The ERM Current™

Yesterday, the CEOs of the eight major U.S. financial institutions testified before Congress on their participation in the Troubled Asset Relief Program (“TARP”).  One of the CEOs, J.P. Morgan Chase’s Jamie Dimon, pointed out the need for the modernization of the U.S. financial regulatory system.  Here’s his view:

“The ongoing financial crisis has exposed significant deficiencies in our current regulatory system, which is fragmented and overly‐complex. Maintaining separate regulatory agencies across banking, securities and insurance businesses is not only inefficient, but also denies any one agency access to complete information needed to regulate large diversified institutions effectively and maintain stability across the financial system. It also results in uneven and inequitable regulation of similar activities and products across different institutions.

I am in complete agreement with Chairman Frank that Congress and the President should move ahead quickly to establish a systemic risk regulator. In the short‐term, this would allow us to begin to address some of the underlying weaknesses in our system and fill the gaps in regulation that contributed to the current situation.

As part of a longer‐term modernization discussion, we stand ready to work with Congress and others to think through any number of complex issues. But waiting for the larger debate over regulatory reform to play out could take months. Every credible regulatory modernization plan includes the creation of a systemic risk regulator, and everyone agrees that this needs to be done – and done right away. I hope Congress will act to get this critical building block in place.”

A good portion of the stimulus bill before Congress should be dedicated to regulatory modernization and as Mr. Dimon suggests, invested immediately.

Yesterday, the U.S. House Committee on Financial Services conducted a preliminary hearing into the investigation of regulatory failure associated with the $50 billion Madoff Hedge Fund fraud.  Among those testifying was Leon M. Metzger, a Yale University professor and expert on hedge fund management.  His commentary included the following:

I wish to stress two things: first, the need for top-notch internal controls and second, that operational risk is the great unspoken danger.   A 2003 study of 100 hedge fund failures over a 20 year period concluded that 50 percent of hedge funds had failed due to operational risk…  When I was interviewed in August 2004 about teaching a hedge funds course at the Yale School of Management, I said that I wanted to emphasize good operational controls, which investors tend to overlook, and are essential to the success of an investment.  I was offered the job, and the importance of those controls is what I stress whenever and wherever I teach.  

Many risk experts fail to recognize the importance of strong internal controls, but they are (to use a football analogy) the “blocking and tackling” of risk management.  Without a solid internal control framework, any hedge fund, financial institution or corporation is likely to suffer a similar demise.  Wheelhouse Advisors can provide a no-cost diagnostic review of your internal control structure.  Visit www.WheelhouseAdvisors.com to learn more.

It appears that the US Congress is beginning to ask themselves once again why they voted for a hastily arranged piece of legislation.  In testimony yesterday to the US House Financial Services Committee, Treasury Secretary Paulson had a rough time explaining why he used his $350 billion “allowance” in a way that differed from the original expectations.  Here is what Rep. Spencer Bachus of Alabama, the panel’s top Republican, had to say:

“Changing too quickly, without adequately explaining why you’ve changed or what you’re going to do next, risks sending mixed signals to a marketplace that is in dire need of certainty and a sense of direction.”

In addition, American Bankers Association Chairman and CEO Edward Yingling said during the hearing,

“…it (TARP) is also a source of great frustration and uncertainty to banks. Much of the frustration and uncertainty is because of the significant and numerous changes to the program and misperceptions that have resulted on the part of the press and the public.”

The continued changes to the application of the rescue packages are leaving both Congress and our financial markets asking themselves the same question – “Which way is up?”  It seems no one knows the answer.