Ten Years of Risk-Management Debacles
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.
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. 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)
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.