What do risk officers worry about?
JPMorgan’s astonishing $2 billion-plus quarterly loss due to trading in credit default swaps from its London office spotlights the crucial role of the chief risk officer (CRO). What exactly are risk officers supposed to do? Is the CRO someone who fills out reports, becomes a fall guy for misplaced strategy or, as a key executive, makes management aware of the risks and has input to decisions made by the senior management team?
Taking on the role of a CRO is not for the faint of heart – even the title grants you a certain degree of unpopularity. You’re the bearer of potential bad news when it comes to strategic decision making. It is your job to provide your boss and peers with possible outcomes of scenarios they often don’t want to hear about. Yet, you are the first to be thrown under the bus when a risk suddenly surfaces and your company has no mitigation plan in place. You can’t say “I told you so,” so you roll up your sleeves and quietly prepare for the next event. Of course, every risk a company faces cannot be predicted and proactively avoided. As recent worldwide financial, economic and societal events have illustrated, it has become critical to employ a process driven by foresight.
To understand how to develop and implement a risk management strategy, we must first learn which emerging risks CROs are most concerned with today. According to a recent survey co-sponsored by the Joint Risk Management Section of the Society of Actuaries, Canadian Institute of Actuaries and the Casualty Actuarial Society, the top two risks reported were financial volatility and failed and failing states. Risk managers also cited cyber-security and the overall interconnectedness of infrastructure, followed by the threat of a Chinese economic hard landing, an oil price shock and regional instability.
From a broader perspective, the survey explains which emerging risk categories most distress risk managers. The economic category leads the pack (56 percent of managers named this as the biggest concern), followed by geopolitical (22 percent), technological (8 percent), societal (5 percent) and environmental (4 percent) risks.
The survey also polled risk managers on the role of strategic planning and incorporating the potential effects of evolving emerging risks into the decision-making process. This revealed that recent events such as the Japanese devastation, Middle East political unrest and European sovereign debt crisis have had great influence on the concerns of risk managers about future risks. The year 2011 marked the largest economic impact of physical disasters in history, which included flooding, monsoons, fires, earthquakes, volcanic eruptions and tornados.
Risk managers reported their top combinations of three risks, which was dominated by financial volatility when combined with failed and failing states, oil price shock and an Chinese economic hard landing.
Although it is the CRO’s duty to outline potential crises, the survey research showed that management teams increasingly believe that it is not a risk manager’s job to predict the future. For instance, in 2010, 77 percent of respondents felt that their companies expected them to be predictive. Nowadays, more than half of surveyed risk managers indicated that predicting specific scenarios is not part of the job. Rather, their role is to generate potential scenarios and their implications, shedding light on both the positive and negative outcomes.
Goldman’s troubles will end when Blankfein goes
The following is a guest post by Christopher Whalen, senior vice president and managing director of Institutional Risk Analytics. You can also follow him on twitter. The opinions expressed are his own.
As Congress was approving financial reform legislation yesterday, Goldman Sachs agreed to pay $550 million to the SEC to settle a civil lawsuit that claimed Goldman had misled investors in a subprime mortgage product as the housing market began to collapse three years ago. The settlement marks the beginning of the end of Goldman’s public humiliation for its relatively small part in the subprime debacle, but the firm still has a great deal of work to do to satisfy the conditions of its settlement, repair its relationship with clients and mend its damaged public reputation.
I have had a “neutral” rating on the forward operating results of GS since Q1 of this year and will leave that rating in place for two reasons. First, the carry trade reflected in record net interest margins in the banking industry is going to slowly diminish at GS and many other banks. Unless the Fed allows interest rates to rise soon, all of the assets of banks and funds will gradually re-price to near-zero. When the media waxes euphoric over the “trading” results of firms like GS, they fail to realize that much of trading revenue comes from simple interest rate spreads over funding.
Second, despite the settlement, GS remains in the midst of a mini-crisis in terms of brand and reputation. As Felix Salmon noted in a post on blog post back in June, Goldman CEO Lloyd Blankfein and his lieutenants are playing customer relationship management in order to retain clients. While JPMorgan Chase is playing offense, looking outside the U.S. for growth, GS is still very much in a defensive posture. Indeed, JPM’s bankers have been aggressively trying to take business away from GS for months.
For GS, everything depends on how the firm manages the process of addressing the remaining financial and political risks that have erupted over the past year. Blankfein has done a reasonably good job in steering GS through the political minefield, but the firm still faces a lot of private litigation as well as the more daunting task of winning back the trust of the blue chip corporate clients. Part of the requirement is simply time, but I believe that GS will eventually need to replace Blankfein and other members of the GS management team to truly put this crisis behind them — but not for the reason most people might think.
Buy side investors don’t do business with GS or the other major sell side firms because they trust them; they do business with firms like GS because they believe that the firm has better access to information. The sad fact is that the trust that once made firms like GS and the old JP Morgan & Co special has long since been lost, leaving the marketplace that remains a hideous, barbaric place bereft of honor — and a source of infinite operational risk to all participants.
The reputation of GS as a firm for being smarter and better informed than the larger firms on Wall Street goes back many decades, to the turn of the last century when Wall Street was run by the white shoe securities firms in Boston, Philadelphia and New York. In those days, firms like GS had to be smarter than everyone else as a basic matter of survival. And in those days, GS protected and nurtured each client relationship because the trust that these clients put in the firm were considered to be a precious asset.
That’s right ppl. Financial firms fleeced you and and took all that hard earned money you ‘invested’ in that big second house you can’t afford. They conned you into spending on all those credit cards you didn’t wanted to use to buy that big home theater system that you didn’t really need.
Go on… blame them. It’ll make you feel better.
Two cheers for the walking wounded
– Mark Hannam is a guest columnist, the views expressed are his own. He formerly worked at the Bank of England and Barclays. He is currently chairman of Fair Finance, a microfinance company –
Some banks have come out of the financial crisis in better shape than others. We should encourage them rather than lump them together with the failures.
Public anger at the recent failings of many of our leading banks, while justified, is not a sound basis for future policy. The temptation facing policy makers — that of failing to distinguish between better capitalized, better managed banks and under-capitalized, poorly managed banks — should be avoided.
The period leading up to the financial crisis was characterized by an insufficient differentiation of risk in the financial markets. Across many asset classes risk premia were compressed to such an extent that the difference in price between low-risk and high-risk assets was insufficiently wide.
Prices are signals and in the past few years they have signaled incorrectly.
Public policy that treats all banks as if they were the same perpetuates the problem of erroneous signaling: JP Morgan does not have the same problems as Citibank; Barclays’ prospects are not identical to those of RBS.
The stress tests in the U.S. — however crude and dubious in methodology — are likely to demonstrate this. We can and should distinguish between those banks that benefit from general government support for the financial system and those that require specific government intervention to remain solvent.
I think that the challenge will be to keep the banking industry from going back to its old ways of not checking out investments, and relying on past history(Good old boy mentality) in order to maximize profits. In order to get stability into the banking system the government must demand that the banks have a long term business plan, reachable goals, and also remove pressure from Wall Street on maximizing short term profits. Banks would also be required to improve due dilligence on investments before purchase, slow down loan approvals, and spread the customer base for investments. We can ill afford another wild ride down the slippery slope of maximizing short term profits.
Credit cards unkindest cut for U.S. consumers
— James Saft is a Reuters columnist. The opinions expressed are his own –
Government intervention or not, banks will be cutting up America’s credit cards at an unprecedented rate, with grave implications for the economy and company profits.
The U.S. Federal Reserve last week added more nutrition to its alphabet soup of rescue programs when it unveiled the Term Asset-backed Securities Loan Facility (TALF), under which, among other things, it will lend up to $200 billion to investors in securities backed by credit-card, auto and student loans.
It did so for a very good reason: the securitization market’s freeze now extends beyond mortgages, imperiling run-of-the-mill consumer financing and making it a certainty that many people who use credit to get them over “cash flow” situations will be, well, denied.
And even though the U.S. car industry may implode if starved of finance and many students will have to defer education, the real potential disaster is in credit card funding, which could push lots of households over the brink and in the process consumption and every business which depends on it, which would be all of them.
Put simply, even with an apparent will to try anything to bring the wheels of finance back into motion it will be very difficult for government to quickly fill the hole left by private finance. Details of the plan are still sketchy, but let’s just take it for granted that it works, even if the plan, at only one year, will give them huge fears about how they get out of their positions at the end of 2009.
Beyond that, the Fed is seeking to kick start securitization by attracting back a species of investors, leveraged ones, who don’t really exist any more.
A piece written by Micahe Farrell; “Welcome To the Keynesian Nightmare” spelled out the dilema many months ago. “It is no secret that the US is a country driven by debt. It now takes approximately $3.25 of total debt in the US to generate $1 of GDP, a significant increase from 1952, when it took just $1.30 in debt to generate $1 of GDP. However, in 1952, government debt—federal, state and local— was $244 billion and accounted for 55.1% of the $443.6 billion in total debt outstanding in the US. Today, government debt stands at $7.2 trillion but accounts for just 15.7% of the $45 trillion in total debt. Household debt today has a much larger impact on economic growth than government debt— at $13.6 trillion, it is almost twice as much as government debt, while in 1952 it was just one-third of government debt.”
The unwinding of U.S. consumer debt is underway. The implication is that the economy will not bounce back to what it was. It will be “pay as you go” for some time to come.
