"Culture of Risk"

This doesn't inspire much confidence:

You may make a mess, but please don't try to clean it up by Barbara Kiviat: It's hard to believe, but people are starting to express outrage over the New York Fed hiring the former chief risk officer of Bear Stearns to help supervise banks. To be fair, I feel like I should acknowledge that it would be practically impossible to clean up this mess without employing some of the people who created it. ...

To be fair again, I feel like I should go back and see what, exactly, Michael Alix has been saying these past few years. Just because he was running risk management at Bear Stearns when the company collapsed from a lack of sound risk management doesn't necessarily mean he was sitting idly by. ...

So I did a little rooting around, and found this June 2006 BusinessWeek story about Wall Street's "culture of risk" for which Alix was interviewed. An excerpt:

Yet for all the risks they're taking on, banks insist they're safer than ever. They've hired many of the greatest mathematical minds in the world to create impossibly complex risk models... "Right now everything on my screen is flashing red," said Michael Alix... But "that doesn't make me nervous"... The bank has built such powerful computing systems that Alix can reevaluate every day the risks of thousands of positions across the firm's trading businesses under various stressful scenarios to be sure the firm doesn't hold too much of any risky investment at any one time. That type of analysis used to take a week to complete. "The machine works," he says.

This, we now know, didn't work so well.

It seems that as chairman of the Securities Industry Association's risk management committee, Alix was also an important part of the effort to convince regulators that investment banks didn't need to hold nearly as much capital as their commercial bank brethren. Here's a letter he wrote to the Federal Reserve's board of governors in August 2003...

This, we now know, didn't work so well, either.

But my favorite thing I found in my rooting around was Alix's June 2004 House testimony on the topic of Basel II. One of the reasons investment banks should be allowed to use more leverage, he said, was because of the protective qualities of mark-to-market accounting...

This, we now know, not only didn't work so well, but is also, we're told, causing a lot of the problems we're having.

Look, I don't envy the position the New York Fed is in. I have the luxury of not having to go out and hire people who 1) deeply understand the operations of finance firms, and 2) are willing to take a job in the public sector. At the same time, I'm guessing I'm not the only person a little squinty-eyed over this one. ...

Comments

[reason]

Brilliant. But just sometimes ex-thieves make the best detectives!

[Apples and Oranges]

Back in the Depression, they hired some of the people who caused the problems to fix them, and it worked. However, back then the people they hired understood the problems, and were deliberately taking advantage of them during the 20s. They knew exactly what to do to stop others from repeating the bad practices. In this case, the people being hired are saying they had no idea that there even was a problem. They knew how to do lots of advanced math, but had no idea how to successfully apply the equations to real world events.

Maybe its time to hire people with common sense. Those who understand the big picture.

[a]

I think the expression is: poachers make the best gamekeepers. It referred to hiring traders to work in the risk departments.

The usual risk manager has only a bureaucrat's knowledge of how to negotiate between traders and upper management. Traders would tell the risk manager what to do, and the risk manager's job was to assuage upper management and the regulators that there was really no problem anywhere. If Alix has no trading background, then this appointment is really a dud. The only advantage would be that Alix knows the BS' systems - just getting the information out can be an effort, so having someone with that knowledge is a definite plus.

[macquechoux]

I am with reason and a on this one; but, lets not hire too many ex-thieves and poachers, Okay?

[Lafayette]

As I've said before, they are putting pyromaniacs in charge of the fire brigade. Paulson brought his prime henchman with him to the Treasury.

Look, what was going on was NOT esoteric magic. First, it was a packaging nightmare as regards the SIV chop shop resellers. That nightmare needs to be unraveled in order to know how to forbid it.

Second, as regards hedge-funds, dealing in them does not necessarily mean you know how to run such a fund or, therefore, regulate it. Frankly, some quarters think they should be regulated out of existence. And, that noise is coming from people who have worked there.

There are a LOT of people who made a humongous amount of money out of the derivatives business and who will be very angry to see that sort of fund tossed onto the slag-heap of Financial History. They are therefore not to be trusted for objectivity.

I suggest that we made a colossal mistake to think that the Finance Industry could regulate itself and we are making another mistake to think that these people know how to best regulate themselves.

There must be other input to this process, both academic (economics, finance) and professional experience, such that they come up collectively with regulations that are workable but circumventable with only great difficulty.

The process needs adversarial components in the fabrication of regulations, or it will have been a wasted effort.

[Ken Houghton]

You can be "squinty-eyed" about it; those of us who are former BSC have another phrase--but this is a family blog.

[ken melvin]

Yeah, cut off it's tail and name it Bernard Baruch oughta work.

[wally]

You only need those experts involved in the fix if you intend to restore the system. If the best course is to get a different system, those guys should just get the boot.

[dd]

"They've hired many of the greatest mathematical minds in the world to create impossibly complex risk models..."

Value is not a function of mathematics. It is an imaginary concept based in emotion, especially during times of extreme stress.
Public markets express consensus value and so are the best expression available for valuation. Without that input (and there were no public markets for many of the "assets") the models were at best a theoretical guess about "value" and had no relevance in determining liquidity aka financial institution reserve requirements.

[Barry]

reason says...
"Brilliant. But just sometimes ex-thieves make the best detectives!"

Yes, but only if you have a remote controlled firecracker surgically implanted between their b*lls. Hiring a known dishonest person when you don't have a credible threat of harsh punishment is not a good idea.

[paine]

the implicit notion here makes me laugh

knaves are not fools looters are not fools
and the hired guns of looters are far from foolish

this guy landed on his feet
who's hiring his ilk now ...uncle uncle and only uncle
out of his ilk
next best ???

selling ladies' shoes

[kthomas]

To the guy on gal on the street, this is total BS.

[kthomas]

Sorry, guy and gal. Came out quite misspelled and ugly, sorry.

[paine]

"They've hired many of the greatest mathematical minds in the world to create impossibly complex risk models..."

yup right here in river city

bares a druming till the crack of doom sounds once more eh ??

oh was that the crack of doom just now ???

"nope just a hiccup
pay no attention to the drop
the coaster always rises further
then it falls
....that's amusment park physics folks"

[reason]

But Barry,
the guy was a risk manager not a CEO. He may well have just been instrumentally dishonest, not inately dishonest.-)

[paine]

"If the best course is to get a different system..."

and it is is is

"..those guys should just get the boot"

never fear the boots is comin wally
the days of the grifters reign
are numbered ---okay... numbered in decades --

behold
a great firing squad is forming ever so slowly
in the sky

and it don't just wear boots
wally

[kthomas]

"instrumentally dishonest"....reason, that is seriously funny.

That term, no doubt, can be applied liberally to the Bush Admin.

[calmo]

Tis a bright sunny day...
just wear your best gear and know the transformative moment is ahead, not behind.
Where to step in here? Behind my pal paine:"They've hired many of the greatest mathematical minds in the world to create impossibly complex risk models..." You need to know the source of this remark comes from the marketers and not the string theorists...from the mathematically feeble whose only tool is persuasion --irrespective of truth...and proof (whateva that could B, you know?).
And I could hear another volley from dd...I could.

[Eric Dewey, Portland, Oregon]

While not necessarily supporting the idea of hiring the bad guys to fix the problems, keep in mind that it probably helps Treasury a lot to have someone who really knows where the bodies are buried (as long as that firecracker is safely tucked into his nether regions)...the fact that his screens were flashing red is probably a good thing, in spite of his lack of spine in even trying to persuade anyone to pay attention.

I'd prefer a Sharron Watkins or a Jeff Wigand to this guy anytime...

[Julio]

paine,

"yup right here in river city"

Good to have you here ;-).

[Patrick]

"... the greatest mathematical minds ... "

No no no. A semimartingale Ito integral archimedean copula fantasy does not a Fields medal merit.

Perelman these guys ain't.

[Thomas]

Dude, you totally made the point that he shouldn't be hired. There are lots of people available in this marketplace with this guys skills that aren't emblematic of one of the worst failures in history...

[Sammy]

Apples and Oranges says...

Back in the Depression, they hired some of the people who caused the problems to fix them, and it worked. However, back then the people they hired understood the problems, and were deliberately taking advantage of them during the 20s. They knew exactly what to do to stop others from repeating the bad practices. In this case, the people being hired are saying they had no idea that there even was a problem. They knew how to do lots of advanced math, but had no idea how to successfully apply the equations to real world events.

Maybe its time to hire people with common sense. Those who understand the big picture.

To the person who wrote this comment: You might want to refresh your memory, no one group or persons ever "fixed" the Great Depression. It was the result of a culmination of events over which people had little control over. Was it the New Deal? the aggregate demand stimulated by the War? Economists are still arguing about the Industrial Revolution.

My opinion on this matter is to be found in Nassim Taleb's THE BLACK SWAN. He has plenty to say on economists, finance types, risk models, and risk management departments in general. I think the New York Fed made a serious mistake.

[kthomas]

hear hear, Sammy.

Obviously, this guy has buddies at the Fed. These parasites take good care of each other.

[dd]

Calmo,
Greenspan and the NY Fed, the mover and the shaker intent on reducing reserve requirements via expanding fictitious valuations (aka "risk modeling") leaving the saver/investor/taxpayer suckers to take the losses. Saw this from the ground floor and quite frankly the mathematicians and computer whiz kids are just a cover for the inevitable greed and fraud that follows. Drexel was the the test case or the great innovator depending on POV. It was a massive and costly failure and it's "innovations" infected the S&L industry and the insurance industry. Even after those failures the Fed and Greenspan pushed forward and the "innovators" moved on; from yesterday's WSJ comes this tidbit:

"In 1987, AIG launched its financial-products unit with Howard Sosin, a math expert and former Drexel Burnham Lambert executive. Among his hires were Joseph Cassano, a former Drexel colleague."
("Behind AIG's Fall, Risk Models Failed to Pass Real-World Test")

[im1dc]

"It's hard to believe, but people are starting to express outrage over the New York Fed hiring the former chief risk officer of Bear Stearns..."

It's hard to believe the people responsible for allowing the financial mess are still doing their best to make more mistakes instead of hiding under their desks, waiting for their pink slips and sending out resumes to headhunters.

If it were possible to replace the entire FedRes and its Banks by a computer that should be President-elect Obama's first request of the next Congress.

I sincerely hope Obama's transition team is paying attention to who is doing what inside Bush's lame duck administration, making comprehensive list and ready to undo everything and everybody on Day One.

[calmo]

Thanks dd.
Twould B good to see the new administration appreciate this bit of history and undo (but more traditional bank robbery heisting is met by the bank getting back the loot, yes? and real jail time with hard labor, yes?) curtail the "financial innovations".
Twould.
So far we have moved from "bailout" to "rescue"...such a criminally weak parody.

[TigerPaw]

A good rule of thumb for the incoming administration:

If you were hired, contracted, or otherwise engaged during the Bush years - then out you go.

The presumption for all of them must be negative given the people that were doing the hiring over the last eight years and the "standards" they were using in selecting.

[dd]

Think it must go beyond "bush" league. Financial institutions are functionally insolvent. All measures of "credit" functionality are now meaningless and bank lending to the real economy is dysfunctional as hoarding must occur to dampen the impact of deconstructing "assets" that under any meaningful public market rubric have little value and are wholly illiquid.
Have said many times that "innovation" is fine but these instruments have failed every transparent public exchange valuation test and for liquidity purposes ought be valued at zero; although alternative valuations for financial statement purposes, with appropriate disclosures could have worked; but now not so much.

[dd]

Might also add, that if "innovation" continues, opaque private markets and black box trading will undermine the functional public markets. Transparency is not as profitable as opacity but opacity is destroying what was once a fine public market structure built on the 1929 failure. The lessons still apply as human confusion about the money illusion remain the same.

says...

the guy was a risk manager not a CEO. He may well have just been instrumentally dishonest, not inately dishonest.-)
It seems I might have been too cryptic here (not up to calmo's standards, but oh well). A little clarification:

The risk manager may have seen his job as having to justify a fait accompli in terms that sound like risk was being minimised. That is - he saw the dishonesty as necessary to (honestly from that point of reference) do his job. He did not necessarily see himself as being actually responsible for the real risk that the firm was taking (which a CEO would be). I never meant to imply that CEO's are (necessarily) by their nature dishonest.

[reason]

That was me.

[reason]

So instrumentally dishonest as in dishonest because he was an instrument (tool if you like) of the firm.