Monday, February 15, 2010

Lessons Not Yet Learned

As it is a holiday today in the U.S., I took the latest copy of the Economist to the gym and read it on the treadmill (as you do). I was particularly interested in the special report on financial risk. The Economist is not a usual source for articles about risk and risk management, but I have a great deal of respect for the publication. But I must say this report stunned me silent (for a minute). Warning about asset class silos and the challenges of enterprise risk management has become one of my specialty subjects (where is Chris Tarrant when you need him?). If you took every article that I have written for Financial News and Traders Magazine and Securities Industry News about moral hazard and risk and financial markets over the past three years or so and threw them together into one - this would be the Economist's article.  One particular article that I wrote in Financial News in December of 2008 pointed out that financial firms had been using VaR incorrectly in the years leading up to the financial meltdown: "Failure of risk management strategies proves Murphy’s Law is alive and well". In it I said: "Valuation models such as value-at-risk were overused or not updated when market conditions changed."
According to the Economist this still holds true today. Shock, horror. Not only that, but they still have not figured out stress testing and continue to be stumped as to how to manage risk across the various asset classes. The Economist's article said: "Two-thirds of the banks surveyed said they were only partially able to aggregate their credit risks." Call me naive but they knew this ten years ago, and the whole trend toward enterprise wide risk management was in response to this issue. Technology to aggregate, analyze, display, signal and manage risk across product silos is exactly what enterprise technology is about, and it has improved by a billion gazillion percent since the first, tentative platforms.
I can only hope that in seeing an article of this granularity, dumbed-down for the masses, some simple risk manager is reading it while he is on the loo. Maybe the light bulb will be illuminated in his poor, addled head and he will say to himself, "Oy. That Economist might have something there. Maybe VaR is not enough. Maybe I should look at - uhhh - operational risk! And liquidity risk! And moral hazard risk (or not, the boss would HATE that)."
What I wrote in Financial News sums it up: "Anglo-Irish author and philosopher Edmund Burke said: “By gnawing through a dyke, even a rat may drown a nation.” By ignoring basic risk management tenets, investment banks and other financial institutions failed to manage credit risk, which turned into market risk which turned into liquidity risk and ultimately systemic risk. They took down not only themselves but global markets.

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