Jose D Roncal

Risk Management Lessons from Bear Stearns

I've had years of experience in directing corporate turnarounds and can remember a time when Specialist Forecasting was straightforward. By the end of the first quarter, managers usually had a reasonably reliable sense of how the business was doing and whether targets were going to be met, missed or exceeded.

These were the numbers that ruled the markets. Investors placed such a high level of confidence in quarterly and annual predictions, if the numbers were off just a few points above or below projections, it was enough to create huge moves in the stock value. This year, however, things have changed. Suddenly the act of announcing projections has become a risky business, and some companies are not making any predictions about their future performance.

It's not that these firms are hesitant to provide a dismal outlook, if that's their financial situation. It's that there is so much uncertainty in the markets they can't feel confident in even making projections.

What is needed is actually very fundamental: the ability to manage risk. We now have sophisticated tools to help in managing financial risk—complex mathematical models analyze potential outcomes and probabilities, based on past performance. There has been a growing reliance on these models, yet many of them failed to predict or alert companies to the current global economic crisis. Today those that were responsible for building the models have taken the brunt of the blame for the financial meltdown.

Does this mean that the models failed? No, because models are only as good as the decisions made after reading the numbers. Even if models accurately report the extent of a potential risk, a mistake in estimating the odds of it happening can lead to a disastrous conclusion.

The current crisis should serve as a wake-up call for companies to take a long hard look at their past approaches to risk management and to start making adjustments for the future. Managers can no longer separate risks into isolated categories like operational risk, market risk, credit risk and so on. They need to have a broader view and take a more integrated approach to risk.

If you need a glaring example of what can go wrong when you isolate risk factors, consider the Wall Street trading desks. These traders were experts in managing market risk, but because they were trading instruments that were fraught with credit risk, they were blind-sighted to the impending global meltdown. It's become clear that each risk category requires it's own knowledge bank, and without an integrated team of specialists, companies are vulnerable to major problems.

Pimco's Gross: Looking at the New Capitalism

The current financial crisis has changed our perceptions of the term capitalism and everything we have always assumed it stood for. The deeper the recession gets, the longer it drags on, the more anger will get directed towards Wall Street.

The intellectual impact of the economic meltdown has been so enormous the financial systems will be changed beyond recognition. The investment banks, those that were formerly the foundation of Wall Street, have already either folded or merged into the ranks of retail banks. For the middle-income families who face losing their homes and their jobs, and for the Wall Street firms that have been falling like dominoes, the economic crisis has been disastrous. Even high-profile investors like Warren Buffett describe it as having “fallen off a cliff”.

Until the dust settles, no one can guesstimate what the total fiscal cost will be. For a major portion of the financial system, it's now governments that have been thrust into the role of the primary borrowers, lenders, investors and insurers of last resort. The future landscape of the entire financial system will depend on how quickly and smoothly the government can dislodge itself from the deep hole of commitments they've dug for themselves. And the magnitude of the crisis will be measured by how well they manage it.

It's not as if we haven't been down this road before. Our economic system today is the result of the successful efforts to fix the mess of the 1930s. It's also the results of the failures. While our current situation is still not as harsh as the Great Depression, it's bound to leave a deep scars for years to come.

Over the past decade or more many government agencies have gotten sloppy or simply looked the other way as savvy, disreputable profit-seekers—the banks, hedge funds, insurance companies, and the Madoffs of the world—were allowed to take too many liberties while running roughshod through Wall Street. We are referring to the new complex investment structures, the toxic assets and tainted schemes, the so-called "wealth-creation investments" that got rammed past the gates and into the system.

These deals had so much leverage and so few underlying resources backing them up, you have to wonder how anybody managed to pull them off in the first place. The fact is that, with exception to a relatively small group of math wizards who were hired to run the numbers and structure the deals, nobody completely understood what was going on—not the buyers and not the sellers—which made it easy to keep pumping more deals into the pipeline. We now know that the government employees who get paid to understand such things, and who are charged with the responsibility to stand guard and protect the public from high level fraud, these are the guys that were asleep at the wheel.

But Wall Street and the banking industry was operating under the umbrella of capitalism, which meant that if so much money was being made, and if these deal were driving the market, then everything was fair game. It turned out to be a game alright, but not a fair game.

Now that the house of cards and the umbrella has collapsed, what is the future of capitalism? Will our current, broken system be replaced with a totally egalitarian, socialist society? That's not likely. Instead, we predict something that Adam Smith might deem suitable.

With all the financial bailouts over the past few months, as well as those still on the table, we're already witnessing a certain degree of government interference in “the market,” maybe a little more than we'd prefer, but we are taking a wait and see attitude considering the extreme situation we're in. We expect to see a gradual increase in taxes as well as an increase in public scrutiny and a demand for higher accountability on the part of those who are still taking large profits—the "capitalists!"

But capitalism, albeit in a more muted version in the short term, will survive. Yes, capitalism has it flaws, but then so does democracy or any form of government. There may be moves toward the exits as citizens explore other modes of financial systems, but when none are discovered, the masses will once again hunker around the warm glow of capitalism.

If you found this helpful, visit financialspeculation.com to claim your own copy of Jose Roncal's popular FREE REPORT, "12 Keys to Smart Speculating in Tough Times." It's chock full of valuable insight on how to rebuild your nest egg. While you are there, check out "The Big Gamble: Are You Investing or Speculating?" See for yourself why Donald Trump has called it "a great read!"

Armageddon Part Two: Securitization Is Too Big to Fail

There was a time when virtually all of the money lent to households originated with banks and other lending institutions. Lenders knew their borrowers and had ongoing dialogues with them, whether they were big companies or individual account holders. Just picture the scene from It's a Wonderful Life to get a sense of this relationship.

But over the last five or six years more than half of the money loaned has come from the securitization market. Since financial institutions have the ability to originate loans, they also have the ability to package and sell those loans to others. So they began to take their assets, many of which were "toxic" home mortgages, and, through the securitization process, create what appeared to be attractive investment packages for pension funds and other types of institutional investors.

Securitization became a tool that very efficiently enabled the flow of capital from end investors back to the borrowers who genuinely needed the money. Ironically, it was the very success of the securitization products that caused investors to assume that these complex structures—which involved a plethora of players in different roles creating something no one really understood—were put together by credible, honest and diligent professionals.

The securitization process did work very well for the most part, until chaos ensued. The more murky things got, the more the system was abused and the more financial hardship was brought to investors and to the underlying financial institutions. In fact, in this week's news it was reported that more than 150 publicly traded U.S. lenders now own nonperforming loans that equal 5 percent or more of their holdings, a level that former regulators say can wipe out a bank’s equity and threaten its survival.

The public had taken it for granted that all the players, the brokers, the investment houses, the lending institutions, regulators, and everyone involved in the process knew what they were doing, and more importantly, that each player knew what all the others were doing. But clearly, that was not the case.

Even the rating agencies played a role in the ruse, making profits by over-rating investments they knew had a high probability for failure. In the case of subprime debt, when it was discovered that billions of dollars were funneled into these rating agencies, it created a huge crack in the foundation of trust and Wall Street started to crumble.

Securitization in and of itself is not the problem; it was the abuse that created a great mistrust and stymied the markets. That's why it's so important for regulators to do whatever is necessary to restore credibility to the process so that investors will feel confident to begin investing again.

We have to recreate an environment where investors can evaluate the risk and have relative confidence that their analysis of the risk is consistent with the potential performance of the underlying investment. A responsible investment needs enough transparency to allow investors to evaluate the risk. Recently, however, investors have been misled.

Naturally, no investment is risk-free. If you read our bookThe Big Gamble, there can be no doubt left about that fact.

Meanwhile, how do we get the markets restored and money flowing again? We believe the markets can be recreated with a higher degree of discipline on the part of each of the players. And that includes the regulators themselves who didn't blow the whistle or notice the things that were going wrong. Big change is called for, but let's not throw securitization out of the process.

The Solution – More Securitization

Even with the so-called TARP funds, there's no possibility of the government, i.e. the tax payers, putting enough capital into banks to allow them to support the high demand for borrowing. What is needed is to restore the practice of securitizations in an honest forthright manner.

The role of government might best be served, not by providing more funds, but by taking the lead in designating a securitization structure that covers the full range of stakeholders in the process, one that provides more transparency and puts the investors' interest out in front. We are not saying that Wall Street bonuses and incentives are bad; they are necessary. But no more rewards for blatant manipulation and dishonesty.

There are three important elements that should be considered while recreating the markets: simplicity, transparency, and fairness. The final goal should be to allow borrowers to get credit on fair terms and to make it possible for investors to truly evaluate the inherent risks before investing.

Speculating On Speculation. How long can it last?

If you've read our book The Big Gamble: Are You Investing or Speculating, you may have made the connection between passages of our book and a recent Forbes.com article entitled, Benjamin Graham: Three Timeless Principles.

Benjamin Graham, the man dubbed "The Father of Value Investing," wrote the The Intelligent Investor in 1949. In it, he spelled out what he considered the most solid investment/speculating principles of the times — principles that are still sound today.

In our book we give you a complete run down on the differences between investing and speculating and highlight some of Graham's philosophy. With the economy in such disarray and the Dow kicking off the week nearly 240 points below the 7,000 mark, we thought this might be a good time to review some of the principles mentioned in our book so you'll be prepared to reenter the market with your eyes wide open.

Speculating is an ancient practice, named after the Roman activity specu-lari, which translates as "to spy out or watch." Today, the most positive connotation of the term is "seeing ahead in business." The most successful speculators have the ability to both systematically and subjectively analyze and gauge market probabilities. But most importantly, remain keenly aware of the risks they are taking.

With the market so low and presumably the bottom close at hand, we know there are many enterprising individuals poised to strike while bargains are hot. We thought this would be an opportune time to review three of Graham's principles.

1.) Always Invest With a Margin of Safety

The Margin of Safety means the difference between a discounted price of a security versus it's intrinsic value. If you do some research on the underlying fundamentals of corporations, you might be looking at the opportunity of high returns and minimal downside risk. Graham would look for the assets that represented stable earning power or liquid cash value.

This strategy can provide substantial profits once the market eventually re-balances and stocks are once again at fair value.

2.) Expect Volatility and Profit From It

Remember, you are never investing; you are always speculating, and that means being prepared for volatility. Instead of panic sell offs when the market goes into a nosedive, the smart speculator sees it as a chance to seek out new places to put their money.

The only thing predictable about the market is that it's unpredictable. Never let your emotions dictate your actions when it comes to money. Instead, consider the stock's value based on a rational investigation of the facts. Then buy when the offering price makes sense and sell when the price becomes too high.

3.) Know What Kind of Investor/Speculator You Are

Graham says there are only two kinds of investors/speculators: "enterprising " or "defensive." The first kind makes a serious commitment in time and energy to do the research in order to estimate an expected return. If this doesn't fit your emotional make up, then you'll need to make your choices more defensively.

To Graham, it's important to understand whether you consider yourself an investor or a speculator. As we explain in our book, an investor looks at a stock as part of a business and the stockholder as the owner of the business, while the speculator views himself as playing with expensive pieces of paper with no intrinsic value. For the speculator, value is only determined by what someone will pay for the asset. To paraphrase Graham, there is intelligent speculating as well as intelligent investing--just be sure you understand which you are good at.

To gain a complete understanding of the difference, please pick up a copy of our book,The Big Gamble: Are You Investing or Speculating. With today's unprecedented economic turmoil, you need all the help you can get to understand what's happening and how to avoid a financial nightmare. Our book gives the insight and practical advice you need.

If you found this article helpful, visit financialspeculation.com to claim your own copy of Jose Roncal's popular FREE REPORT, "12 Keys to Smart Speculating in Tough Times." It's chock full of valuable insight on how to rebuild your nest egg. While you are there, check out "The Big Gamble: Are You Investing or Speculating?" See for yourself why Donald Trump has called it "a great read!"

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Madoff Scandal: 'Biggest Story of the Year'

Who would have doubted the integrity of one of the most reputable firms on Wall Street run by an individual that was instrumental in framing the structure of the SEC?

Once again, where were the auditors/accountants? Did it not raise any red flags that the company had reported consistent earnings for the past 20 years? And how could this privately-held company managing that amount of money not be regulated, audited, controlled or provide any safeguards to their so called “investors?”

Apparently the SEC had even received numerous letters from investors trying to sound the alarm that something didn’t smell right. Why was no investigation conducted?

Yes, I understand the secretive nature of Hedge Funds, but will this finally be enough to wake up regulators to change these ineffective oversight rules?

I’ve always maintained that the word “investment” is a misnomer. It’s all speculation. Nothing is really safe. Now the search begins to find the gory details of the billions lost. But what has really been lost is more faith and trust in our financial system. Madoff’s firm had been highly regarded on Wall Street, but trust me, this downfall will just be the tip of the iceberg.

The economic downturn has already caused a run on Hedge Funds and the redemptions have been enormous. Investors cashed out a record $130 billion in November alone. In Madoff’s case, he’d only had requests for $7 billion of redemptions but was struggling to find the liquidity to return funds.

We’ll find out in the next few hours just how serious the collateral damages will be. Early indications are that the actual number of clients is few, but each stands to lose billions. This will not do much to bolster the confidence in the rest of the investment world.

It just drives home the point that there are so many weak links in our financial system, so little government oversight, and too many loopholes that invite under-handed deals.
It will take years to revamp the structure of the system. But I still have a hard time understanding how the watchdogs, the regulators, state auditors, private auditors, accountants, and even the investors can be so blind.

There are tough lesson to be learned, and many questions to be answered. One of the most important and relevant questions we have to ask ourselves is posed in the title of our book, “The Big Gamble: Are You Investing or Speculating?”

This comment was posted by Jose Roncal, co-author of "The Big Gamble: Are you investing or speculating?" - For more information, visit financialspeculation.c...

Will the White House Bail Out Detroit?

Since the U.S. has become a Bailout Nation, why don’t we just give them the $100 billion now, check it off Obama’s to-do list and stop wasting time and taxpayer’s money on a Congress that seems to be operating without a compass. This has already dragged on too long.


In my opinion, any so-called Car Czar that can rescue these two companies with $14 billion, also wears a cape and can leap off tall buildings. This whole deal strikes me as a way to buy time. The auto industry has a long row to hoe before they reap any results, what with restructuring, slashing their work force, closing plants, dealing with UAW, etc not to mention actually producing cars that consumers want.


So what exactly is on the Car Czar’s to-do list? So far it sounds like he’ll come up with some guidelines for restructuring GM and Chrysler by the first of next year. But if the auto execs can’t prove that they have a plan to reinvent themselves by Feb 15, they have to give the money back. Give me a break!


If the $14 billion is an emergency loan, it’s just a survival kit, so what money will be left to give back? One forecasting firm is saying that with or without the bailout, Chrysler is already a lost cause. And what restructuring plan? Didn’t they already submit a plan? Furthermore, under whose leadership will these terms be set? A lame duck’s or will they be enacted after Obama takes the oath?


Apparently the bill will restrict executive compensation, but why are these two CEO's still there? I personally would have resigned a long time ago. But these poor excuses for leaders either weren’t paying attention to the mess they were creating, or they just didn’t care. Who are they going to blame now? The reluctant consumer? Oil prices? Japanese and Korean cars? The economy? Who?


I’ll tell you who’s to blame. It’s you, the auto industry CEOs who bear the full responsibility. You were the ones who were either too complacent or else didn’t have the vision to foresee the geopolitical and economic forces that shaped competition as you continued to crank out gas-guzzling SUVs. It is you who have not mastered the core principles of leadership or even the most basic skills required to manage. I’m referring to the bottom-line business basics of planning, organizing, motivating, performance management, risk management, forecasting, and so on. It’s all there in Management 101!


And I also fault the boards of directors for failing in their oversight. Boards are charged with the responsibilities of setting broad policies and objectives, selecting, appointing, supporting and reviewing the performance of the chief executive, ensuring the availability of adequate financial resources, approving annual budgets, being accountable to the stakeholders for the organization's performance.


These are standard duties for members of any corporate board, but they should be even more rigorously adhered to by high-profile publicly-traded corporations. I give these CEOs and their boards a failing grade on all points –they not only failed, they failed miserably!


And what’s worse, millions of people are being affected, not only throughout the Rustbelt, but millions more across America and around the globe in places like Argentina and other countries where there are manufacturing plants. You have let down all your stakeholders!


Perhaps the savior in the cape, the one they will call the Car Czar, will do a better job than the two CEOs have done. And while the czar will only be a puppet position until Obama takes the reins, I’d like to suggest this as the first order of the day—fire everybody at the top of the auto industry chart who was responsible for creating so much grief.

This comment was posted by Jose Roncal, co-author of "The Big Gamble: Are you investing or speculating?" - For more information, visit financialspeculation.c...

Obama's Infrastructure Rally: Take a Swig of Kool Aid

Obama's Plan Sends Markets Up, But For How Long?

The big news of Monday was the DOW hitting the 9,000 mark. The big question now is, “Have we hit bottom”? Our answer is, “Maybe, but don’t rush into anything on a single day’s news just because you’re worried that you might miss out.”

The pundits tell us, "The market is a discounting mechanism." But relying on market "fundamentals" falls far short of explaining what’s really happening. Colorful trend charts can’t gauge the true intentions of buyers and sellers, and plugging in discount rates, risk premiums or annualized growth rates into a formula is no measure of the true fair market value of a financial asset.

But there are a few facts that the market has apparently already discounted which might explain the rally of the past few days:

• Monday: Stocks Rally Worldwide, DOW hits 9,000, S&P 500 hits 1-Month High on Obama Plan
• The market withstood the 533,000 job loss report on Friday—worse than expected
• Obama presented a proposed stimulus package with the largest expenditures on U.S. infrastructure since the 1950's
• Over the weekend the Asian markets rallied, China announced expansions of stimulus package and India has approved it’s own $4 billion of stimulus infusion
• The future is uncertain for the NASCAR race car economy. Formula 1 is the first victim as Honda has pulled a $300 million plug
• A $15 billion bridge loan for the Big 3 U.S. Automakers will be voted on next week, which if signed would tide the industry over only until March 09
• Dow Chemical is slashing 11% of its workforce and shutting down 20 facilities
• Advertising expenditures are way down and today’s retail sales report was enough to harsh Main Street’s holiday buzz

The worldwide crisis isn’t going to get fixed over night. I expect further volatility in the days ahead. For instance, when corporate earnings are released in January, it could trigger more volatility. Things are likely to continue like this well into 2009 or 2010. You may agree as you consider the following:

• U.S. bailout packages have been bridges to nowhere
• First stimulus package of $160 billion led nowhere
• New structure of financial industry still not addressed
• Regulators and credit rating agencies don’t have their act together—the 23rd U.S. bank failed last week
• States like California and many others are going broke, if they haven’t already, and urgently need life-support
• Corporations are filing for chapter 11 or chapter 7 due to inept executives who claim they couldn’t foresee this coming
• Risk management is non-existent in most organizations today – “surprises” are becoming the new standard
• GM and Chrysler (even with the expected bailout) will be back for more sooner than later
• Commercial lending, even though better collateralized than residential lending, could bring the issue of their $900 billion credit cards debt to the handout table.
• Expect further losses and write-downs from JP Morgan, Bank of America, Citigroup as well as other major financial institutions


I could go on and on without even mentioning our under-funded heath care system and other government program. There are simply not enough funds to do everything.

A situation that began as a housing crisis has turned into the worst financial crisis since the Great Depression. More than $31 trillion has evaporated through equity and debt losses. And the write-downs on the books of the world largest lenders and investors is approaching $1 trillion. We’d never want to be accused of saying, “We told you so!” but the fact remains that all of this was predicted in our book "The Big Gamble: Are You Investing or Speculating?” by Jose Roncal and Jose Abbo as weI’ve always maintained, that in the end, it’s all speculation.