Comments on: Regulations, Risk and the Meltdown

By: Edward Vielmetti

Edward Vielmetti — Tue, 14 Oct 2008 13:47:27 +0000

I note that the day of reckoning for Lehman credit default swaps is October 21, 2008, and that there's going to be awful lot of money changing hands that day.

By: Gunnar

Gunnar — Tue, 07 Oct 2008 11:48:13 +0000

“US banks are already intensely regulated under an alphabet soup”
I think this misses a key point – many of the institutions you listed Bear
Stearns, Lehman were not retail banks on a large scale and so not really
subject to all those regs. Sure, _retail_ banks are regulated, however they
are actually the large financial institutions that are faring the best.
Wells Fargo has a P/E of 19!!!!!
The Wells Fargo’s CEO take on subprime was – “I don’t know why banks needed to invent new ways to lose money when the old ones worked just fine.”
The derivatives books that are causing this mess were manifestly _not_
regulated. So the examples you gave actually show that the institutions that were more heavily regulated have fared far better (i.e. still in business) than the ones that were not.
The Sage of Omaha called derivatives financial wmd (notably, he said this 5 + years ago), and of course last week he said to Goldman and Wall St – all
your banks are belong to us. The guy is a case study in risk management. If
you study what they do, every move they make has 3 layers of protection.
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Warren Buffett:
AIG would be doing fine today. It was one of the ten largest companies in the United States in terms of market value, over 200 billion, the most respected insurer and everything in the world. If they never heard of the word derivatives, they’d be doing fine. They’d be going to work in the morning and they would have no troubles. But they — they — it was very easy to do, because it’s very tempting to write numbers on little pieces of paper and you can report the profit you want to, and there is no limit on it. I mean there is no capital requirements to it or anything of the sort. And basically, I said there were possibly financial weapons of mass destruction, and they had them. They destroyed AIG. They certainly contributed to the destruction of Bear Sterns and Lehman. Although Lehman had other problems, too.

By: beri

beri — Thu, 02 Oct 2008 10:14:04 +0000

Edward: I don’t think those traders “misunderstood” anything. They made a lot of money doing whatever they wanted. In fact, they are being investigated by the SEC and the FBI for collusion and whatever else they call it when traders sell their lies back and forth (and make money, as you point out, on every trade).
We don’t need regulation. We need to take back their ill-gotten gains and perhaps bring back the guillotine or the firing squad. They may not take stealing our money seriously but they do value their greedy pathetic little lives. Masters of the universe, my foot.

By: wordman

wordman — Tue, 30 Sep 2008 16:03:19 +0000

I don’t think the “risk” part of GRC falls by the wayside because of budgets; it falls by the wayside because it’s really flippin’ hard.
In order to manage financial risk properly, you not only have to be a lawyer, an economist, and a statistician, you need to be a GOOD lawyer, a REALLY GOOD economist and an AMAZINGLY GOOD statistician.
Oh yeah… and you’ll never be able to tell if you got it right until everything goes to hell.

By: Edward Vielmetti

Edward Vielmetti — Tue, 30 Sep 2008 10:50:11 +0000

Mismeasurement of risk is a systemic problem, not one that’s isolated to the misfeasance or malfeasance of any bank.
The standard models for evaluating credit risk assume a binomial model of dispersion; they are just like Black-Scholes in that regard. There’s a systematic underestimation of the likelihood of unusual events, and a systematic and willful ignorance of correlation.
When Long Term Capital blew up it was in part because of unanticipated correlation in the markets; this one will eventually get diagnosed the same way.
There’s good reason in the short term for traders to misunderstand and simplify risk; they get paid on the transaction happening, but the firm (or the government) takes the risk of the blow-up.