The ERM Current™

A new book detailing the events leading up to the recent global financial crisis hit the shelves this week and it is a compelling read.  Entitled “The Sellout”, the book provides an inside look within the largest financial institutions that contributed to the massive meltdown.  Author Charlie Gasparino provides a candid view of the leaders at these organizations as the Wall Street Journal reports below.

Mr. Gasparino chronicles how, across Wall Street in the years before the 2008 crisis, managers with a healthy fear of risk lost corporate power struggles to men more likely to ignore it. Stanley O’Neal, who climbed to the top at Merrill Lynch, would use the company helicopter to visit his favorite golf courses but never found time to learn about his firm’s multi-billion-dollar “warehouse” of collateralized debt obligations. Even after Mr. O’Neal was fired in late 2007, Merrill’s board somehow decided against hiring Lawrence Fink, a mortgage-market expert, and instead hired John Thain as CEO. During the interview process, Mr. Gasparino reports, Mr. Thain never even asked to see details on the assets that were generating billions of dollars in losses. A spokesman for Mr. Thain denies this account.

While many factors played a role in the crisis, it is apparent through Mr. Gasparino’s book that a large portion of the blame rests on the failure of  leadership to understand and appreciate the risks they were taking.  This is a primary reason that leaders must demand strong enterprise risk management practices at their companies.

Today’s post marks a significant milestone for The ERM Current™.  This is the 200th post to the blog since it was launched a year ago.  As we all know, the past year has been a remarkable one for the global economy and the practice of risk management.  Given the milestone, it is certainly appropriate to look back to evaluate the role of Enterprise Risk Management (“ERM”) in the financial crisis that erupted at the same time this blog was launched.  In today’s issue of Business Insurance Magazine, the following assessment of ERM was made.

Some observers have questioned whether enterprise risk management was to blame for the financial crisis, as the industry where ERM is most widely practiced is financial services. Others say ERM was not the problem; the real culprit was companies’ failure to use ERM.

I agree with the latter view. Enterprise risk management makes both theoretical and practical sense, but what many people misunderstand is that there is no one-size-fits-all approach to managing risks, be they hazard risks or business risks.

Traditional risk management is concerned with hazard risk—that is, the effects of accidental loss. ERM encompasses hazard risk as well as business risk, which holds the possibility of loss, no loss or gain. ERM also is about maximizing organizational value, which requires viewing risk as both possibility of loss and opportunity.

One of the lessons from the financial crisis is that companies must take a strategic view of risk and manage it so that they can avoid disaster and position themselves to create opportunities, or at least take advantage of ones that arise.

This is a spot-on assessment that many companies and risk professionals should take to heart.  As we emerge from the crisis, some may become too focused on the hazard risks and miss out on exceptional business opportunities.  On the flip side, others may be emboldened by the fact that they survived the crisis and ignore potential risks.  A comprehensive ERM program is crucial to navigate through the myriad of risks successfully. Wheelhouse Advisors can help. Visit www.WheelhouseAdvisors.com to learn more.

Last week, an article from the Wall Street Journal provided unique perspective of the current financial crisis in the United States from “across the pond” in Europe.  The article rightly points out that the crisis is not the result of a lack of regulation, but a lack of effective regulation due to overwhelming complexity and redundancy.  Here is an excerpt:

“American financial regulatory bodies have historically been fragmented. In a report published in November 2007, the U.S. Financial Services Round Table counted 10 different federal regulatory bodies with over 30,000 employees, and that’s not even counting regulators for the 50 states. The report frequently describes U.S. financial regulation as prescriptive, complex, formalistic, expensive and inefficient. Regulations often overlapped, making the same financial institutions subject to different rules and different enforcers. The U.S. regulatory landscape may resemble a jungle, but only because of all the choking vines.”

The report they reference in the article provides a very relevant example of the excessive and redundant requirements.  

“large U.S. banking organizations are being required to establish overlapping internal control reporting and compliance structures, as well as specific operational risk data collection, validation processes, and IT systems requirements. For example, the requirements of FDICIA and GLBA implicitly, and the requirements of SOX and [Basel II] explicitly, require a comprehensive system of “risk control self assessments” (RCSA) and related documentation. The cost of compliance with each of these regulatory requirements is significant, albeit difficult to quantify and segregate.”

As the U.S. works to improve the effectiveness of its regulatory system, companies also need to look for ways to streamline and improve their compliance programs.  Wheelhouse Advisors can help.  Visit us on the internet at www.WheelhouseAdvisors.com to learn more.

Michael Chertoff, US Secretary of Homeland Security, recently shared his thoughts on the current financial crisis and how our nation has addressed it from a risk management perspective.  In his remarks to the Wharton Business School, Mr. Chertoff was quite candid about the United States’ lack of preparation to manage risks before they manifested into a full-blown crisis.  He stated,

“The nation now faces financial woes that were to some degree or another predicted over a period of years, going back into the 1990s…. We have not managed to address the risk in a way that prevented what was … a [financial] disaster of the magnitude of a natural disaster and a terrorism disaster.”

He also warned that for both the US Government and corporations, risk management often becomes less of a concern once the crisis has subsided.  

“We begin to decide that we are spending too much money trying to avert the risk, and we begin to degrade our preparation once again.” 

As we have seen with the escalating costs of the current financial crisis, risk management is certainly not an area to be penny wise and pound foolish.

An article in yesterday’s Washington Post provided some interesting details behind the collapse of Washington Mutual.  It appears that the Office of Thrift Supervision (“OTS”) failed in its job to provide effective oversight by allowing executives at the nation’s largest savings and loan institution to ignore the advice of its own risk managers.  Here is an excerpt from the article.

In 2005, a small group of senior risk managers drew up a plan that would have required loan officers to document that borrowers could afford the full monthly payment on option ARM loans. The plan was shared with OTS examiners, according to a former bank official who spoke on condition of anonymity because the bank’s practices are the focus of a federal investigation as well as several lawsuits. ”We laid it out to the regulators. They bought into it. They supported it,” the former official said.  But when a new executive team at the bank nixed the plan, the former official said, “the OTS never said anything.”

This is another example of the breakdown in regulatory oversight and management that fueled the current financial crisis.  It also shows that what is needed most is not necessarily more regulation, but more effective regulation.