By Donald van Deventer on 5/20/2009 4:02 PM

Unlike Countrywide Financial, which struck its rescue deal with Bank of America in January 2008, Washington Mutual, Inc. survived longer into the credit crisis.  Its subsidiary bank and thrift were seized by the FDIC and resold to J.P. Morgan Chase & Co. on September 25, 2008, shortly after Kerry Killinger was ousted as Wamu CEO.  The purpose of this post is not to lay blame.  It's in the tradition of an "incident report" in the military, or an autopsy.  A patient who shouldn't have expired did in fact pass away.  Why did this happen, and what needs to be done to prevent it from happening in the future?  The short answer is again simple--the institution had a traditional focus on legacy interest rate risk analysis, but it didn't ask the same questions about macro factors like home prices that it did about interest rates. More precise, if those questions about home prices were asked by management, they did not deem them im

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By Donald van Deventer on 5/18/2009 7:00 PM

A few months ago, Mr. P from Geneva urged his colleagues, "Let's forget this crisis and look forward, not backward."  With all due respect to Mr. P, we believe that George Santayana was right when he said "Those who cannot remember the past are doomed to repeat it," (The Life of Reason, Volume I, 1905).  A long series of institutions have failed in this crisis because they relied on legacy risk systems and legacy thinking about risk management that didn't work.  These institutions spent lots of time on interest rate risk but couldn't analyze the impact of drops in home prices on their own safety and soundness.  Countrywide Financial, New Century, Lehman Brothers, IndyMac, Washington Mutual, and FNMA failed because they had blinders on, both from a conceptual and a systems point of view.  This post focuses on the lessons that can be found in the 2006 and 2007 10-k filing of Countrywide Financial and its 2006 annual report

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By Donald van Deventer on 5/15/2009 6:49 PM

Our two posts on capital allocation, comparing the "common practice" of VAR with the Merton and Jarrow put option approach, have prompted an interesting dialogue.  "I read the posts," said R in New York, "and I need you to help me understand why actual bank losses were so much larger than their VAR figures at the time.  I thought the VAR numbers were supposed to overstate the true capital needs as measured by the put."  This post explains the differences between black swans, bad VAR, good VAR, and better puts!

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By Donald van Deventer on 5/14/2009 6:28 PM

Our blog the other day on "A Ratings Neutral Investment Policy" prompted the Wizard to respond.  The Wizard is one of the most accomplished risk experts we know, working for one of the world's largest financial institutions.  He spends his day in constant motion, trying to do the right thing.  My good London friend Suresh Sankaran introduced me to detective novelist G. K. Chesterton, whose quote in 1905 describes the challenges the Wizard faces: "And being good is an adventure far more violent and daring than sailing around the world." (The Club of Queer Trades, Wildside Press Edition, page 36).  The Wizard focused on one sentence in our "Ratings Neutral Investment Policy" and the ethical obligations of CFAs in recommending investments to their employer.  This post explains his comments.

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By Donald van Deventer on 5/13/2009 6:39 PM