Risk managers: guiding light or pesky whistle blowers?

BREAKING NEWS: Crosby has resigned from the FSA.

The watchdog has issued its own statement:

"The Financial Services Authority can confirm that specific allegations made by Paul Moore in December 2004 regarding the regulatory risk function at HBOS were fully investigated by KPMG, which concluded that the changes made by HBOS were appropriate. The chairman of the FSA will write to the Chancellor of the Exchequer by the end of today, setting out the details.

"Sir James Crosby has decided to resign from the board of the FSA, for the reasons he has set out in his public statement, and we would like to thank him for his very significant contribution to the FSA over the past few years."

"...if there is a question about the value of a position or a disagreement about a risk limit, the risk manager’s view should always prevail"

Would it not be better if Directors and senior executives could say:

"... if there is a question about the value of a position or a disagreement about a risk limit, my view will prevail"

Paul Moore applied the traditional approach to risk management. This approach usually results into a conclusion by the traditionalist to advice against the product or project. He sees a high risk, therefore, don't do it.

When all the other banks are profiting from the issuance of sub-prime mortgages and have been reporting record corporate growth, does one really think that a cautious advice from a Paul Moore (i.e., that HBOS expanding too quickly and its aggressive sales culture) would make any bank think twice in taking the same high risks as the other main street banks are taking? The higher the risk, the higher the profits and man, were they raking in the bucks! Of course, the likes of Paul Moore were considered roadblocks to profitability.

Raising the status of risk managers from roadblocks to guiding light is hardly the answer.

I just read another article in which Paul Moore is blaming Gordon Brown as well for this financial crisis. If Paul Moore truly had a messianic view of this economic tsunami (which not only affected HBOS), then he should have raised it with the FSA.

History teaches us that after 1929, that SEC (independent agency of the US Government) was established to be that watchdog. In the UK, the equivalent body is FSA, although accountable to Treasury Ministers, its financed by financial services industry. We also became dependent on Credit Rating Agencies (that issue ratings for debts of corporations) which I suppose measures the risks some way or another. But these CRAs are amazingly slow to downgrade their ratings ("March 25, 2008 - Standard & Poor’s (S&P) is considering downgrading its ratings on Goldman Sachs and Lehman Brothers. The credit rating agency is concerned that volatile markets will reduce profit at both investment banks this year. S&P is predicting that in 2008, the banks could post profit that is between 20% and 30% lower than in 2007. It has already revised its ratings outlook for each bank to negative.")

In 1933, Glass-Steagall Act was passed by US congress. This Act banned connections between commercial banks and investment banks. Since 1933, the regulators have also softened on some of the separations of securities and banking functions.

During the heady days of exponential potential growth and irrational exuberance brought on by the Internet economy and the IPOs that went along with it, this collusion (of institutional investors and underwriters) was observed to have created the stock market bubble. If we harness the relevant statistics, perhaps we will find that sub-prime started at about the same time as the stock market bubble.

When all the banks are doing the same sub-prime deals, then I think it's Government regulators' position to be savvy enough to forecast the results of the high risks that these banks were taking.