Tuesday, January 06, 2009
When (nearly) everyone fails
We are in dire economic straights. There has been much blame laid, but there is one group whose failures clearly played a role in the catastrophe. That group is America's risk managers, the people who evaluate the risk of economic choices so that decision-makers can factor in the risk when choosing what to buy or sell. In short, most risk managers greatly undervalued the risk of investing in mortgage-backed securities. Based on this bad advice, banks and other financial institutions bought huge amounts of these securities, which resulted in huge losses and the ensuing economic collapse.
How did they get it so wrong? Partly, there was an over-reliance on one tool to assess risk, known as Value at Risk. VaR is a simple-to-understand number which expresses in a dollar value the risk of a given investment. For example, a $1 billion investment might be said to have a value at risk of $50 million/week-- that is, the chance is 99% that less than that amount would be lost in the next week. VaR is a convenient tool, in that it seems so solid. However, what happened is that the 1% happened, all over, at the same time.
Some institutions, such as the management group at Goldman Sachs, looked at things more broadly, properly assessed the risk in mortgage-backed securities, and got out of them in time. Most did not, relying instead on their risk managers.
And, of course, minimizing that risk was the answer that the risk managers wanted to give, because it is the one their bosses wanted to hear. To raise a red flag would have been to signal to the boss that he was wrong to buy those securities, which too often is a route to job insecurity.
Once, again, as with the accounting scandals of the 90's, the root of a financial debacle is very likely those who did not want to disappoint the client. The problem, of course, is not just the person who should have been bearing the bad news-- it is also the culture of a place where they shoot the messenger.
How did they get it so wrong? Partly, there was an over-reliance on one tool to assess risk, known as Value at Risk. VaR is a simple-to-understand number which expresses in a dollar value the risk of a given investment. For example, a $1 billion investment might be said to have a value at risk of $50 million/week-- that is, the chance is 99% that less than that amount would be lost in the next week. VaR is a convenient tool, in that it seems so solid. However, what happened is that the 1% happened, all over, at the same time.
Some institutions, such as the management group at Goldman Sachs, looked at things more broadly, properly assessed the risk in mortgage-backed securities, and got out of them in time. Most did not, relying instead on their risk managers.
And, of course, minimizing that risk was the answer that the risk managers wanted to give, because it is the one their bosses wanted to hear. To raise a red flag would have been to signal to the boss that he was wrong to buy those securities, which too often is a route to job insecurity.
Once, again, as with the accounting scandals of the 90's, the root of a financial debacle is very likely those who did not want to disappoint the client. The problem, of course, is not just the person who should have been bearing the bad news-- it is also the culture of a place where they shoot the messenger.
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Blah blah blah... I like the panda stuff better. Did you see that Britney Spears' comeback is failing? That girl is kooky.
# posted by 
: 11:15 AM
: 11:15 AM
Keep your eyes open Anon 10:15! These appointments of soft on crime professors with no practical experience in the REAL world will just lead to more pandas on the streets. Flamethrower bearing pandas! And rampant bamboo infestation, most likely.
You know as well as I do that once they outlaw flamethrowers, only the pandas will have them. And where will that leave us law abiding folks? Hiding in the bamboo, that's where!
You know as well as I do that once they outlaw flamethrowers, only the pandas will have them. And where will that leave us law abiding folks? Hiding in the bamboo, that's where!
# posted by : 11:21 AM
: 11:21 AM 
Will this Dawn Johnson live in Woodley Park? Is she slow? If so, she may meet Argbf!
# posted by : 12:54 PM
: 12:54 PM
I know, we need a recipe or a repressed memory or something, the Razor is getting far too serious!
Iplaw, bamboo is your friend! Did you know that they make some nice high end underwear from bamboo? It is the new hemp, I suppose.
Iplaw, bamboo is your friend! Did you know that they make some nice high end underwear from bamboo? It is the new hemp, I suppose.
So if I wear bamboo underwear, and someone says, "Is that a stalk of bamboo in your pants or are you just glad to see me?" I can say "both"?
# posted by : 4:05 PM
: 4:05 PM
IPLG - not going there.
I have bamboo floors in my house, bamboo bath towels and a bamboo blanket on my bed. I plan to plant some 'invasive' bamboo along our property line so I don't have to look at my neighbors shed and other various junk.
It is the new hemp, but I don't know anything about how either one is smoked.
I have bamboo floors in my house, bamboo bath towels and a bamboo blanket on my bed. I plan to plant some 'invasive' bamboo along our property line so I don't have to look at my neighbors shed and other various junk.
It is the new hemp, but I don't know anything about how either one is smoked.
Wow, I’m not sure where to start.
Yes VaR is a simple tool to understand. Using Goldman as an example of someone who ‘got’ it is not bad either except that Goldman as a company was structured differently and subject to ‘some’ different rules. They also had different objectives as they were still a ‘true’ investment bank (IB), whereas most of the other culprits on Wall Street have banks, credit card company’s and other subsidiaries that factor into the strategies that the company’s employ. They also were not a public compnay until a few years ago, so thir corporate objectives were very different. Goldman recently changed it’s structure so that it would qualify for TARP funds. I wonder what drove that decision?
Although VaR is easy to understand you need to realize that investment banks analyze risk out the whazoo. Each traded product has it’s own specialized, in house, risk analysis group. These groups take the current portfolios for the various trading areas they support and run them through hundreds of simulations each and every day at the close of business. The result of these simulations is a daily valuation for each and every item in the portfolio. ‘Funny’ results are brought to the head of the trading desk and reviewed. This is how they find rogue traders/sales people and determine how to adjust their trading positions(each and every day). Overall direction is provided from the 'top' management (trickle down) and the trading desk has to figure out how to execute the planned objective.
Each of these firms also has a Credit Review and Credit Analytics division. These groups are responsible for determining who the IB will do business with and under what terms. This impacts daily margin requirements for positions help for all sorts of securities traded. These groups review the other company’s financials but rely heavily of the ‘rating agencies’.
The second part of the equation involves the valuation of debt. With a corporate security, when debt is issued, the IB that is coordinating the debt offering is involved with getting that debt RATED by S&P, Thompson’s and a few other agencies. These rating agencies are responsible for assigning the rating which is generally tied to the health of the issuing company. It is important to note that these agencies are not government backed. I do not know what, if any type of govt regulations they may have to follow in rating process. I have always been under the impression that they are INDEPENDENT (ha, ha). These ratings may get re-evaluated each quarter when the issuing company prepares various Govt filings and announces earnings. They also get re-evaluated if there are scandals. Companies issue lots of debt and each issuance is assigned its own rating.
Mortgage Back Securities are trickier. As we have all learned these are securities made up of thousands of individual mortgages (pools). In the old days they lumped (pooled) like type mortgages together and they could determine a WAC and WAM for each pool of securities. WAC = Weighted Avg. Coupon and WAM = Weighted Avg Maturity. These factors are used to determine a ‘remaining’ pool value. It is obviously easier to value and predict an MBS pool made up of fixed rate mortgages as opposed to all the garbage the mortgage brokers were making up on the fly (balloon loans, ARMs and the like). Most mortgages in this country end up being ‘pooled’ by either FNMA or FHLMC and then traded as securities. It is a secondary market
As we have all learned, not only where MBS traded but then the big investment firms were able to create NEW speculative products to ‘insure’ these mortgage pools (and other debt) with the Credit Default products (CDO and CDS). You bought insurance for something you did not own.
I would like to say that I know many people who worked in various Derivative Risk Analysis group at Citi and other banks and these people are math and computer geeks. These people, by nature, are not RISK TAKERS they are number crunchers. They run the simulations and present the numbers to the people on the trading floor. The guys and gals on the trading floor are the RISK TAKERS so assigning blame.
In the end, I blame the mortgage brokers (not necessarily ‘reputable’ banks) that put people into loans that were way over their heads. These people turned around and SOLD the loans (wiped their hands) and took their profits leaving the rest of us to suffer the consequences and try to clean up their respective messes.
Yes VaR is a simple tool to understand. Using Goldman as an example of someone who ‘got’ it is not bad either except that Goldman as a company was structured differently and subject to ‘some’ different rules. They also had different objectives as they were still a ‘true’ investment bank (IB), whereas most of the other culprits on Wall Street have banks, credit card company’s and other subsidiaries that factor into the strategies that the company’s employ. They also were not a public compnay until a few years ago, so thir corporate objectives were very different. Goldman recently changed it’s structure so that it would qualify for TARP funds. I wonder what drove that decision?
Although VaR is easy to understand you need to realize that investment banks analyze risk out the whazoo. Each traded product has it’s own specialized, in house, risk analysis group. These groups take the current portfolios for the various trading areas they support and run them through hundreds of simulations each and every day at the close of business. The result of these simulations is a daily valuation for each and every item in the portfolio. ‘Funny’ results are brought to the head of the trading desk and reviewed. This is how they find rogue traders/sales people and determine how to adjust their trading positions(each and every day). Overall direction is provided from the 'top' management (trickle down) and the trading desk has to figure out how to execute the planned objective.
Each of these firms also has a Credit Review and Credit Analytics division. These groups are responsible for determining who the IB will do business with and under what terms. This impacts daily margin requirements for positions help for all sorts of securities traded. These groups review the other company’s financials but rely heavily of the ‘rating agencies’.
The second part of the equation involves the valuation of debt. With a corporate security, when debt is issued, the IB that is coordinating the debt offering is involved with getting that debt RATED by S&P, Thompson’s and a few other agencies. These rating agencies are responsible for assigning the rating which is generally tied to the health of the issuing company. It is important to note that these agencies are not government backed. I do not know what, if any type of govt regulations they may have to follow in rating process. I have always been under the impression that they are INDEPENDENT (ha, ha). These ratings may get re-evaluated each quarter when the issuing company prepares various Govt filings and announces earnings. They also get re-evaluated if there are scandals. Companies issue lots of debt and each issuance is assigned its own rating.
Mortgage Back Securities are trickier. As we have all learned these are securities made up of thousands of individual mortgages (pools). In the old days they lumped (pooled) like type mortgages together and they could determine a WAC and WAM for each pool of securities. WAC = Weighted Avg. Coupon and WAM = Weighted Avg Maturity. These factors are used to determine a ‘remaining’ pool value. It is obviously easier to value and predict an MBS pool made up of fixed rate mortgages as opposed to all the garbage the mortgage brokers were making up on the fly (balloon loans, ARMs and the like). Most mortgages in this country end up being ‘pooled’ by either FNMA or FHLMC and then traded as securities. It is a secondary market
As we have all learned, not only where MBS traded but then the big investment firms were able to create NEW speculative products to ‘insure’ these mortgage pools (and other debt) with the Credit Default products (CDO and CDS). You bought insurance for something you did not own.
I would like to say that I know many people who worked in various Derivative Risk Analysis group at Citi and other banks and these people are math and computer geeks. These people, by nature, are not RISK TAKERS they are number crunchers. They run the simulations and present the numbers to the people on the trading floor. The guys and gals on the trading floor are the RISK TAKERS so assigning blame.
In the end, I blame the mortgage brokers (not necessarily ‘reputable’ banks) that put people into loans that were way over their heads. These people turned around and SOLD the loans (wiped their hands) and took their profits leaving the rest of us to suffer the consequences and try to clean up their respective messes.
My word to describe this is GREED.
I will see if I can find out more on how MSB are valued today.
Now back to PANDA discussions - it is far more interesting.
I will see if I can find out more on how MSB are valued today.
Now back to PANDA discussions - it is far more interesting.
OK - as for MBS valuation. I suggest if you really want to know about it you Google. valuation of MBS and look at a few of the 'papers' that come back. Let's just say that miss Lewis and Mr. Krucki didn't teach me any of this at good old GPN.
Risk Valuation is definitely a field for math and computer geeks!
Risk Valuation is definitely a field for math and computer geeks!
Whoa, Iplawguy! (shocked chuckle)
Christine you are a Superstar of knowledge! You should orchestrate Britney Spear's next comeback, it would surely work with you at the helm...and you can use some of that bamboo to keep her in line.
Christine you are a Superstar of knowledge! You should orchestrate Britney Spear's next comeback, it would surely work with you at the helm...and you can use some of that bamboo to keep her in line.
Christine whipping Britney Spears with a bamboo pole... what are you trying to create here, Ginger Hunter?
And will there be video?
And will there be video?
# posted by : 5:52 PM
: 5:52 PM
Brittany who?
If I had been her parent, none of you would know who she is and she wouldn't be divorced with 2 kids and staging a comeback.
I would have strapped them all down with bamboo and stood guard with my flame thrower until they had at least finished high school.
Respectfully yours:
Argbf
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If I had been her parent, none of you would know who she is and she wouldn't be divorced with 2 kids and staging a comeback.
I would have strapped them all down with bamboo and stood guard with my flame thrower until they had at least finished high school.
Respectfully yours:
Argbf
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