in some circles.