Hens Volunteer, Foxes Approve

A small piece in Forbes today reviewed the earnings report from Morgan Stanley, and noted yet another setup for the next big debacle.

When my second piece in the series on derivatives runs on NationalMemo.com, you’ll see that I have become even more cynical about the business of risk management at the big banks. (Was that possible?)

As I put it in a phone call today to a friend, “Let’s see, it must be almost time for another hundred-year flood since four years have passed since the last one.”

My co-author Danielle Reed and I lay out in the upcoming second installment of our series on derivatives how these “rare” events happen far too often to accept the risk models that imply they only come along every century or so.

Now it’s getting worse, and the regulators have already bought the modified myth.  That myth used to say you could measure your risk by looking back over just the last few years.  Morgan Stanley has boldly gone where no financial fool has been before by changing that look-back period to just one year.  What if, instead, they looked back 100 years to get an idea of what might happen once a century?

On the basis of their new risk measurements, the brilliant folks at Morgan Stanley can now assure us that they have quite a bit less money at risk than they did before they changed the model.  Am I the only one who thinks this is crazy?

Regulators stuck believing the Street’s own models.

It’s kind of horrifying to think that the regulators can’t and don’t independently verify or measure risk at our largest banks.  But that won’t be a surprise to anyone who has followed the history of outside verification.  For example, did you think that auditors value structured finance assets and liabilities?  If you believe that, you’re in for a surprise.  Like the bank examiners and SEC, they rely on the staff at the banks to run the banks’ own models to get their results.

It’s a matter of budgets and personnel, you see.  If we ever needed an example of “penny wise and pound foolish” it would be in the Congressional budget process that sees SEC registration fees as a happy little piggy bank that they can divert to other projects while doling out pennies to the staff charged with reviewing our securities markets and dealers.

These past few years, even after the Fed literally guaranteed many times the GDP in private debt, and the taxpayers got stuck with the bill for hundreds of billions at AIG and the “private” (read that “take the profits during the good years and run away in the bad years”) mortgage Agencies, we still have Congressional committees chaired by people who say the oversight committee is there to work for the banks.

To underscore their commitment to that principle of working for the banks, Congress significantly cut the requested budgets of the SEC enforcement and surveillance divisions.  All that while the fees generated by the securities business far exceed those requests for funding.

So what do the SEC staffers do?  The best they can under the circumstances.

They don’t have the billions Wall Street spends on systems, nor the half million or more in salaries that really good, really knowledgeable people cost.  They are stuck asking the industry itself to run its own models, and then asking questions, hoping to be convinced that those models make sense.

Imagine how (un)surprised I am to read that Morgan Stanley decided to drop its “look-back” period used to measure risk to just one year, thus NOT including the recent meltdown when measuring how bad it can be.

If I ever saw a way to guarantee the next meltdown or once-a-century event comes along sooner rather than later, this would be it.

As my friend Jim Kingsland would say — got gold?

But even if you do, get ready for it to be worth a lot less than you think.  When the next liquidity crisis happens, a lot of people will be selling their gold to cover losses elsewhere, since there always seems to be a price for the yellow metal, and sometimes there is no price at all for derivatives or even bonds or stocks.



One Response to Hens Volunteer, Foxes Approve

  1. Conscience of a Conservative says:

    Ah Morgan Stanley decides to weight VAR by the last four quarters instead of the past four years, which to everyone’s surprise increase earnings or should I say reduces the impact of tail risk. Not only does this make a mockery of VAR(which we all know is useless) , but proves once and for all that bank earnings and the accounting behind them are not worth the ink they are printed with. Let’s not even discuss the current and past treatment of reserves, and off balance sheet investments

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