Financial Crisis Awards

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Now that Oscars season is upon us (and now that chief risk officers finally have their day in the Hollywood spotlight, thanks to ERM guru Demi Moore), it's time to unveil the award nominees for the 2011 Financial Crisis Inquiry Commission Report.

The report, released this week, is a doozy: lengthy, detailed, contentious (commissioners who dissented with the report published their reasons why), and engaging. The 14-page conclusions section marks a good place to begin if you can't devote hours to reading through all 662 pages.

This report calls to mind the 9/11 Commission Report in its tone and scope (which in no way suggests that I'm comparing the loss of $11 trillion in U.S. household wealth to the loss of lives on Sept. 11, 2001). That said, I think this narrative qualifies as required reading for all finance and risk professionals in all industries.

The following awards highlight some of the most compelling findings, insights, and sentences in the portions of the report I have read so far (Conclusions, Dissenting Views, Part I, and Part V):

Best Pull Quote: “In this instance, too big to fail meant too big to manage.”

Worst Compensation Strategy: Compensation systems — designed in an environment of cheap money, intense competition, and light regulation — too often rewarded the quick deal, the short-term gain — without proper consideration of long-term consequences. Often, those systems encouraged the big bet — where the payoff on the upside could be huge and the downside limited. This was the case up and down the line — from the corporate boardroom to the mortgage broker on the street.

Best Measure, Horror Category: By one measure, their leverage ratios were as high as 40 to 1, meaning for every $40 in assets, there was only $1 in capital to cover losses. Less than a 3 percent drop in asset values could wipe out a firm.

Worst Acronym: GSE: government –sponsored enterprises (e.g., Fannie Mae and Freddie Mac)

Best Pull Quote, Runner-Up: “We had a 21st-century financial system with 19-century safeguards.”

Best Dissenting View: Commissioner Peter Wallison, a lawyer and American Enterprise Institute fellow, who notes that “the Glass-Steagall Act, frequently cited as an example of deregulation, had no role in the financial crisis. The repeal was accomplished through the Gramm-Leach-Bliley Act of 1999, which allowed banks to affiliate for the first time since the New Deal with firms engaged in underwriting or dealing in securities. There is no evidence, however, that any bank got into trouble because of a securities affiliate. The banks that suffered losses because they held low-quality mortgages or MBS were engaged in activities — mortgage lending — always permitted by Glass-Steagall; the investment banks that got into trouble — Bear Stearns, Lehman, and Merrill Lynch — were not affiliated with large banks, although they had small bank affiliates that do not appear to have played any role in mortgage lending or securities trading.”

Best Performance by a Villain: "… Over the past 30-plus years, we permitted the growth of a shadow banking system — opaque and laden with short-term debt — that rivaled the size of the traditional banking system."

Questionable Performance by a Regulator: Days before the collapse of Bear Stearns in March 2008, SEC Chairman Christopher Cox expressed “comfort about the capital cushions” at the big investment banks.

Least Ethical Performance: The number of suspicious activity reports — reports of possible financial crimes filed by depository banks and their affiliates — related to mortgage fraud grew 20-fold between 1996 and 2005 and then more than doubled again between 2005 and 2009. One study places the losses resulting from fraud on mortgage loans made between 2005 and 2007 at $112 billion.

Best Case for Addressing Risk Culture in 2011: “It was the failure to account for human weakness that is relevant to this crisis.” ###

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GRC expert Eric Krell supplies the Business Finance community in-depth articles and commentary examining governance, risk, and compliance.

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