Ten Years of Risk-Management Debacles

The best risk managers are judged by what doesn’t happen to their companies. They don’t have huge trading losses, their executives don’t get investigated for fraud, and the names of their institutions don’t disappear from the Street.

But when you’re in the business of taking financial risk, all your bets can’t be right. Sometimes the best you can hope for is that the self-inflicted damage is survivable.

Here’s a list of Wall Street’s greatest whiffs over the past ten years:

JPMorgan , 2012: a group of traders in the London branch of the bank’s chief investment officer unit make bets on an illiquid corporate credit-derivatives index, ostensibly to hedge the bank’s overall exposure to the markets. (Read More: JPMorgan Trader 'London Whale' Leaves - Source)

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JP Morgan Chase headquarters

After prices move against them, the trades wind up costing bank $5.8 billion and a public drubbing. (An additional billion or so remain on the balance sheet of the firm’s investment bank.)

The debacle also prompts Congressional hearings, an organizational restructuring, and the departure of CIO head Ina Drew. (Read More: JPMorgan Profit Declines on $4.4 Billion Loss from 'Whale')

Lesson: Don’t let traders browbeat risk managers in to standing down, and don’t assume market conditions won’t move against you.

MF Global, 2011

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MF Global

MF Global, 2011: the futures and derivatives trading firm files for bankruptcy protection in October after revelations of large exposures to troubled European bonds spur credit-rating agencies to slash its rating.

(Read More: Former MF Global CEO Jon Corzine Is Really Sorry But Wants His Notes Back)

The firm is later accused of misappropriating $1.6 billion in customer money that went missing in the days before the Chapter 11 filing as the firm fought margin calls, or demands for additional cash and collateral, from its creditors.

Lesson: Protect the firm from investments in risky assets, even sovereign entities, and segregate customer funds from those of the company.

Merrill Lynch, 2007-08

Merrill Lynch, 2007-08: Nearly $30 billion in losses related to soured mortgage investments in the fixed-income unit, paving the way for a fire sale to Bank of America during the credit crisis that September.

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Merrill’s enormous lapses in oversight later cause trouble for BofA chief Kenneth Lewis, who is eventually driven from his post at the end of 2009 partly over accusations he hadn’t fully disclosed the extent of Merrill’s balance-sheet holes to his shareholders before they approved the acquisition.

(Read More: Bank of America to Buy Merrill Lynch for $50 Billion)

Lesson: Have what some watchdogs call a “culture of challenge” with more empowered risk managers and cleaner reporting lines. Holding more capital as a buffer against losses from risk assets would also have helped.

Citigroup, 2007-08

Citigroup , 2007-08. Total losses, write-downs, and charges of roughly $60 billion from a toxic cocktail of collateralized debt obligations and other mortgage-related assets after a lax team of risk managers, some of whom are personal friends of the head of trading, fail to troubleshoot. (Read More: Citi Reaches $590 Million Settlement Over Debt Exposure)

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Citigroup Building

The lack of stress-testing for risky assets and general insouciance toward risk are memorialized in a July 2007 Financial Times interview in which then-CEO Charles Prince, speaking of the bank’s leveraged-loan business, declares that “as long as the music is playing, you’ve got to get up and dance” and that “we’re still dancing.” Four months later, he resigns.

Lesson: Ensure greater independence of risk overseers from risk takers. Stress-test illiquid assets to see if they can be sold in turbulent markets and whether the bank can absorb resultant losses.

Morgan Stanley 2007

Morgan Stanley , 2007: Mortgage trader Howard Hubler, making assumptions about the future valuation of certain highly-rated mortgage-backed securities, costs the firm $9.6 billion when his bets go awry. (Read More: The Inside Story of America's Economic Crisis)

The losses provoke the ouster of firm co-president Zoe Cruz — who has until then overseen risk management in Hubler’s division — and are eventually described by author Michael Lewis as “the single biggest trading loss in the history of Wall Street.”

Lesson: Don’t believe that even the highest-rated debt securities won’t at some point lose value, and don’t let your risk managers report directly to a business head.

-By CNBC's Kate Kelly
@KateKellyCNBC