Confessions of a risk manager

An insider explains why it is so hard to stop traders behaving recklessly

IN JANUARY 2007 the world looked almost riskless. At the beginning of that year I gathered my team for an off-site meeting to identify our top five risks for the coming 12 months. We were paid to think about the downsides but it was hard to see where the problems would come from. Four years of falling credit spreads, low interest rates, virtually no defaults in our loan portfolio and historically low volatility levels: it was the most benign risk environment we had seen in 20 years.

As risk managers we were responsible for approving credit requests and transactions submitted to us by the bankers and traders in the front-line. We also monitored and reported the level of risk across the bank’s portfolio and set limits for overall credit and market-risk positions.

The possibility that liquidity could suddenly dry up was always a topic high on our list but we could only see more liquidity coming into the market—not going out of it. Institutional investors, hedge funds, private-equity firms and sovereign-wealth funds were all looking to invest in assets. This was why credit spreads were narrowing, especially in emerging markets, and debt-to-earnings ratios on private-equity financings were increasing. “Where is the liquidity crisis supposed to come from?” somebody asked in the meeting. No one could give a good answer.

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The Global Economy’s Inevitable Hard Landing

In recent weeks, the global liquidity and credit crunch that started last August has become more severe. This is easy to show: in the United States, the euro zone, and the United Kingdom, spreads between Libor interest rates (at which banks lend to each other) and central bank interest rates – as well as government bonds – are extremely high, and have grown since the crisis began. This signals risk aversion and mistrust of counterparties.

To be sure, major central banks have injected dozens of billions of dollars of liquidity into the commercial banking sector, and the US Federal Reserve, the Bank of England, and the Bank of Canada have lowered their interest rates. But worsening financial conditions prove that this policy response has failed miserably.

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Prem Watsa: He has never been more bearish

The head of Fairfax Financial had a front-row seat when the Japanese market began its 15-year retreat. And he thinks the U.S. indexes might be about to do the same.

The global credit squeeze is in its "early days," says investor Prem Watsa, who is so bearish that his insurance company has stashed the bulk of its $18-billion investment portfolio into ultrasafe government bonds.

In a rare interview, the chairman of Fairfax Financial Holdings Ltd. said he thinks it's possible the United States is on the cusp of a prolonged market slide, similar to the one endured by Japan between 1990 and 2003, when the Nikkei index plunged 80 per cent.

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Buffett could reap gains from credit turmoil: report

Warren Buffett, chairman of Berkshire Hathaway Inc., may cash in from the credit market turmoil and worries surrounding the financial strength of bond insurers, including Ambac Financial Group Inc. and MBIA Inc (MBI.N: Quote, Profile, Research), the Wall Street Journal said in its online edition on Monday.

With more than $45 billion in cash on its books, a triple-A credit rating and years of experience insuring other insurers against catastrophic losses, Berkshire Hathaway (BRKa.N: Quote, Profile, Research) is in a position to provide relief to some of these companies and could get into the bond-insurance business itself, the Journal said citing people familiar with the matter.

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Crisis Counsel

Will the subprime lending meltdown and credit crunch send us into a financial free fall? We asked the sharpest minds in business to share their reactions to the downturn, and their insights on the road ahead.

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