By Matt Stoller, the former Senior Policy Advisor to Rep. Alan Grayson and a fellow at the Roosevelt Institute. You can reach him at stoller (at) gmail.com or follow him on Twitter at @matthewstoller
I read this headline in Bloomberg: UBS Has $2B Loss; Man Arrested in London. Apparently, a rogue trader lost $2 billion, and is now sitting in jail because the trade was unauthorized by senior management. Since it’s the 3rd anniversary of the Lehman Brothers bankruptcy, I figure it’s a good time to be nostalgic about who is authorized to lose what. Here’s bankruptcy trustee Anton Valukas, talking about Lehman Brothers and the losses that led to its bankruptcy.
We found that Lehman was significantly and persistently in excess of its own risk limits. Lehman management decided to disregard the guidance provided by Lehman’s risk management systems. Rather than adjust business decisions to adapt to risk limit excesses, management decided to adjust the risk limits to adapt to business goals. We found that the SEC was aware of these excesses and simply acquiesced.
The SEC knew. So did Lehman management.
So an appropriate governance plan was in place to set risk limits. But management did not observe the limits. For example, Lehman committed to what was its largest single investment – Archstone – in May 2007, with closing to occur later. It was clear prior to the commitment that the Archstone transaction would put Lehman over its then existing risk limits, but the deal was committed anyway. With the inclusion of Archstone, Lehman was clearly in excess of its established risk limits. But in the face of exceeding its risk limits, Lehman did not take steps to reduce risk; rather, it simply raised the risk limits.
Losses were authorized.
Senior management made the conscious decisions to exceed risk limits and complete the Archstone and other deals because they believed, erroneously, that those deals would be profitable.
Well it was a decision. And they thought it would be fine. Losses were authorized.
Archstone was the largest, but not the only instance in which risk management’s view was overruled or disregarded. Lehman was in breach of its established risk appetite limits on a persistent basis during the second half of 2007. Lehman ultimately cured the breaches at the end of the year, not by reducing risk, but by raising risk appetite limits again.
Once again, losses were authorized.
Lehman also had in place a “single transaction limit” framework to limit the size of individual transactions as a risk control. But in late 2006, Lehman management made the affirmative decision to disregard the single transaction limit because it had cost Lehman significant profit-making opportunities. As a result, Lehman committed to and closed dozens of transactions that were vastly in excess of that business unit’s risk limits.
Authorized losses, again.
At that time, a senior Lehman officer, Ian Lowitt, observed: “In case we ever forget; this is why one has concentration limits and overall portfolio limits. Markets do seize up.”
They do seize up. Here’s the thing, though. A UBS trader is now in jail for losing a few billion dollars. That’s probably reasonable. In Lehman’s case, no one went to jail, and Dick Fuld if a multi-millionaire, even though the losses run into the trillions.
Moral of the story: Make sure your losses are authorized.