A Recipe for Failure

The lack of transparency into the TARP program is well known and a primary source of criticism.  The Wall Street Journal has presented new information into the side deals by our elected officials that are plaguing the rescue effort. In an article yesterday, they noted the following:

The goal of aiding only banks healthy enough to lend -- laid out by the Treasury when the program began -- clearly seems to have shifted, but in a way that's hard to pin down and that the Treasury has declined to explain. Part of the problem is that some powerful politicians have used their leverage to try to direct federal millions toward banks in their home states.

One of those politicians is none other than Barney Frank, chairman of the U.S. House Financial Services Committee. According to the Wall Street Journal, Rep. Frank directed the issuance of $12 million in TARP funding to OneUnited, a small bank in Rep. Frank's home state of Massachusetts.  Just prior to issuing this money, OneUnited had been given a "cease and desist" order by the FDIC due to poor lending practices and executive compensation abuses.  In addition, the bank was ordered to dispose of a 2008 Porsche sports-car that had been reserved for executive use.  Given the depreciation of high-end sports-cars, the Porsche must have qualifed as a "troubled asset".  

Back door dealings and excessive pay practices led us into this current financial crisis.  Continuing these practices under the guise of a rescue effort will certainly doom it to failure.  Here is Rep. Frank discussing his planned bill to place restrictions on use of TARP funds.  Let's hope he includes a Porsche restriction provision in the bill.

We Need to Make It Work

President Obama's nominee for Secretary of Treasury, Timothy Geithner, finally testified at his Senate confirmation hearing yesterday after a week delay caused by the disclosure of his failure to pay income taxes several years ago. Evidently, this issue was discovered in early December and disclosed to the Senate panel responsible for examining Mr. Geithner's nomination.  However, it was not disclosed to the public until last week.  Only then did the Senate Finance Committee decide to delay his confirmation hearing to investigate further.  

Whether or not paying his taxes was just an honest mistake on Mr. Geithner's part is not the larger issue here. The larger issue is the lack of disclosure and transparency into the nomination process.  Mr. Geithner's comments to the committee were ironic given the situation.  Here is an excerpt from his prepared testimony about the much maligned TARP program.

I know there are serious concerns about transparency and accountability, confusion about the goals of the program, and deep skepticism about whether we are using the taxpayers’ money wisely.  Many people believe the program has allowed too much upside for financial institutions, while doing too little for small business owners, families who are struggling to keep their jobs and make ends meet, and innocent homeowners.  

We have to fundamentally reform this program to ensure that there is enough credit available to support recovery.  We will do this with tough conditions to protect the taxpayer and the necessary transparency to allow the American people to see how and where their money is being spent and the results those investments are delivering.  And we are going to do that.  This is an important program and we need to make it work.

Mr. Geithner is right in his comments.  We need to make the TARP program work and the only way to do that is to provide full disclosure and transparency.  Without it, investor confidence will not return to our financial markets anytime soon.

The Sooner, The Better

Last week, a document was released by the Group of Thirty that provides some interesting ideas and insight into the future of our financial regulatory system.  For those unfamiliar with the Group of Thirty, it is a private, nonprofit, international body composed of very senior representatives of the private and public sectors and academia that aims to deepen understanding of international economic and financial issues, to explore the international repercussions of decisions taken in the public and private sectors, and to examine the choices available to market practitioners and policymakers.  Notable members of the Group of Thirty include Paul Volcker, Tim Geithner, and Lawrence Summers - all future members of the Obama Administration.  

The document is entitled "Financial Reform: A Framework for Financial Stability" and provides recommendations for improving our financial system once we have moved beyond the immediate financial crisis we are in today.  Of particular interest to readers of this blog are the following set of recommendations focused on governance and risk management. 

Regulatory standards for governance and risk management should be raised, with particular emphasis on:

a. Strengthening boards of directors with greater engagement of independent members having financial industry and risk management expertise;

b. Coordinating board oversight of compensation and risk management policies, with the aim of balancing risk taking with prudence and the long-run interests of and returns to shareholders;

c. Ensuring systematic board-level reviews and exercises aimed at establishing the most important parameters for setting the firm’s risk tolerance and evaluating its risk profile relative to those parameters;

d. Ensuring the risk management and auditing functions are fully independent and adequately resourced areas of the firm. The risk management function should report directly to the chief executive officer rather than through the head of another functional area;

e. Conducting periodic reviews of a firm’s potential vulnerability to risk arising from credit concentrations, excessive maturity mismatches, excessive leverage, or undue reliance on asset market liquidity;

f. Ensuring that all large firms have the capacity to continuously monitor, within a matter of hours, their largest counterparty credit exposures on an enterprisewide basis and to make that information available, as appropriate, to its senior management, its board, and its prudential regulator and central bank;

g. Ensuring industrywide acceptance of and action on the many specific risk management practice improvements contained in the reports of the Counterparty Risk Management Policy Group (CRMPG) and the Institute of International Finance.

These are great recommendations that will certainly strengthen the governance and risk management of our financial institutions.   However, implementation of these recommendations will take a great deal of effort and time.  The sooner we can begin to address these recommendations, the better.

Reducing Expenses May Not Reduce Risk

More and more companies are looking for ways to reduce expenses and a popular method recently has been outsourcing.  While many benefits come with an outsourced relationship, so does increased risk.  Proper due diligence and carefully crafted service level agreements are essential.  However, with the recent fraud at Satyam in India, those activities may not be enough.  A recent article in CFO magazine highlights the problem. Here is a excerpt from that article.

The enormously inflated cash balances at Satyam have popped a hole in the reputation of the outsourcing market, which has grown from business offering solely tech business, to back-office work such as finance and accounting. "This has really shaken up the outsourcing industry," says Peter Allen, a partner and managing director for outsourcing advisory firm TPI. "The industry is built on relationships that imply some level of trust and confidence and integrity."

How comfortable are you with your outsourcing partner?  Have you assessed the risks with the relationship lately?  If not, Wheelhouse Advisors can help.  Visit www. WheelhouseAdvisors.com to learn more.

Managing Risk is Job #1 for Boards

Corporate boards of directors have their plates very full these days with mounting financial pressures and, as a result, it is becoming painfully obvious that having a solid understanding of risk management is critical.  A recent article in Corporate Board Member magazine highlights the role of the board as it relates to effective risk management.

In the view of most directors, risk is the responsibility of the full board and the crux of the job. That’s why it is essential that the board become comfortable with the way management perceives and deals with risk in the company’s operations. Management needs a company-wide process for uncovering risk, usually some kind of enterprise-risk-management system that aggregates all the known risks the company faces—from access to capital to talent retention to viruses in the software—and prioritizes them according to the magnitude of their potential effects on the company and the probability of their occurrence. Then it is the board’s role to define the 10 or 20 most important risks, making them regular agenda items and part of every discussion of strategy.

Wheelhouse Advisors can assist management or boards of directors in developing a cost-effective enterprise risk management framework that will facilitate a better understanding of how risks are being managed throughout the company.  Visit www.WheelhouseAdvisors.com to learn more.

Startling Results

A recent survey of banking executives across the world provides confirmation of the very issues discussed on The ERM Current™ and should be a wake-up call to all corporate boards of directors - financial and non-financial alike.   The survey was conducted by KPMG and here is a sample of the results:

More than three-quarters (76 percent) of the almost 500 global banking executives surveyed report that risk management is still stigmatized as a support function at their bank. Only half (48 percent) said that risk management is understood to be the responsibility of everyone in the organization, and another 45 percent of respondents said their board lacks risk expertise.  When asked to rank the leading contributors to the credit crisis, the banking executives named incentives and remuneration (54 percent), followed closely by lack of risk governance (50 percent) and risk culture (48 percent).

For those who have been following The ERM Current™, these results should come as no surprise.  However, for those new readers, these are startling results indeed.  Much work remains to strengthen risk management practices and to ensure that they remain a vital part of corporate operations.

Are You Prepared to Ride the Wave?

Is your company prepared for the coming wave of regulation?  How flexible and cost-effective is your company's enterprise risk management program?  Answers to these questions may make or break companies as they struggle to emerge from the financial crisis.  A recent article in Treasury & Risk Magazine reinforces the risk management challenge.

With lip service paid to risk management but no real clout singled out as one of the culprits in the financial crisis, many companies in 2009 aim to make risk management a daily function of good governance. And since a new Congress and president both promise increased regulation, companies should expect to deal with risk management on Washington’s terms.  The chief risk officer’s (CRO) job will evolve from what was mainly a focus on regulatory compliance to include across-the-the board oversight of everything from Sarbanes-Oxley to credit risk to business continuity.

Wheelhouse Advisors is uniquely equipped to help companies build flexible, cost-effective and sustainable enterprise risk management programs.   Contact us at NavigateSuccessfully@WheelhouseAdvisors.com to learn how we can help you