There are a number of blogs that have been predicting this – some since as long ago as 2005. Namely housing bubble blogs.

What was not understood in 2005 is that the housing bubble was in fact a credit/fraud/leverage bubble.

As it came to be understood that in fact the ‘housing’ bubble was really much more than that, the dots to lenders, hedge funds and investment banks were connected. And yes, this happened in 2006 – well ahead of what the sleepy media recognized.

I suggest you check the housing bubble blog, another f*cked borrower blog, or housing doom blog. You might be surprised what information was suspected *by complete outsiders*, and when.

But if that’s a confusion, its a much better one than expecting the board of directors to perform the very same function.

Thanks for your response.

I’m very new to your blog, but have had about 30 years experience in banking. It certainly doesn’t surprise me from the quality of your posts and comments that you would be quite attuned to the head winds.

Interesting comment about public ownership – I visited the Salomon trading floor in the 80’s and saw Gutfreund in action – yes he was a legend. I never worked for a non-public bank but you’re probably right – public accountability no doubt breeds committees and blurring of responsibility. Having said that, the bank I worked for bought an investment dealer in 1988, rescuing it from near bankruptcy, after incredibly bad risk and capital management on a single underwriting deal.

More generally, my overreaction to one particular comment related to the unrealistic superman role expected for directors. My view is that’s the wrong generalized scapegoat in this case, as with most cases of risk. When it comes to capital allocation, asset mix, strategy, and risk, the role of the Board is to ask tough questions. It’s not to do the CEOs job. It’s not to do the job of the senior executives.

However, it is the directors’ job to choose the CEO, among other things. Probably the Merrill and Citi Boards could be criticized for this. The time when these banks could be run by glad-handing salesmen or lawyers (unbelievable) or even the latest incarnation of the ‘team player’ is past. These banks require CEOs who themselves have the intellectual capability to ask the right questions about risk and capital allocation so they can make the right decisions about asset allocation. The problem with these banks is not that they took these risks – it’s the concentration of these risk categories and their overreaching in their overall risk exposure – in other words, their asset allocation strategies – which is the same fundamental challenge as in investment management. Bank CEOS must be able to judge risk. They can’t delegate this skill set up to their directors or down to their staff.

Who knows? Maybe what I just wrote above is compatible with the old Salomon culture.

I started blogging December 18, 2006, so there are no posts of any kind “a year ago” here.

But in January, I had quite a few posts on the worrisome amount of liquidity/leverage in the financial markets, complacency about risk, bizarre overconfidence, and yes, CDOs.

But (being new at the game) I didn’t see correctly how this would devolve (in fairness, no one anticipated a seize up in the money markets), I thought we’d see trouble with hedge funds that could damage the investment banks (basically, a rerun of LTCM but worse because, by virtue of being spread over multiple organizations, it would be difficult/impossible to orchestrate an orderly wind-down). I also said a spike up in oil prices (read: we get stupid with Iran and they close the Strait of Hormuz) could trigger a crisis.

So on a more generalized basis, this blog was talking about excessive leverage in the financial system basically from its inception, and anticipated that Things Would Turn Out Badly.

FWIW.

a, Independent Accountant, flory,

I’m not defending the IBs, but the mentality was that if there was a buck to be made, they were going to make it. Liquidity was so abundant (remember Prince’s notorious “we’re still dancing” comment) that everyone thought they could exit when they needed to. And that pressure was heightened by being public (look ho O’Neal was obsessed with trying to match Goldman’s performance).

But they fell for their own sales talk (old hands at Lazard used to warn of the dangers of believing your own PR). Merrill, Deutsche Bank, Barclays and Morgan Stanley all bough mortgage brokers very late in 2006/early 2007 (the Merrill deal was in February) thinking they were buying near the bottom.

flory,

That video is actually kind of scary. People in suits yelling jingoism at each other passes for analysis? This illustrates why I don’t watch TV.

Anon of 8:40 AM,

Agreed, but I think (and hate to sound like a broken record) but this is again a function of public ownership. I’ve worked from time to time with proprietary trading firms, and the guy who was in charge of managing risk was usually either the most powerful or second most powerful guy in the shop.

When Salomon was private, John Gutfreund performed de facto risk management. He has his desk on the trading floor, and he was famous for his ability to read what was happening. He would regularly walk up to guys who were in or about to get in trouble and ask about their positions. He clearly regarded this as his most important job (why else hang out all day there if you aren’t running a trading desk?).

Similarly, at Goldman, risk decisions were tightly controlled (and defined more broadly than you might think). Example: only partners could quote fees or likely deal pricing (Goldman VPs got ribbed for it regularly, since their coutnerparts at other firms could do so).

That’s ridiculous. Point me to an article on this blog posted a year ago that predicted the sub-prime mess, CDOs, and bank write-downs.

The entire financial blogging world saw this coming at least a year ago. Not too hard a stretch to believe that the banks’ own directors should have been able to.

flory

But these deals did not just come out of the blue. Someone sold these debt instruments to these huge banks and investment banks.

The banks were apparently innocent counterparties to these complex debt deals that somebody else dreamed up.

Erm….No.

flory

http://tinyurl.com/2a6e5k

Of course Peter was right (he always is) and Ben looks REALLY dumb. Charles Payne looks dumb, too.

Mike

The purpose of capital is to protect against losses. The purpose of allocating capital is to maximize expected returns on a risk-adjusted basis. The quantitative models that support risk analysis (including CDO risk) and capital allocation are ever deepening. Big blow-ups are inevitably failures of risk analysis and prudent capital allocation, including avoiding concentration risk in one asset category.

The problem is that the capital allocation call is a CEO function, but the analysis it depends on is a risk management function. The risk function in these organizations is caught somewhere underneath the CEO and CFO functions. The directors who are expected to ask the ‘tough questions’ inevitably ask these questions of the chief risk officer. Conversely, the CEO often passes the buck to the chief risk officer when asked these questions. The directors often do ask these questions in committees. But there’s absolutely no way they can be expected to understand the substantial complexity of capital allocation modeling, let along CDO risk modeling. Sorry to say, but the directors are a joke in this regard – but more of a joke is the idea that they can be expected to understand much of anything deeper than the most superficial cut at the risk issues. This will never change. What may change in future is the risk DNA of CEOs.

Prediction: the fallout from this round of eminent write-offs will (once again) be a superficial elevation of the risk management function on the organization charts of these institutions.