Implementing Compensation Reforms

This week, the Institute of International Finance released a study of the compensation practices at major financial institutions around the globe.  The results point to a need to increase the linkage between risk management and pay practices.  The study was based on a set of seven principles outlined by the Institute of International Finance last year that seek to improve the compensation structures at these institutions.  Here is a summary of their findings.

Respondents are working towards convergence with the Institute of International Finance principles: current alignment varies by principle, some critical gaps need to be addressed (see figure 1 below). Respondents have a high degree of alignment to a number of the IIF’s principles; however, there have been critical gaps in the area of risk-adjusted performance measurement and compensation phasing to coincide with the risk time horizon of profit. Only 11% of respondents stated that they were fully aligned to Principle 3: risk adjustment and time horizon alignment, although the vast majority of institutions (83%) already have plans to close the gap. Indeed, 60% of respondents expect to be fully aligned to all seven principles once their plans are implemented.

Changes required for successful implementation

1. Organisational will and strong leadership are needed to ensure internal acceptance of changes to compensation policy. The current point in the cycle unquestionably represents the most opportune time to implement change, although survey respondents still believe that retaining competitiveness versus peers will be a challenge. In order to implement change, senior management, including the CEO, CFO and CRO, need to be fully involved in the change process and closely engaged with Human Resources on compensation. Boards should demand transparency around performance metrics and employee incentives to accurately appraise compensation schemes. We encourage supervisors and regulators to support an industry push towards compensation structures and governance that avoid any undue build-up of risk at financial institutions.


2. More effective oversight of the compensation system; improved checks and balances. Discussions with industry participants indicated that improving the governance process through which compensation is debated and validated, and striking the correct balance between fact-based metrics and more discretionary aspects, will be critical to shaping new compensation practices.


3. At a time of significant industry and individual stress, significant mobilization is required. Dedicated resources, senior management time and influence, and strong links between management, finance, risk and human resources teams will be necessary to implement the changes required.

Now is the time to align risk management and compensation so that another crisis of this magnitude can be avoided.  Wheelhouse Advisors is prepared to help you with your implementation challenges.  Visit www.WheelhouseAdvisors.com to learn more.

A Recipe for Disaster

Risk Management can be only as effective as a company wants it to be, as evidenced by the continuing saga of American International Group ("AIG").  The Wall Street Journal reported last week that certain high level executives who may have had a hand in limiting access of key risk management personnel remain on the job.  AIG's Chief Risk Officer, Robert Lewis, was at the center of the discussion since he is responsible for AIG's Enterprise Risk Management program.  Here's what the WSJ had to say.

AIG's outside auditor and a regulator raised concerns months before the bailout about the ability of AIG's risk management to monitor what was going on in some units.

At an AIG board-committee meeting in January 2008, AIG's auditor, PricewaterhouseCoopers LLP, "expressed concern that the access" Mr. Lewis's department and other top AIG executives had into the financial-products unit, AIG Investments and other subsidiaries. Access "may require strengthening," according to minutes of the meeting released by Congress last fall.

Two months later, the federal Office of Thrift Supervision, which regulated AIG's financial-products unit, sent a letter to the company, also released by Congress. OTS said the unit "was allowed to limit access of key risk control groups while material questions relating to the valuation of the [swap portfolio] were mounting."  The OTS said those "control groups" included Mr. Lewis's department.

At a congressional hearing last week, Rep. Gary Peters (D., Mich.) asked AIG Chief Executive Edward Liddy, "Where was the risk management of your company? Where was the failure of your own internal risk-management procedures?"

Mr. Liddy responded, "We had risk-management practices in place. They generally were not allowed to go up into the financial-products business."

Selective risk management within a company is a recipe for disaster.  Any area that is deemed "off-limits" should be a gigantic red flag for both senior management and the board of directors. 

Making Their Move

As expected, the U.S. government is making its move to reform regulatory oversight and strengthen risk management practices at major U.S. financial institutions.   More will be required from these institutions, both in terms of capital as well as compliance and control.  Here is what the Wall Street Journal reported yesterday about U.S. Treasury Secretary Tim Geithner's plans.

Mr. Geithner is expected to call for a strict and consistent set of regulations for large firms, as well as more power for the government to monitor emerging risks to the economy. The new rules will likely require financial institutions to hold more capital as a buffer against losses and will bolster risk-management standards. All told, the proposals would mean significant expansions of power for the Treasury, Federal Reserve and other regulators.

Preparations for these sweeping changes must begin now.  Is your company ready?  Visit www.WheelhouseAdvisors.com to learn more about how we can help.

Simple and Robust

Last week, the Governor of the Bank of England, Mr. Mervyn King, delivered a speech to a group of international bankers about how we can emerge from the current economic crisis successfully.  In his view, regulatory reform should be both "simple and robust" to be effective.  Here's a brief excerpt from his speech.

A lesson of history is that few generations have been able to avoid a repetition of earlier banking crises. The essential problem is that we can no more bind our successors than our predecessors were able to bind us. Rare events, even when dramatic at the time, lose their power to shape policy as memory recedes. The role of institutions is to retain a collective memory and to resist the temptations of the present. That is one of the most important roles of a central bank. It is accepted as such in the domain of monetary policy. And there is an equivalent role in financial stability.

The introduction of simple and robust policy tools into a regulatory regime based on the exercise of constrained discretion would make it easier to resist overly rapid expansion of financial institutions. In particular, the authorities should maintain a clear focus on the issues that matter when the worst occurs – liquidity and leverage. It should be intrusive, in the sense of knowing what is going on, but not bureaucratic. A system in which it is easier for a large bank to expand and then destroy its balance sheet than for an individual to open a bank account has lost focus. That is not the fault of regulators, but a reflection of the pressures and incentives they have faced – from all of us.

The same can be said for a company's enterprise risk management program - a simple, yet robust approach is required to be both successful and sustainable.  Wheelhouse Advisors can help you build an effective ERM program to meet these objectives.  Visit www.WheelhouseAdvisors.com to learn more.

Internal Audit is a Key ERM Component

In a recent webinar to the Institute of Internal Auditors, John A. Wheeler from Wheelhouse Advisors provided a view of the role that internal auditors should play in the development and sustainment of a company's Enterprise Risk Management ("ERM") program.  One of the main points from the webinar was that internal auditors must help management look forward to emerging risks rather than reacting to current loss events.  In the current environment, internal auditors are uniquely qualified to guide management in this direction.  A recent report on the state of the internal audit profession by PricewaterhouseCoopers confirms this view.  Here is what they had to say.

To provide the greatest value, internal audit departments, as well as a company’s risk management function, should strive to anticipate and monitor the risks that are truly relevant to the success of the business. As previously noted, the strategic and business risks that have recently lead to breathtakingly rapid drops in shareholder value have caught even the most sophisticated risk management functions by surprise. Now more than ever, companies need an objective evaluation of, and additional assurance over, their enterprise risk management functions. The forward-thinking internal audit leader will want to consider the following:

• Board members, shareholders, regulators, and rating agencies have questioned internal audit leaders about their risk management evaluation capabilities. Successful departments have the answers and play an important role in the company’s overall ERM process.

• In 2008, S&P began to formally review ERM programs and consider risk management capabilities in their credit-rating process, putting this topic on the table with boards, CEOs, CFOs, and treasurers. With risk at the center of company creditworthiness, internal audit leaders—given their knowledge of risks and controls—should be part of the solution.

• Many companies have established risk committees to lead enterprise risk management efforts. This sets up a new constituent that requires internal audit leadership attention.Internal audit will increasingly have a place at the table when it comes to identifying and managing risk within the organization. In broadening the scope of its activities beyond financial and compliance risks, internal audit can also demonstrate value by enhancing the organization’s enterprise risk management function. 

Internal audit should, therefore, align its efforts with the company’s changing risk profile, especially those strategic, operational, and IT risks that are integral to shareholder value. If properly aligned, internal audit leaders will be in a position to provide assurance over the risks that are most relevant to the company, as well as to provide assurance over the company’s ERM function itself.

Wheelhouse Advisors can help your internal audit group build a risk assessment framework and audit program to ensure your ERM efforts are solid.  Visit www.WheelhouseAdvisors.com to learn more.

ERM Integration is Critical

A recent study by Governance Metrics International found that many large corporations either have or are looking to implement an Enterprise Risk Management ("ERM") program.  However, few companies have yet to fully integrate their program into their business processes.  Treasury & Risk Magazine noted the following about the study's findings.

The report highlights the case of Tyco International, a $20-billion diversified industrial company, which seven years ago was a risk manager’s nightmare. Its CEO indicted and later convicted of defrauding shareholders of $400 million and its books cooked beyond recognition, Tyco was often mentioned in the same breath as Enron and WorldCom. Today, broken up, restructured and under completely new management, Tyco has put risk management front and center in its strategic planning and operations. 

“Today risk management is a component of how this company operates on a day-to-day basis,” says John Jenkins, Tyco’s corporate secretary. “So, for example, with strategic planning, it’s not a matter of the risk manager sitting on the side and suddenly chiming in; it’s just a component of the whole process." 

Integration is critical for an ERM program to be truly successful.  Visit www.WheelhouseAdvisors.com to learn more.

Spotlight on Risk Management and Pay Practices

The debate over financial regulatory reform continues on Capitol Hill with a great deal of attention on compensation practices.  It has become blatantly obvious that incentive plans have not been designed to promote the best interests of shareholders or the long-term viability of institutions.  Here is what Federal Reserve Chairman Ben Bernanke had to say as reported in yesterday's New York Times.

Last week, Ben S. Bernanke, the Fed chairman, also called on regulators to supervise executive pay at banks more closely to avoid “compensation practices that can create mismatches between the rewards and risks borne by institutions or their managers.” Much of the plan would require the approval of Congress, where divisions are forming over how best to overhaul financial industry oversight.

The core of effective risk management hinges on the alignment of a company's strategic objectives, risk appetite and compensation plans.  Once these become out of alignment, the company will certainly suffer over the long-term.

20/20 Hindsight

This week, the U.S. Senate Committee on Banking, Housing and Urban Affairs held a hearing into the lessons learned in risk management oversight at federal financial regulators.  Not surprisingly, all of the representatives from each regulatory agency agreed that risk management practices in the institutions they regulate must be strengthened.  Here is what Mr. Timothy Long from the Office of the Comptroller of the Currency had to  say.

The unprecedented disruption that we have seen in the global financial markets over the last eighteen months, and the events and conditions leading up to this disruption, have underscored the critical need for effective and comprehensive risk management processes and systems. As I will discuss in my testimony, these events have revealed a number of weaknesses in banks’ risk management processes that we and the industry must address. Because these problems are global in nature, many of the actions we are taking are in coordination with other supervisors around the world. 

More fundamentally, recent events have served as a dramatic reminder that risk management is, and must be, more than simply a collection of policies, procedures, limits and models. Effective risk management requires a strong corporate culture and corporate risk governance. As noted in the March 2008 Senior Supervisors Group report on “Observations on Risk Management Practices During the Recent Market Turmoil,” companies that fostered a strong risk management culture and encouraged firm-wide identification and control of risk, were less vulnerable to significant losses, even when engaged in higher risk activities.

Hindsight certainly is clearer given the magnitude of the recent economic meltdown.  However, these views must remain with us as we emerge from this downturn and inevitably enter better economic times.  

Reputation Risk Takes Center Stage

A new report about reputation risk management was released this week by The Conference Board.  The report is based on the findings of The Conference Board Reputation Risk Research Working Group and a survey of 148 risk management executives of major corporations.

More than three quarters of the respondents to the survey said their companies are making a substantial effort to manage reputation risk (82 percent) and they have increased focus in this area over the last three years (81 percent).

Other key findings of the study:

• Reputation risk should be managed throughout the organization. Although communication is of critical importance in responding to a risk event, a company's reputation should be considered during the preparation and execution of strategy and new projects, which hasn't been the case in most companies.


• Reputation risk is often not incorporated into risk management. Only 49 percent of executives surveyed said that the management of reputation risk was highly integrated with their enterprise risk management (ERM) function or another risk oversight program.


• Assessing reputation risks is a top challenge. Fifty-nine percent indicated that assessing the perceptions and concerns of stakeholders was an extremely or very significant issue, making it the highest-ranked challenge.


• Media monitoring has become more sophisticated. Today, there are tools to assess whether coverage is positive, neutral or negative; the credibility of publications; the prominence of coverage, etc.


• Efforts are being made to quantify the value of reputation. A select group of companies is making progress in this area by working with specialist consulting firms to quantify the impact of reputation on share price.


• Social media are gaining influence, but most companies are ignoring them. Although consumers and investors are increasingly gathering information from blogs, online forums, and social networking sites, only 34 percent of the survey respondents said they extensively monitor such sites, and only 10 percent actively participated in them.

Given the speed and efficiency of today's modern communication and news infrastructure, reputation risk should be a serious concern for all companies.  As Warren Buffett said, "It takes 20 years to build a reputation and five minutes to ruin it."

Are You Successfully Navigating the Torrent of Risk?

More and more companies are coming to the realization that risks can no longer be ignored and must be managed in a proactive manner.  An article in this month's Business Finance magazine provides a perspective on the rapid evolution of enterprise risk management in organizations of all shapes and sizes.  Here's a brief excerpt:

It's no secret that many publicly listed, closely-held, and even not-for-profit organizations have begun to embrace enterprise risk management (ERM) as a corporate imperative. Corporate boards have reassessed their role in today's legal and economic environment and are beginning to exert pressure on the C-suite (the CFO in particular) to understand and analyze enterprise risk as a necessity to help achieve corporate objectives. Further, analysts are beginning to question CFOs and CEOs during earnings calls about how the company is addressing risk from an enterprise basis. And, with Standard & Poor's and Moody's coming under fire for less-than-rigorous evaluations of risk to corporate ratings, ERM will likely stay at the forefront of leadership attention.

What is your company doing to address risks in a more proactive manner?  

Visit www.WheelhouseAdvisors.com to learn how we can help your company Navigate Successfully™.

™

G-20 Tells U.S. to Get Moving on Reform

This past weekend, finance ministers from nations representing the Group of Twenty ("G-20") met in London to review progress made on action plans from the emergency meeting held in Washington D.C. last fall.  A major outcome of the meeting was a rebuke of the United States call for further capital injections into weak financial institutions.  Instead, the G-20 pressed the need to make progress on the action plans to reform financial regulation and risk management.   Here are a few views of G-20 members as reported in yesterday's  Wall Street Journal.  

The U.S.'s overseas allies ratcheted up pressure during the weekend to tackle the ailing banking system. "Some countries have not fixed their banks, so I want them to fix their banks," Canada's finance minister, Jim Flaherty, said, in what appeared to be a veiled reference to the U.S.  Germany's finance minister, Peer Steinbrueck, made a similar point as a way of deflecting U.S. demands for more stimulus spending.  "We are convinced it makes no sense to pump more and more money in our economy when we haven't restored the confidence on the financial markets," he told reporters .

As a result, expect to see some major headway in the regulatory reform movement over the next few weeks. Click here to view the latest progress report by the G-20.  

A Step in the Right Direction

Last week, the U.S. Chamber of Commerce published a declaration of their regulatory reform principles for consideration by the Obama Administration and the U.S. Congress.  Among other things, the declaration calls for greater transparency within the regulated entities as well as the regulatory authorities.  Here are their views.

Important elements for improving transparency and market integrity include:

1. Fostering information flow among all significant financial institutions and credible, effective regulators;


2. Enhanced risk management practices and disclosure thereof within regulated entities;


3. Improved and timelier risk modeling, particularly in times of stress;


4. Improved timely cross-border and cross-institutional information sharing among regulators; and


5. Oversight of credit rating agencies that promotes greater transparency, adherence to best practices, and initiatives to minimize conflicts of interest. Improved self-regulation should be supplemented by responsible and more internationally consistent government regulation of the industry.

As stated in previous blog posts, a crisis such as the one we are currently experiencing can lead to positive change.  These principles set forth in this declaration are certainly a step in the right direction.

New Wave of Regulation

As expected, plaintiff attorneys and prosecutors are gearing up for a flood of cases related to the roots of the current economic crisis - financial fraud.  However, an article in yesterday's New York Times suggests that the attorneys may have a tough time winning the cases.  

The herdlike behavior suggested that bankers were competing for business using widely shared assumptions, rather than trying to get away with a crime. It would be hard to prove that anyone broke the rules, these lawyers said, since regulations in the riskiest parts of the mortgage industry were so lax.

While the attorneys may have a difficult time, regulators will not have any problem tightening the rules.  Is your company prepared for the new wave of regulation?  Visit www.WheelhouseAdvisors.com to learn how we can help you prepare.

A Small Price to Pay

Yesterday, the U.S. House Committee on Oversight and Government Reform conducted a hearing into the oversight and administration of the U.S. Treasury's Troubled Asset Relief Program ("TARP").  The committee was highly critical of the lack of internal controls related to the use of TARP related funds.  Here is a summary of their recent review of the program.

Section 116 of EESA requires Treasury io conduct oversight over the use TARP monies. Specifically, Treasury must "establish and maintain an effective system of internal control" of TARP monies in such a manner as to 'provide reasonable assurance of the effectiveness and efficiency of operations, including the use of the resources of the TARP" and the "reliability of financial reporting." 'The Act mandates that this system of internal control be consistent with the standards prescribed under the Federal Managers Financial Integrity Act of 1982 (FMFIA).

Federal agency heads are required by law to prevent waste and loss of federal monies they administer. FMFIA requires executive agency heads to "establish internal accounting and administrative controls that reasonably ensure that... all assets are safeguarded against waste, loss, unauthorized use, and misappropriation..."

Under existing agreements between Treasury and TARP recipient financial institutions, Treasury has broad contractual authority to scour company books in search of, among other things, waste and abuse by TARP recipients. But in practice, Treasury is not doing so. In the absence of statutory or regulatory definitions of waste and abuse or explicit conditions for use of TARP funds - either promulgated in term agreements by Treasury under its broad authority, or prescribed by Congress in EESA - Treasury's oversight will not find them and cannot enforce them. In other words, Treasury is not now conducting oversight of TARP monies disbursed through the Capital Purchase Program to prevent their use for perks for company management, loans to foreign governmental authorities, investments in outsourcing jobs held by Americans, investments in foreign company operations overseas, and the repurchase of company common stock, or any other potential example of waste and abuse. 

With such a massive amount of taxpayer money funding the program, the U.S. Treasury must ensure that the funds are administered appropriately.  A tiny fraction of the $700 billion within the TARP could be used to provide the necessary controls to prevent fraud and waste.  It seems to be a very small price to pay to protect the interests of U.S. taxpayers.

Streamlining Regulatory Oversight

Chairman Ben Bernanke of the Federal Reserve Board spoke yesterday to the Council on Foreign Relations about his strategic view of regulatory reform.  His comments were focused on managing risk at the macro level, but still ring true for companies on a micro level as well.  He stated the following,

"We must have a strategy that regulates the financial system as a whole, in a holistic way, not just at its individual components.  In particular, strong and effective regulation and supervision of banking institutions, although necessary for reducing systemic risk, are not sufficient by themselves to achieve this aim. "

His view sounds very similar to the aims of enterprise risk management underway at many corporations today. Much like risk and compliance processes must be streamlined in companies, the Federal government must streamline its hodge-podge approach to regulating our financial system.

Help Wanted at the U.S. Treasury

The U.S. Treasury is having trouble staffing its team at the very height of the current economic maelstrom according to an article in the New York Times.  Last week, the nominee for the number two position at the Treasury withdrew herself from consideration while many positions remain unfilled.  The lack of qualified personnel is beginning to impede the progress of major initiatives such as the anticipated regulatory reform blueprint that was slated to be unveiled at the upcoming G-20 summit in London.  Here is what the Times reported yesterday.

Administration officials say they are postponing their plan to produce a detailed road map for overhauling the nation’s financial regulatory system by April, in time for the Group of 20 meeting in London. Though officials say they will still develop basic principles in time for the meeting, the plan will not include much detail.

Lack of detail creates a great deal of uncertainty.  Uncertainty is exactly what our fragile financial markets cannot support in times like these.  Let's hope that Secretary Geithner can quickly staff his team to begin filling in the gaps in his plans.

Risk Controls to Receive More Scrutiny

As more attention is devoted to post-mortem analysis of the economic meltdown and what financial institutions can do to improve their risk management practices, it is becoming clear that regulatory and credit rating scrutiny will become much more intense.  Here is an excerpt from an article in today's London Times that supports this view.

 "there was the failure of external regulators and rating agencies to monitor the banks' risk-controls. Despite deficiencies in bank management, some of the problems could have been averted with stronger checks and balances from the regulatory bodies charged to assess risk. But rating agencies undervalued risk when assessing new products. And regulators ignored the dangers of macroeconomic contagion, as well as failing to apply any independent checks to the risk models used by banks."

How is your company preparing for the increased scrutiny?  Wheelhouse Advisors can help with cost-effective strategies to manage your risks and meet stricter regulatory requirements.  View the brief video below or visit www.WheelhouseAdvisors.com to learn more.

[googlevideo=http://video.google.com/videoplay?docid=6188056548864645559]

Devil is in the Details

This week the U.S. Senate Committee on Homeland Security and Governmental Affairs conducted a hearing on how systemic risk needs to be governed by our financial regulatory agencies.  All agreed for the need of a single regulator, but there was not unanimous agreement on who should serve in the role.  Most point to the Federal Reserve given their role as the lender of last resort.  However, a few fear the increased level of political influence on the Federal Reserve given that they are the central bank for the United States.   Here is the view of Robert Pozen, Chairman of MFS Investment Management and Senior Lecturer at Harvard University.

1. The United States needs one federal agency to play the role of systemic risk regulator because of the increasing frequency of global financial crises and higher correlations among different investment markets.

2. Congress should give this role to the Federal Reserve Board because it has the job of bailing out financial institutions whose failure would threaten the whole financial system.

3. The Federal Reserve Board should focus on five areas that are likely potential sources of systemic risk – inflated prices of real estate, institutions with high levels of leverage, new products falling into regulatory gaps, rapid growth in an asset class or intermediary and mismatches of assets and liabilities.

4. The Federal Reserve Board should monitor closely the activities of all types of financial institutions with very large or otherwise very risky assets since they are the ones most likely to impact the whole financial system.

5. If the Federal Reserve believes that actions need to be taken to reduce systemic risks, it should work closely with the regulatory agency with primary jurisdiction over the relevant institution, product or market.

Senator Joe Lieberman, chairman of the committee holding the hearing, said lawmakers have a large task in redesigning financial regulation, which is now broken. "We cannot expect the creation of a systemic risk regulator to be a universal remedy for all that ails our financial services industry today," Lieberman said. "As always, the devil is in the details." 

What You Don't Know Can Hurt You

More and more attention is focused on the potential risks of outsourcing and offshoring due to high profile cases such as the massive accounting fraud at Satyam Computer Services in India.  Companies looking to accelerate expense reduction in the face of dwindling revenue are increasing their exposure to a variety of risks through business process outsourcing ("BPO").  Here is a related observation from a recent article in CFO magazine.

Experts predict that recent events will spur more-comprehensive scenario planning regarding potential offshoring vulnerabilities, including performance problems, power outages, terrorism, and fraud. "It's causing a lot of people to pause for a second and say, 'Oh my God, there are more unknowns and risk than I thought,'" says Robert E. Kennedy, executive director at the University of Michigan's William Davidson Institute, and author of a book about offshoring called The Services Shift.

How well do you know your BPO partner and the potential risks associated with your relationship?  Wheelhouse Advisors can help build a risk assessment framework to provide the necessary insight to manage a successful relationship.  Visit www.WheelhouseAdvisors.com to learn more.

Recovery Risk Management

According to the Implementation Guidance for the American Recovery and Reinvestment Act of 2009 (aka "Recovery Act" or "Economic Stimulus Act") issued to all agencies of the U.S. government, risk management will be a central focus to provide the appropriate transparency and accountability promised by President Obama.  Agencies are encouraged to perform a risk assessment of all programs receiving funding within their purview.  Here is an excerpt from the guidance memo issued by the President's Office of Management and Budget.

For programs that receive Recovery Act funding, agencies should consider the following when assessing risk (note that the following list is intended to be illustrative):

1. Which programs are receiving the most funding;


2. Are program outputs and outcomes clear and measurable;


3. Are existing resources sufficient to achieve program objectives and proper award and management in accordance with statutory and regulatory requirements;


4. Who is (are) the final recipient(s) of funds (e.g., contractor, sub-contractor, state, locality, educational institution);


5. Are existing internal controls sufficient to mitigate the risk of waste, fraud, and abuse adequately;Are there performance issues with (potential) funding recipients; and 


6. Are there leading indicators or lagging indicators (e.g., error measurements) to monitor ongoing program performance?

Agencies should also develop a plan for monitoring and reassessing risk throughout Recovery Act funding availability and project close-out.

Kudos to the President and his staff for utilizing risk management practices such as these to improve the overall effectiveness of the programs receiving the massive amounts of funding.  As taxpayers, let's hope the implementation is successful.  

Saving For The Perfect Storm

Some banking regulators are beginning to admit the errors made in the early part of this decade that have resulted in the extreme severity of the current economic downturn.  One area that is rearing its ugly head is the inadequacy of loan loss reserves by the largest financial institutions.  As loans were being made at a frenzied pace, the reserves for the inevitable losses associated with those loans were not increased.  The Wall Street Journal reported yesterday that John Dugan, the U.S. Comptroller of the Currency, made the following admission.

He noted that the record profits of the banking industry at the beginning of this decade weren't coupled with an appropriate increasing in reserving. Instead, Dugan said, the ratio of loan loss reserves to total loans actually fell even though bank executives had to know that record profits couldn't last forever.  "Stated differently, rather than being counter cyclical, loan-loss provisioning has become decidedly pro-cyclical, magnifying the impact of the downturn," Mr. Dugan said.

Like many American consumers, the banks themselves were guilty of spending freely by making bad loans and not saving for a rainy day - or, in today's case, saving for the perfect storm.

The Oracle Speaks About Overreaction

Last week, Berkshire Hathaway, Inc. released its 2008 results as well as Chairman Warren Buffett's letter to shareholders.  Both provided a sobering view of the 2008 economic crisis and the bleak outlook for 2009.  Of particular note, Mr. Buffett (aka the "Oracle of Omaha") discussed his view of the pricing of risk in today's investments. Here's what he had to say.

The investment world has gone from underpricing risk to overpricing it. This change has not been minor; the pendulum has covered an extraordinary arc. A few years ago, it would have seemed unthinkable that yields like today’s could have been obtained on good-grade municipal or corporate bonds even while risk-free governments offered near-zero returns on short-term bonds and no better than a pittance on long-terms. When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s. But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary.

A crisis and panic will drive people to do crazy things, such as overreact in the face of uncertainty.  Having a solid risk management framework and approach provides the discipline to avoid overreaction.  Visit www.WheelhouseAdvisors.com to learn more.