A group of Wall Street executives released a report on Wednesday that outlined how the industry failed to foresee the financial meltdown of the last year and what companies can do to improve risk management.
The 172-page report (PDF), written by chief risk officers and senior executives at banks like Lehman Brothers, Merrill Lynch and Citigroup, also provides suggestions about technical issues at the same time as it offers a bit of a mea culpa.
“Virtually everybody was frankly slow in recognizing that we were on the cusp of a really draconian crisis,” said E. Gerald Corrigan, a managing director at Goldman Sachs and a chairman of the Counterparty Risk Management Policy Group III , which released the report.
Wall Street failed to anticipate how wide-reaching problems with mortgage bonds would spread into seemingly distant corners of the financial markets, the report said. Awash in easy money, banks doled out credit without sufficiently charging for the risk. Wall Street also created complex structures that masked connections between asset classes as well as compensation incentives that pushed traders to take risky steps for short-term gain. The industry’s failings have now translated into pain for the broader economy, the report said.
In many ways, the report acknowledged short-comings that have already been raised by Wall Street’s critics.
Mr. Corrigan, a former president of the New York Federal Reserve, formed the group in April to develop a private-sector plan for minimizing future problems in the financial markets. He said in an interview that he hoped the report’s suggestions would be adopted industry-wide within two years.
FT.com
Big banks seek to limit their own risks
By Aline van Duyn in New York
Published: August 6 2008 16:39 | Last updated: August 6 2008 21:08
Many of the world’s biggest banks are proposing reforms that would limit the size and scope of their businesses in one of the most dramatic responses to the credit crisis.
The proposals would hold down the number of investors who can buy complex financial products, bring large swathes of the derivatives markets into regulators’ sights and call on banks to spend more on technology and risk management.
“No one has any illusions [about the severity of the problems],” said Gerald Corrigan, managing director of Goldman Sachs and former head of the Federal Reserve Bank of New York, who led the study on which the proposals are based.
“Costly as these reforms will be, those costs will be minuscule compared to the hundreds of billions of dollars of writedowns experienced by financial institutions in recent months, to say nothing of the economic dislocations and distortions triggered by the crisis.”
Backed by banks including JPMorgan Chase, Merrill Lynch, Citigroup, HSBC, Lehman Brothers and Morgan Stanley, the proposals are being delivered to global regulators in the hope of producing rules for credit markets that would cut risk of contagion and restore confidence.
Perhaps the most unexpected proposals involve new criteria for the “sophisticated investors” allowed to buy complex financial products. Under the plans, even pension funds and other institutional investors would no longer be automatically allowed to buy bonds backed by assets such as subprime mortgages. All but the wealthiest retail investors would be barred from buying structured products, such as auction rate securities, a $330bn market used by municipalities and student loan providers to raise funds.
Mr Corrigan said the “markets had been sandbagged by complexity” and suggested the new rules would help ensure sophisticated financial products were only sold to investors with the resources and skills to understand and monitor them.
“Is this the death of securitisation?” he asked. “No. But it could mean a lesser degree of securitisation and other high-risk complex products. Is the lend and distribute model on the junk heap? No. This will change, not end, that business model.”
Mr Corrigan added that banks could be required to provide “multiple” billions of dollars in capital to back their promise to the New York Fed to create a clearing house for the $62,000bn credit derivatives market this year. The banks put their weight behind accounting changes to be introduced by 2010 requiring them to hold many complex products on balance sheets.