Lessons from the creditcrisis
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For a Few Dollars More
Lessons from the Creditcrisis
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Human Ruin by Peter Callesen.
Why did banks fail?
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Estimated losses• Latest estimate IMF
– April: 4.000 billion dollar
– January: 2.200 billion dollar
– April 2007: 1.100 billion dollar
• Write-downs until now– 1.290 billion dollar
(Bloomberg)• 30.000 billion dollar
loss in share prices
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Just an example
Lost 31 billion Euro in 2008
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In perspective
Gaza: estimated cost of rebuilding $2.8 billion
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Explanations?
“Like many other financial institutions, Lehman Brothersgot caught in this financial tsunami.”
Richard S. Fuld, CEO Lehman Brothers
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Explanations?
“We are all struggling to understand how this crisis happened in the first place and to find out what might have prevented it.”Martin Sullivan, CEO AIG
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Explanations?“Nobody could expect that a number of financial institutions, like Lehman, AIG en Washington Mutual, would collapse, and that the stock exchanges would reach such a low level. Our dikes are high, but they appeared not high enough for this financial tsunami.”Michel Tilmant, CEO ING
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Tsunami?
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Too much risk
“The situation we find ourselves in is to a great extent a product of banks - all over the world - taking risks that they should not have and which in many cases they did not even understand. And governments all over the world are having to take action to deal with this.”
-Press release UK Treasury, January 19 2009.
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Leverage
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NINJA-mortgagesThe $103.000 shed
Marvene Halterman, 61 years old Long history of drug and alcohol abuse, 13 years unemployed
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European banks are also over
leveraged
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Bank executives earned a lot of money
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Renumeration 2003-2007• Fuld (Leman
Brothers)– $256 million
• Lewis (BOFA)– $133 million
• Dimon (JP Morgan)– $108 million
• Blankfein (Goldman)– $102 million
• Purcell (Morgan)– $95 million
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But not only the board . . • Twenty year old
analist:– Base salary:
$250.000– Bonus: $250.000
• Thirty year old trader:– Base-salary:
$180.000– Bonus: $5 million
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Basic theme“As long as the music is playing, you’ve got to get up and dance. “We’re still dancing.”-Chuck Prince, CEO Citigroup, August 2007.
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AIG: “Blind Eye to a Web of Risk“
• AIG Financial Products– Credit Default Swaps: 513 billion dollar on
CDO’s– 17.5% total profit AIG in 2005– Operational profit 83% of revenue– Average bonus; 1 million dollar per person
(377 man)– Loss: 25 miljard dollar – Total salary Mr. Cassano: $280 million in 8
years
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Lessons• Better linkage with
organisational performance
• Better balance between salary and bonus
• Focus on long-term• Payments must
deferred until until profits have been realised
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Riskmanagement and Internal Control
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“We’ve got the right people in place as well as good risk management and controls.” E. Stanley O’Neal, CEO Merrill Lynch 2005.
Management “In control”
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Management “In control”“Our job is to set a tone at the top to incent people to do the right thing and to set up safety nets to catch people who make mistakes or do the wrong thing and correct those as quickly as possible. And it is working. It is working.” -Charles O. Prince III CEO Citigroup, 2006
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Management “In control”“Almost no one expected what was coming. It’s not fair to blame us for not predicting the unthinkable.“ -Daniel H. Mudd Former CEO, 2008
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Management “In control”“The board can't run the risk book of a company.The board as a whole is not going to have a “granular knowledge" of operations.”-Robert E. Rubin Director Citigroup, 2008
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What is happening here?
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That’s an awful lot of weed!
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Growth in CDO’s
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Did anyone see it?“The management of market risk and credit risk has become increasingly sophisticated. … Banking organizations of all sizes have made substantial strides over the past two decades in their ability to measure and manage risks.”-Ben Bernanke, FRB speech, 12 June 2006.
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We have systems!!!!!!
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Sox 404? 2007 2008
Citigroup: V VJ. P. Morgan Chase: V VBank of America: V VBear Stearns: V n.a.Goldman Sachs Group: V VLehman Brothers: V n.a.Morgan Stanley: -/- VMerrill Lynch: V VAIG: -/- n.a.RBS: V, but exception ABN AMRO V, butLloyds TSB Group: V n.a.HBOS: -/- merged Lloyds
TSB)Barclays: V VHSBC: V, but VDeutsche Bank: V VUBS: V VCredit Suisse: -/- V, butING V VABN Amro V VAegon NV V V
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AIG• PWC: material weakness relating to
risk management AIGFP (november 2007)
• Office of Thrift Supervision– Lack off 'critical elements of
independence, transparency, and granularity' (March 10, 2008).
• Annual report 2007 approved by auditor
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UBS AG“UBS was not aware of the extent and the nature of its risk exposure to the Subprime mortgage and related markets until the beginning of August 2007, and was thus unable to take appropriate measures in a timely manner ” -Report Swiss Federal Banking Commision, 30 seotember 2008
But they declared otherwise in their Sox 404 statement!
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Citigroup“But many Citigroup insiders say the bank’s risk managers never investigated deeply enough. Because of longstanding ties that clouded their judgment, the very people charged with overseeing deal makers eager to increase short-term earnings — and executives’ multimillion-dollar bonuses — failed to rein them in, these insiders say.”-New York Times, 22 november 2008
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Risk and profit
Two sides of the same coin
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Observation• Problems especially
in new financial products
• Why did Riscmanagement fail?– Insufficient
knowledge?– Wrong risk models?– Warnings ignored?– Or all of them?
• Freddie MAC– CRO warns CEO in
2004 for NINJA mortgages
– Response• You are fired
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Supervision?
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Bernie Madoff• Fraud $50 billion• Auditor: Frieling
& Horowitz– 2 employees– Not registered
PCAOB– No supervision
by AICPA
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David G. Friehling CPA
Office Friehling & Horowitz
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Non-executive directors?• Insufficient
supervision– Lehman
• Finance and Risk Management Committee only met twice a year
– Members with no Wall Street experience
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New trend?
• UBS appointed three new board members with financial expertise
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Rating Agencies“These errorsmake us lookeither incompetent at credit analysis or like we sold oursoul to the devil for revenue, or a little bit of both.”A Moody’s managing director in an internal management survey.
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Reliable Ratings?The real problem is not that the market …underweight[s] ratings quality but rather that in some sectors, it actually penalizes quality. … It turns out that ratings quality has surprisingly few friends: issuers want high ratings; investors don’t want ratings downgrades; short-sighted bankers labor short-sightedly to game the ratings agencies. “Unchecked, competition on this basis can place the entire financial system at risk.”-R. McDaniel, CEO Moody’s.
In one document, an S&P employee in the structured finance division writes: “It could be structured by cows and we would rate it.” In another, an employee asserts: “Rating agencies continue to create [an] even bigger monster — the CDO market. Let’s hope we are all wealthy and retired by the time this house of cards falters.”-Hearing on the Credit Rating Agencies and the Financial Crisis
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Final shootout
The good, the bad & the ugly
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Important lessons• We must end remuneration structures/bonuses
of banks being characterised by excessive short-termism. This neither supports prudent risk management nor works in owners’ long-term interests
• Risk management departments in banks must have much more influence, status or power
• A fundamental role of the board is to provide oversight, direction and control but also to challenge where necessary. Banks need more and better qualified non-executive directors.
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CVProf. Dr. R. A. M. Pruijm CPA is management-consultant, interim-manager and professor emeritus Accounting Information Systems at the Erasmus University Rotterdam. He was recently appointed as part-time lecturer Corporate Governance at the Fontys Professional University. He is a well-known expert in corporate governance, corporate social responsibility, and business ethics.
Corporate governance is a generic term that describes the ways in which rights and responsibilities are shared between the various corporate participants, especially the management and the shareholders. Corporate governance is about promoting corporate fairness, transparency and accountability.Corporate social responsibility is about open and transparent business practices, that are based upon ethical values and respect for employees, communities, and the environment, designed to deliver sustainable value to society at large and to shareholders.
For over 30 years Professor Pruijm has been speaking to top level business executives and organizations all over the world. He is author of numerous books and articles, and is a regular guest on radio and television. As an independent observer and thought-leader he is frequently consulted by the press, politicians, and business leaders.
Office: Kievit 12 -113
5111 HD Baarle Nassau
Tel. 013 – 507 03 41
Mobile 06 547 36 391
E-mail: [email protected]