One of the telling stories in the sub-prime saga is about how Citigroup’s former CEO woke up to the bank’s problems. In September 2007, Chuck
Prince asks his CFO, Thomas Maheras, if everything was ok. Yes, everything is fine, Maheras reassures him.
That’s what Maheras has been saying for a while. Rather belatedly, it occurs to Prince to get the position double-checked. A risk management group is asked to examine the bank’s mortgage-related holdings. The truth soon comes tumbling out and Citigroup announces billions of dollars in losses.
So, is this how one of the top banks in the world managed risk? By relying on the word of one executive? According to a story in the International Herald Tribune, the senior risk officer and Maheras’ deputy were close pals, so the hard questions were not asked. That says something about the culture of the bank. If a man at the top keeps quiet, nobody else is supposed to ask questions.
At , the CEO, Richard Fuld, left risk management to a trusted deputy, Joe Gregory. Gregory apparently relied on ‘instinct’, not hard analysis, when it came to managing risk. A senior executive, steeped for years in the real estate business, warns him that things are getting out of hand. Gregory’s ‘instinct’ tells him he should get rid of the troublesome guy. Fuld goes along. The rest, as they, is history.
Just think of it. Citigroup had over $2 trillion in assets; Lehman Brothers $640 billion. And the decisions on risk or even information about risk exposures were confined to two or three people! Leave aside the board, even the people working in these firms had no clue what they had got into.
The problem with firms in distress today was not just that they had the wrong risk management models. It was not lack of talent either. It was that life-and-death decisions about risk were concentrated in a few people at the top. Autocratic decision-making is what destroyed many of the biggest financial firms in the world.
So let’s get this straight: risk management is not about fancy models or employing rocket scientists. It is an aspect of firm governance. If risk is to be properly managed, it is absolutely essential, first, that a large number of people within the firm should be involved in the risk-taking decisions. An even larger number should have the information on risk exposures.
When you see how the mighty have fallen in the present crisis, you begin to understand why a firm’s processes need to be democratic, why it is necessary to actively foster diversity and dissent. Doing so is not a matter of practising virtue.
It is simply a condition for a firm’s long-run performance. That was the theme of a magnificent business book that came out in 2004, The Wisdom of Crowds (James Surowiecki). And yet, as the failures in the present crisis clearly show, the modern firm remains one of the most undemocratic institutions in the world.
Prince asks his CFO, Thomas Maheras, if everything was ok. Yes, everything is fine, Maheras reassures him.
That’s what Maheras has been saying for a while. Rather belatedly, it occurs to Prince to get the position double-checked. A risk management group is asked to examine the bank’s mortgage-related holdings. The truth soon comes tumbling out and Citigroup announces billions of dollars in losses.
So, is this how one of the top banks in the world managed risk? By relying on the word of one executive? According to a story in the International Herald Tribune, the senior risk officer and Maheras’ deputy were close pals, so the hard questions were not asked. That says something about the culture of the bank. If a man at the top keeps quiet, nobody else is supposed to ask questions.
At , the CEO, Richard Fuld, left risk management to a trusted deputy, Joe Gregory. Gregory apparently relied on ‘instinct’, not hard analysis, when it came to managing risk. A senior executive, steeped for years in the real estate business, warns him that things are getting out of hand. Gregory’s ‘instinct’ tells him he should get rid of the troublesome guy. Fuld goes along. The rest, as they, is history.
Just think of it. Citigroup had over $2 trillion in assets; Lehman Brothers $640 billion. And the decisions on risk or even information about risk exposures were confined to two or three people! Leave aside the board, even the people working in these firms had no clue what they had got into.
The problem with firms in distress today was not just that they had the wrong risk management models. It was not lack of talent either. It was that life-and-death decisions about risk were concentrated in a few people at the top. Autocratic decision-making is what destroyed many of the biggest financial firms in the world.
So let’s get this straight: risk management is not about fancy models or employing rocket scientists. It is an aspect of firm governance. If risk is to be properly managed, it is absolutely essential, first, that a large number of people within the firm should be involved in the risk-taking decisions. An even larger number should have the information on risk exposures.
When you see how the mighty have fallen in the present crisis, you begin to understand why a firm’s processes need to be democratic, why it is necessary to actively foster diversity and dissent. Doing so is not a matter of practising virtue.
It is simply a condition for a firm’s long-run performance. That was the theme of a magnificent business book that came out in 2004, The Wisdom of Crowds (James Surowiecki). And yet, as the failures in the present crisis clearly show, the modern firm remains one of the most undemocratic institutions in the world.
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