The Need For Risk Management and Its Implementation

|
Includes: FMCC, FNMA
by: David Enke

The New York Times had an article yesterday about how the CEO at Freddie Mac (FRE) ignored the warnings signs of potential problems, in particular its financing of questionable loans that threatened its financial health. Not necessarily news, but it once again stresses the need for not only implementing a risk management system within companies, but actually listening to the recommendations offered by the chief risk officer. Insiders at Freddie Mac say that CEO Richard Syron made things worse by repeatedly ignoring recommendations from the chief risk officer at Freddie, David Andrukonis, regarding poor underwriting standards that were becoming too weak and too risky.

Andrukonis is quoted as saying:

The thinking was that if something really bad happened to the housing market, then the government would need Freddie and Fannie more than ever, and would have to rescue them. Everybody understood that at some level the company was putting taxpayers at risk.

Moral hazard at is best, or ugliest. Of course, this comment is not quite as telling as the one made by CEO Syron, who contends:

If I had better foresight, maybe I could have improved things a little bit. But frankly, if I had perfect foresight, I would never have taken this job in the first place.

While none of us has 20-20 business vision, the need for better insight is exactly why companies need to utilize some type of risk management. Although not a perfect science (far from it), risk management can at least provide managers some of that needed foresight. While the future cannot be forecast at a level that makes it easier to sleep at night, risk management can at least provide scenario analysis supported with statistics and various risk measures, among other techniques, that will give managers some idea of where potential problems lie so that safeguards can be taken (such as increasing capital or laying off risk) and corrective action can be planned and anticipated.

It appears that Wall Street and Corporate America are getting the message as companies struggle to educate themselves on enterprise risk management, implement risk management systems, and hire employees with the proper risk management skills. Understanding credit risk, market risk, operational risk, Value-at-Risk, Basel II, RAROC, and GARCH volatility modeling are causing businesses to seek out universities and consultants as they rush to receive the needed education and training.

Of course, like TQM in the 1980s and 1990s, it is up to businesses to actually practice what they preach, or at least practice what they put in place. Fortunately, for those interested in risk management, challenges and job security will be available as innovation and capital growth offer new problems for businesses. Hopefully, it will not take another Bear Stearns (NYSE:BSC), Freddie Mac, or Fannie Mae (FNM) in a few years to once again drive the point home.

Disclosure: None