ELEMENTARY MY DEAR...

So I slept on it...and slept and slept.

Got a call from a buddy

"You were wandering in you thoughts."
"No *&^% Sherlock."
"It's elementary, really."
"Oh is it?"
"Yes of course it is. Your point is that if you leave it to machines and formulae you ignore the greatest human strength."
"Which is?"
"What is found only in humans but often lacking."
"Common sense?"
"Of course. As I said, elementary."
"*&^%!"

He was right of course. It matters little who or what is appointed or designated as the overseer of risk. It all comes down to the INDIVIDUALS performing the task and their experience, not only with the area, the products but with the people involved. Let me explain:

A baseball manager with a man on first and needing a run to tie the game may well leave it to the runner as to whether he attempts o steal second based on the runner's experience and past performance. A risk manager may well, within agreed maximum perimeters, allow considerable more leeway to one individual than to another. In a sense, the first law of banking, "know your customer," is applied to the most important level of action within the institution, the art of taking risk. BUT, this requires substantial experience and knowledge; the risk managers within an institution must be among the most professional and knowledgeable of all employees. I am afraid that in some cases that is not always the case or that risk management, while deemed important, is actually regarded and compensated as a lesser job where no rain makers are found. Profit and the making of the same is all important.

Another problem is easily found upon inspection. There is often an enormous amount of pressure to, in all cases, get the deal done. This leads to the close calls that most often result in the problems that rise up only at a later date. Most deal-doers are convinced that they can structure their way around a problem and will go to great lengths to convince risk management that the issues raised have been resolved but their structuring brilliance. In some cases this is true; in others the result is layer upon layer of complexity that in itself creates addition risk that should never be undertaken. Sometimes the ultimate reward is worth the additional risk. Sometimes. The problem, however, is that too often every risk is deemed the ultimate deal. They never are. Intelligence and EXPERIENCE is what makes a really good risk management team.

There is another problem that is not often seen or recognized. Risk managers are like all other humans; they like to be loved and wanted. Saying "no" to colleagues with whom one shares a corporate existence or setting parameters which limit the taking or risk (and hence, profit and pay) is a difficult existence. A simple example from my past. I was asked to approve a simple risk on an interest rate swap for a western hemisphere country with whom we had little business. It was a one-off transaction that had no business being done for a variety of reasons (not the least of which was that the country was on the wrong side of the swap given the direction of interest rates). I approved the transaction nevertheless primarily because the risk to the institution was small but if I were to be honest because I liked my colleagues and wanted to help. This happens all the time. The desire to be seen within the institution as being "constructive" is a huge motivator as well. At the end of the day, all went well except for the country who would have been better off by not doing anything but as a wise man once said, "do not mislead a client, but if he is determined to make an honest mistake on his own that benefits you, accept the gift." Make your own call on that little gem.

In any case I think the function of risk management in financial institution should be as divorced from the general management line as possible. Risk managers should be independent, reporting to, perhaps, a sub-committee of the board and directed by a separate line of management. I would not at all be opposed to external direction of some sort. In the good old days in London, the Bank of England used to assign a retired senior British banker to newly opened foreign institutions in London just to make sure things were done the "right" way. Not a bad idea. For those institutions deemed to present a "systemic" risk (you know who you are) a cadre of risk managers in specific areas might be assigned by the regulator from a pool of proven professionals trained in risk management either independently or at oversight institutions, and their reporting line would be to the institutions not the regulator. Their pay, given their environment would be commensurate with the private sector levels in the institutions to which they are assigned. Remember, you pay peanuts, you get monkeys. They could even be moved between institutions after a period of time to insure independence. On Monday, J.P Morgan could have a risk manager who worked for Citibank on the previous Friday. Now wouldn't that be a kick? Think about it.

Coming up tomorrow, a little discussion on our girl friend Ms. Bair who, moving with her usual grace undoubtably planted the story on Citibank management problems in the WSJ last week, and other Potomac follies to which we have alluded. In the mean time the Supremes allowed the stay in the Chrysler bankruptcy this afternoon. Could it be that Ruthie, a lovely Yiddisha girl with her female experience came to a better decision than Rahm, a nice Yiddisha boy? We shall see.