Risk Control: Wall Street's Achilles' Heel

Includes: AIG, SCGLY, UBS
by: Jake Zamansky

A 31-year-old trader just cost UBS (NYSE:UBS) $2.3 million and its CEO. Jerome Kerviel, collared Societe Generale (OTCPK:SCGLY) with losses of $7.2 billion with his so-called “rogue” trading. In March 2008, 100-year-old investment bank Bear Stearns collapsed, its stock price falling from $160 to $2 per share. In 2007-2008, Citigroup’s (NYSE:C) enormous undisclosed subprime exposure eventually caused its share price to fall from $60 all the way down below $3. And lastly, UBS deceptively sold over $1 billion of Lehman structured products to unsuspecting retail customers and has been pummeled in arbitration hearings.

What do these financial disasters have in common? Inadequate risk controls, lax supervision and shoddy training. State-of-the-art risk controls and professional supervision comprise the basic safety net investors and regulators expect from Wall Street. Unfortunately, in recent years both have been borderline nonexistent.

The Bear Stearns Hedge Funds that went belly-up in the summer of 2007 had touted to investors their superior “risk controls” as part of their sales pitch. In reality, the lack of meaningful controls appears to have sunk the funds, resulting in a total loss to investors.

The elite group within AIG (NYSE:AIG) that once raked in billions by selling insurance on corporate debt bragged that it wouldn’t lose a dollar on its credit default swaps. The group was so confident that its senior managers didn’t even require the traders to hedge their risk. A few weeks later, it took a $5 billion write-down and needed the first installment in a seemingly never-ending lifeline just to survive.

Firms up and down Wall Street - household names, blue-chip banks - leveraged themselves 30:1 chasing outsize profits and massive paydays. Most blew up and survived only with serial bailouts. We are now, in the words of Meredith Whitney, in a world populated by “zombie banks.”

Wall Street’s leading firms cast aside the industry’s cardinal principle in the industry: strong risk controls and proper supervision and training of brokers. The rest of us paid the price with hundreds of billions in taxpayer-funded bailouts, a cratering economy, intractable unemployment and now the threat of a “double-dip” recession.

But rather than recognizing the roots of the current fiasco and shouldering some blame, Wall Street’s main objective now is to repeal or roll back the Dodd Frank rules put in place just a couple of years ago to correct the problems that led to the 2008 financial meltdown, and hopefully prevent a repeat. They are spending millions on lobbyists to convince Congress that Dodd Frank is too burdensome, too strict and won’t allow them to come up with the next great “financial innovation.”

Here’s an idea: spare us from the brand of creativity that brought us mortgage-linked synthetic CDOs last time around and nearly caused another Great Depression. Get back to the basics of stringent risk controls and strict supervision.

On Wall Street, some people just never seem to “get it.”

Disclosure: “Zamansky and Associates represents investors in arbitration cases against UBS regarding the sale of Lehman Brothers Structured Products.” (mh 7/27). For others, “Zamansky & Associates is a New York law firm which represents investors in court and arbitration cases against securities brokerage firms and issuers. The firm may represent investors in cases against companies mentioned in this blog.”