Sunday, 31 May 2015

27,000 risk managers at Lehman?

16:15 Posted by The Thalesians (@thalesians) No comments

This September, it will be seven years since Lehman Brothers collapsed, triggering the financial crisis. I was working at Lehman at the time. Hence, it's an episode that I'll probably be thinking about for many years to come. I've gone over the subject on several occasions both in my blog (Lehman Brother can you spare a yard?) and it also formed the backdrop for the introduction in my new book Trading Thalesians - What the ancient world can teach us about trading today (Palgrave Macmillan).

This week, we heard from one of the main protagonists in the whole sorry episode of Lehman's demise. Dick Fuld, Lehman Brothers' former CEO made a public appearance, speaking at the Marcum Microcap conference (I suppose his previous public appearances in front of US politicians were a more case of being "volunteered", if there is such a phrase??). Perhaps unsurprisingly, Fuld's appearance, attracted a large amount of media coverage: what would he say after all these years? The most reported soundbite to come out of his speech was his statement that Lehman had 27,000 risk managers, namely all the employees. Unfortunately, this appears to ignore the point that as CEO and also the biggest shareholder, he was the most important risk manager of all. If you lead a company, you are paid to take responsibility, you are not paid to blame all your employees for your failure to manage them. Lawrence MacDonald, the author of a Collosal Failure gave his own interpretation of Fuld's comments on Twitter:

It wasn't "27,000 risk managers" at Lehman, it was 26,992 people making money at Lehman, and 8 guys losing it

Fuld seems to be of the view that the blame for Lehman's collapse was the US governments decision not to bail out the bank and there was a "perfect storm" of events. Whatever you might think of the U.S. government's decision in 2008, the fact that Lehman *needed* to get bailed out was not the doing of the U.S. government. They did not force feed Lehman Brothers a diet of leverage to gorge on illiquid and toxic assets, which came unstuck when the U.S. housing market changed direction. It's like a builder using very cheap materials to build his own house, which then collapses as a result. Rather than admitting he used poor building materials, he then blames the police for failing to stop him building in the first place.

Significantly, there were no apologies from Fuld or an acknowledgement of mistakes made at Lehman. He seems to be lost in a web of events, where Lehman Brothers' adversaries were all apparently outside the company, rather than inside its boardroom overlooking Times Square. Yes, external events eventually conspired to pull Lehman under, but only because Lehman had a significant risk exposure to them. Furthermore, those who were shorting Lehman were proved right.

Every trader makes mistakes. It's the inevitability of the activity called trading. You take a risk to make a profit, thats the dictionary definition of trading. Sometimes, risks you take will land you with losses. A loss is never something to cherish. What a loss does give you however, is the opportunity to both admit and learn from it. If you manage your risk effectively, these losses will not be enough to destroy you. It's not even something confined to trading, arguably the ability to learn from mistakes is crucial for any business. I've made many mistakes along the way trying to go independent in creating a financial research business, after working in banking for a number of years. Sure, I've had great advice, some of which I took on board and some of it which I've (mistakenly) ignored, whilst making this transition. What is clear though is that any difficulties I've had going independent have taught me a huge amount (although I really don't wish to repeat them!). Reality is the harshest of teachers, one you can't ignore!

You can only learn from mistakes, if the mistakes you make are small enough that you can survive. If you place all your risk on a single massive trade, if it goes wrong and you lose everything, it becomes difficult to blame anyone else but yourself. Moreover, an inability to admit a mistake is probably the biggest disqualification for a sound risk manager, that you could think of. If Fuld wants to be congratulated, the best word he can say is "sorry" - for that, he will get 27,000 rounds of applause.

(I'll be in Frankfurt speaking about my book and doing a live Python FX demo in Wed 3 Jun - register here - and also speaking at Open Source in Quant Finance also in Frankfurt on Fri 5 Jun - hopefully see you there!)

Like my writing? Have a look at my book Trading Thalesians - What the ancient world can teach us about trading today is on Palgrave Macmillan. You can order the book on Amazon. Drop me a message if you're interesting in me writing something for you or creating a systematic trading strategy for you! Please also come to our regular finance talks in London, New York and Budapest - join our group for more details here (Thalesians calendar below)

03 Jun - Frankfurt - Trading Thalesians book talk / Python FX intraday demo - Saeed Amen / The Thalesians (tickets here)
17 Jun - London - Using Python to build trading strategies - Man-AHL & Saeed Amen
18 Jun - New York - Dr. Tim Leung - Exchange-Traded Funds and Related Trading Strategies - IAQF-Thalesians
22 Jul - London - TBA


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