The year in Risk - 2010's most memorable moments!

In order to sustain your 'rapt' attention, this years list has been limited to 5 items......making the selection process quite a challenge, given a myriad of choices.

If nothing else, 2010 taught us that ignorance, avarice, and bluster far outranks common sense and pragmatism in the field of human endeavor when it comes to Risk management. Some events this year were almost Darwinian in their manifestations - assuming that Darwin foresaw that some of the survivors of these events would be returned to their maker through repetition of the same mistakes.....at least eventually.

So lets get on with the list...........enjoy!!!

In no particular order the TRC 2010 nominations for Risk Management awfulness (if there is such a word!) go to:

1. Oracle - Everyone hates Oracle, but that's not really the point.  The point is that if you really don't know what you are talking about, buy it and then claim you invented the subject. Oracle, you are the best, which makes your mercurial boss whose foot seems permanently lodged in his mouth, all the more wonderfully absurd. Just go to the Oracle site and admire the view courtesy of Logic Apps, KPMG, Fusion Apps and a lot of smart hired guns opining on the subject of GRC (Governance Risk and Compliance) which was undoubtedly invented all by Oracle...hmmmmm .... I remember not a single reference to risk management when I tried to find one on the Oracle site in 2005, but that's ok, because Risk Management was just invented by ......remember, Oracle of course!   

     

2. JP Morgan. This one's a real "head shaker" and a clear leader in that category. Not   satisfied that the common man was quite upset enough by the hubris of proprietary trading of large Banks - of course, now theoretically curtailed under the Dodd Frank Act - it turns out that JP Morgan and its beneficiaries are in fact the owners of GBP1Billion worth of cooper according to the London Metal Exchange. That's just over 50% of all the copper stored in London. Bad enough even if they had cornered the market with mostly client ordered trades (ever heard of the right to say NO, guys!), worse still is the fact is that JP Morgan is one of the banks starting an EFT specifically to cover, yep you guessed it....Copper.....
Great PR, great COI, could it ever be more obvious that there is something odorous going on here. "Prove it", will say the lawyers, once everyone is "lawyered up" after the inevitable disasters (ie clients losing money at the expense of everyone except the bank). Somehow the mal odor seems quite enough burden of proof!      

3. HSBC. Nice job HSBC in managing Bernie Madoff's trades, steering his feeder funds and touting the scammers wares. Over a ten+ year period, HSBC cleared trades on the weekend, sanctioned Madoff accounts that were parked in Government securities funds whose name had changed years before and settled trades that were actually outside the price ranges on the trade dates. A case of big fees and blind eyes perhaps!! There cant be a conflict of interest here surely.............. ?

 I would like to call HSBC a bunch of crooks or idiots but I think that should be up to the judiciary who will in time, I'm sure, be much more eloquent in its damning of the bank, and extract a fair amount of restitution for its beleaguered clients. Then there's the fine and punitive damages.....it would be fun to watch if it weren't for the fact that so many innocent bystanders were caught up in the frenzy of greed .     

4. Goldman Sachs. No self respecting list of Risk management bloopers should ever be  without an entry for the "Bank of Greed". Hardly has the dust settled over the $550 million settlement on 15th July 2010 of the SEC action alleging manipulation of the Sub Prime market in colusion with their pals at Paulsen & Co. that the august firm is back firmly in the headlines yet again. This time star trader Michael Swenson was uncovered as the thug identified in the 2007 manipulation of credit default swap prices for MBSs in an attempt - ultimately successful - of keeping the swaps prices low so that Goldmans could load up on insurance while betting against the securities.

"So what", you might say, "no big deal", just about what was expected of Goldman in the bad old days before the crash.

Yeah, absolutely, but with a slight difference and implication for the future. You see, most mortals usually have a consequence to pay for patently unacceptable practices that earn the distain of regulators, scorn of the public and distaste of the markets. Not so at Goldmans apparently.

The fact is that the July 2010 settlement was made with no admission of guilt on behalf on Goldman (sorry guys but  $550 million of 'innocence' just doesnt cut it!). The revelations of Mr Swenson's disgusting behaviour (you have to read the emails!)  didnt exactly hurt him. Still firmly ensconced as Managing Director of the structured Products group at Goldmans, Mr Swenson apparently enjoys the full support of his employers.

Goldams official response to the uncovering of Mr Swensons activities during the Financial Markets crisis congressional hearing last Wednesday 8th December 2010.....

“This type of language sounds awful and is very disappointing, but it does not reflect the reality of what happened. There was no short squeeze.”

So Goldman, what do you about the awful and disappointing bit? Same as the Paulsen deal, same as Lloyd Blankfeins response to the Wall Street pay revelations? 

"Contrition, contrition, contrition......then wait, hold breath, hold a little longer, problem goes away. Stupid public has no retentive memory, it will be ok." May be that isnt quite verbatim from the Goldman Sachs operations manual, but i will bet that is pretty close!

And yeah, we are pretty stupid, us members of the public. But one day, just one day, you will make us just mad enough about your belief that a few moments of contrition can overcome any act of financial chicanery that someone is going to come and drag you all you from your towers and put you where you belong ...in jail

Goldman Sachs can and will survive and prosper, but only when it truly understands that reputational risk is more deep seated than it knows.  

5. France - The Judicial System x 2. This year, France has truly outdone itself. And of course, being English, it is my prerogative to lambast our cross channel neighbors and allies (even if I happen to do so from the US):

a. Societe Generale verdict - Poor Jerome Kenviel - seems like - according to the Parisan Judge - that all Soc Gens trading woes were his fault and his alone. How gallicaly absurd! In the judicial summation it was acknowledged that the Bank's controls infrastructure was weak and defficient, and that management supervision was 'lacking' in Kerviel's case. 
So......Bank good, Employee bad. Parisian judge real stupid!!

b. After 10 years of wrangling the July 2000 crash of the Air France Concorde that tragically took the lives of 113 people was squarely blamed on Continental Airlines (An American company!) . The ruling made by a Paris court found that Continental Airlines Inc. was “criminally responsible” for littering a piece of metal on the runway of Charles de Gaulle airport. The metal punctured a tire on Air France Flight AF4590 and spewed debris into the jet's engine, sparking a fire that downed the Concorde with catastrophic results.

Continental's lawyer, Olivier Metzner, denounced the ruling as one "that protects French interests exclusively" and said he would file an appeal. No kidding!


I can quite understand how, in French eyes at least, nothing could ever be blamed on, well, the French! But come on guys, think about the implications for air safety.


The US FAA, UK's CAA and European JAA have all spent the past 15 years setting up anonymous 'no fault' mechanisms to allow the reporting of near accidents precisely so that unintended mistakes can be exposed and rectified before they result in catastrophe. What this ruling does is to put every one of these potential incidents going forward back deep into the mental recesses of the reporters, never to be aired again. And that will inevitably result in avoidable accidents becoming tragedies precisely because the French courts frightened the responsive and the responsible out of doing trhe right thing.


Next fatal aviation accident of anything, anywhere, I say we sue France!


So on that joyful note, it's Happy Holiday Season to all!


May 2011 be a beacon of hope in the annals of Risk, because there is surely an ocean of opportunity to improve upon a wretched 2010!   

I learned from that......

Flying is fun, flying is absorbing, but once in a while flying can be downright scary!

So why is a story about flying weaved into a risk management blog you might ask?....For the skeptics among us who cant quite make the connection between managing risk and flying, the 2008 FAA Instrument flying Handbook (pages 1-17 and 1-18) truly read like a risk management manual! Only what we know as MMM (Measure, Manage, Monitor) the FAA calls PPP (Perceive, Process, Perform).

Even the FAA's PPP process continuum map looks eerily similar to the circular MMM process maps so familiar to risk managers....  


One major error in the skies may be one's last, but there are many ways to avoid that one mistake. The PPP approach is designed for that purpose, as is the more sophisticated DECIDE model below:





  

Now the story...

I have a flying license but I am a novice. Let's get that out of the way. With 190 hours on the clock, I have now actually figured out that I am neither the Red Baron nor do I know everything ever written about flying. But I am careful. What happened this summer in Maryland over the Chesapeake Bay started as really scary, and ended up being yet another lesson in applying consistent principles to assessing risk.

It was a fine late summers day. With calculated fuel burn after a long flight (long by the meagre standards of the minuscule 3/4 ton Diamond DA 20) requiring 18 gallons to refill the tanks to overflowing after landing (note here the capacity is 24 gallons which means I arrive with 6 gallons or 50 minutes of flight time in reserve), the fuel truck is called after a day of fun and apparently safe flying.

As the refuellers flow meter passes, 18, then 19, then 20 gallons delivered, my smug self satisfied demeanour is replaced by horror in knowing that not only was I wrong about the amount of fuel remaining, but that I nearly went for an unscheduled swim, having spent the last 20 minutes of flight over water. Overall 22.5 gallons were loaded on boar, suggesting around 15 minutes of flying time remaining - the sort of 'Oops' moment that gets airline pilots fired, and keeps the FAA 'enthralled'.

But how come such an egregious mistake....i am getting a little long in the tooth but not so old that I cant do simple math to figure out fuel burn in what amounts to no more than an aerial Moped (a nice one, but still no F15!). The math was correct; I should have had 6 gallons remaining, but the evidence suggested otherwise. 

The fuel tank was the size it was supposed to be in the books, the fuel burn was accurate, and everything else checked out (ie fuel measure before and after flight, engine performance etc.). Three weeks of self doubt and mild paranoia passed before the inconsistency was resolved. It was accomplished using a PPP analysis of all the components of the flight and the clue to the resolution is as follows:

The DA 20 is a low wing aircraft.....     

$20 to the first person who solves the mystery before we reveal the answer in 2 weeks time! 

Process first ......and the numbers will follow

Bad banks, lousy banking, and no one properly watching the store.

Case in Point Allied Irish Banks (AIB) in Ireland or further east, Hypo Group Alpe-Adria in Austria. After nationalization of both institutions amid bailouts of €25B and €3.75B respectively, the governments are trying to get to grips with:

1. Crappy loans 
2. Crappy loans to the wrong sorts

Admittedly AIB may not be in the same league as Hypo who stand accused of close ties to Balkan crime organizations, but the premise that while government intervention and re-financing in both cases may eventually get them through European stress test on the numbers alone, no amount of number crunching will ever reveal just who got lent to, why, and what the long term outcome of such practices are......

The point? It really doesn't matter who or what the institution is, or what the numbers need to look like to pass regulatory scrutiny, the soundness of a banks business (or indeed any custodian, or fiduciary) depends ultimately on how it manages the processes around what it does and what the likely outcomes are.

Basel III as it now expected to be enacted is probably adequate for its numbers, but it can only ever be a part of the picture, not the whole. Markets have repeatedly defied the trust of government in an unregulated environment to act in a judicious and responsible manner. Why should we ever expect that markets should change their tune unless the incentive to do so exists. Valuing assets against "capital tiering" criteria is proven to be a broken model. Maybe its time for a far more systemic evaluation of business operational practices - in reality, Enterprise Risk Management applied in its widest possible context. After all, the risks we are most afraid of are systemic in nature.........

I DO NOT work for The Keane Organization!!

I know that, and hopefully most others, if not all, do now too. But it seems that the The Keane Organization may still be a little confused about that!

Just to set the record straight, my employment relationship with Keane came to an end on 18th May 2010.

Apparently, I was on vacation or otherwise unavailable and actually still headed the BRMS division of Keane from 18th May until Mid June according to what Keane was saying verbally, and in published materials. That was not correct. 

I DO NOT work for the Keane Organization, nor do I endorse ANY statements or assertions they make concerning their abilities or qualifications in the area of Risk Management. What is still on their site today, relating to Risk Management may or may NOT be consistent with their experience in Risk Management, but whatever it is, it is nothing that I am associated with. 

I do NOT have any interest, residual or otherwise in the Keane SCORE application. The original application team, including vision, design, and all key application development components is NO longer employed by Keane.  



What I do have going forward is far more interesting....Teuten Risk Consulting is up and running and open for business. Check us out at http://www.teutenriskconsulting.com/.  

We are an outsourcing Risk management and due diligence analysis service with a simple mission: to make you and/or your clients businesses more secure, more defensible, and more transparent to shareholders, regulators, customers, partners and current and prospective stakeholders. 

We are drawing on all our many years of experience to provide a service that is second to none with knowledge and expertise that is unique and unparalleled in the industry. 

What ever it is that Keane are now offering, please be assured that it is NOT anything to do with me personally, or in any other capacity. I sincerely apologize if anyone feels they have been mislead over this issue. However, any such assertions are made without my knowledge and certainly without my permission or endorsement.  

Measure, Manage, Monitor - The reality!

For those of us sufficiently familiar with "Star Trek: The Next Generation", the diagram below is really not the Borg!

Sadly, though, many organizations treat the concept of putting in place a few robust processes mapped to a risk and controls matrix as if it were. The Borg was bad, MMM is good - lets just get that one out of the way early!  

    

So whats so good about MMM.........well imagine that you are (which you may indeed be!) a risk manager or compliance director (or CTO, CCO CIO or actually anything with a C in it!) and that you are besieged by regulators, shareholders, markets, customers and internal stakeholders and they all seem to want you to show that you are following every regulation, managing risk 'effectively' and are generally better than anyone else around you.

Sound familiar? Sound almost impossible?

Well it really isn't, thankfully. Not because this MMM concept is a new form of intelligence (sic The Borg!) but because it moves all functions into a best practices step processes, and using a series of associative algorithms (nothing genius here, just joining dots with cause and effect conditions) it becomes possible to prove that a business or indeed any entity is "doing the right thing" which is the key not only to defensibility but to a better business all around.

So, next time you hear a Quant expound about Black Scholes anomalies, or VAR interdependency or even Sochastic variable inconsistency, its ok to continue to look dumbly at the source (as i still do!). Why: because other than not knowing what they are talking about, you should also know that the people that need to know what the Quant is saying (and upon whose evaluation your and my future depends!) are likely to also be as blissfully clueless about what is being imparted. More importantly they will give so much more credence to "doing the right thing" and proving that they have done so than being given reams of sometimes meaningless, and often at best confusing, data.  

Of course, the secret to MMM is not actually in the diagram....................  

If you were to "Google" Measure, Manage, Monitor you will get approximately 22,200,000 hits. Funny how the best and smartest concepts are so copied. MMM was a concept I authored in 1999, no less (with the documentation to prove it, of course!). Love to see that Microsoft, IBM all so many other good folks flatter me with their plagiarism!!! 

Credit default swaps.....Just like Vegas!

What if, what if, what if..........                                                          

What if the safety blanket were 12" underneath the picture!

Then no one gets hurt, of course; but we the casual observers don't know that.

And that, ladies and gentlemen is how credit default swaps are traded! Rightly or wrongly, he who has the greater picture and the ability to legally disguise the outcome always has been, is now, and always will be, the winner.

If that sounds a little contrary, consider that under existing SEC rules neither of the parties in the trade need be the guy on the tightrope, so that anyone gets to play the game if they have the nerve. Just like Vegas, really.

The market's justification for this? The same tired old argument of creating market liquidity to enable efficient deployment of capital.... strictly,of course, for those with VERY short memories!

Lest we forget: Liquidity curves become parabolic exactly because of capital flights which are every bit as likely as orderly flows, especially in a fast paced trading environment. Add in the ability to create 'interest' in an outcome when there is inherently none, and the parabola effect is multiplied to the extent of the additional liquidity infusion.

In plain English. Everyone can bet on what they want, and everyone can trade with the bookies - and this will all work great as long no one has to wind up their position without having enough cash to cover it.

Oops.......not so likely, after the SEC agreed in 2004 to the Net Capital rule which increased the overall leverage of the "Big Five" Wall Street brokerage houses to an average of 33:1 within 18 month. Yep, the same guys making the book.   

What has all this to do with Risk Management? Well, rather a lot actually. 

Perhaps if the traders had:

1. Looked beyond the picture and considered that the security of their counter parties (ie the blankets under the tightropes!) were potentially as frail and exposed as they were

2. Understood that covering their own positions could only happen with liquid assets unrelated to the market that triggered the need in the first place.     

......then much market volatility could have been avoided.

But human nature won the day. Mans need to get ahead of man for the immediate win will always instigate the Parabolic liquidity trap in any market unless order exists alongside the free flow of information.

The former implies much regulation, the latter that all trades are made with equal knowledge - both counter intuitive to the concept of freely competitive markets. Let's see our Global brains trust dig us out of this one. If the CFTC rules being written to regulate OTC derivatives as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act truly engage and compel markets to properly assess risks before their impacts occur, maybe just maybe history will not once again repeat itself quite so soon.