14 September 2009

26 Wall Street: Risk Management Ground Zero...

Today President Obama speaks from the same place in Wall Street that the U.S. government has some of it's roots as a nation. The topic on this anniversary of the demise of Lehman Brothers is risk management. This ground zero of managing credit, market and operational risk in one of the financial capitals of the globe brings several topics to the discussion table. Liz Moyer makes the point:

It's been a year since the $600 billion bankruptcy filing of Lehman Brothers and the financial market meltdown that forced the government into a multitrillion-dollar rescue of the U.S. banking system.

But for all the talk and hand wringing (and billions in direct government equity stakes in major banks and loan and debt guarantees) there's also been little real progress on how, or if, Washington might regulate its way out of this kind of mess in the future. Don't expect that to change anytime soon, as markets become more, not less, complex and interconnected.

If the American public has witnessed substantial up hill battles with reform for health care, they can be assured that the "Financial Services" lobby will be even stronger. The regulation of institutions such as so called alternative investment firms (hedge funds) has many of them already leaving the U.S. for safer havens overseas. The trading will continue and the people behind the unique investment vehicles are getting even more creative. Investors are now buying up the pools of insurance products that have to payout upon peoples deaths. Life insurance settlements are being bundled and sold just as toxic mortgages and the bets are on with these products, just as they were with the housing market. Are people living longer or dying sooner? I guess that depends on where you live, what you eat and what your family history is.

The creativity of trading new and exotic products will continue and the watch dogs will have their hands full trying to figure out where to regulate and what agency should have the oversight. Free market capitalism as the regulator has already proven that it doesn't work. Consolidation of agencies that focus on the regulation and compliance enforcement of the financial services and investment industry is a tremendous risk in itself. The systemic root cause of the greed, compensation exploitation and the financial product innovation lies with some very smart people. The same people who can make a major difference in managing risk in their institutions going forward.

Regardless of the instruments that are invented for trading and the people who trade them, they all rely on one thing. Software and escalating requirements for more computing power, Terabytes and Petabytes of storage and the operational risks associated with information moving around the planet at almost light speed. Information and bits of data that can influence decisions on the buy or sell strategies, is only as good as the mathematics and the algorithms coded into software.

The oversight of future financial products and the ability to take new offers to the market must have people looking at the math and the code. The systemic risks that erupted in the world markets over a year ago are a result of a complexity of systems and the speed of change in our connected economy. All of the transparency, accountability and reform of compensation packages will not impact the zeros and ones that make up the sophistication of the trading markets.

A single consumer financial protection agency will make the consumer feel better that the government is looking after them. It will modify behavior in the innovation and it may even close the gaps in the current rule sets. However, the operational risks associated with the confidentiality, integrity and assurance of information will continue to rise. These risks are consistently displayed in the public press and websites such as the Identity Theft Resource Center:

There are currently two ITRC breach reports which are updated and posted on-line on a weekly basis. The ITRC Breach Report presents individual information about data exposure events and running totals for a specific year. The ITRC Breach Stats Report develops some statistics based upon the type of entity involved in the data exposure. Breaches are broken down into five categories, as follows: business, financial/credit, educational, governmental/military and health care. Other more detailed reports are generated throughout the year and posted on a quarterly basis.

It should be noted that data breaches are not all alike. Security breaches can be broken down into a number of categories. What they all have in common is that they usually contain personal identifying information in a format easily read by thieves, in other words, not encrypted. The ITRC tracks five categories of data loss methods:

  • Data on the Move
  • Accidental Exposure
  • Insider Theft
  • Subcontractors
  • Hacking

Yet operational risks such as these are only a piece of the total risk management equations as it pertains to Wall Street, International Banking and the so called systemic risks talked about today as the Washington Post says:

Warning that "history cannot be allowed to repeat itself," President Obama urged Wall Street on Monday to help jump-start a stalled effort to overhaul the U.S. financial regulatory system and head off a potential reprise of the U.S. economic crisis.

Visiting New York on the first anniversary of the nation's biggest bankruptcy, Obama used a speech at Federal Hall at 26 Wall St., site of George Washington's 1789 inauguration, to rally support for regulatory reform and call on the financial community to take responsibility for avoiding the abuses and failures that led the nation into a financial crisis last year and triggered a global recession.

Our greatest threat is complacency as was indicated today in the context that we do nothing as a result of the failures of people, processes, systems and external events.

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