Nov 20, 2008

Investment Banking explained!

As actuaries we all know investment Banking is a complex business.
This Youtube video explains the essentials of Investment banking in about 8 minutes.

Be sure to study the video seriously, it will be the best study investment you've done in years.

Credit Crisis Indicators

Credit Crisis Indicators: Treasury, Libor, Ted, Paper & Bonds.

The credit markets indicators give a better measure of the crisis than the stock markets. NYT gathered five ways to measure the recent disruptions in the credit markets.


Actuarial aerodynamic careers

Did you know that actuarial careers follow the laws of aerodynamics?

Read more about this and find out whether you are a "Balloon Career Maker" or a "Wing Career Maker.


Nov 15, 2008

Whistleblower Risk Management

We all know Risk Management is key in our business.

Yet, almost all risk models (e.g. Coso) emphasize mainly on known or knowable risks.

Of course, as we could have seen in the 2008 credit crisis, the art of Risk management is in managing the unknown or unknowable risks.

But how?

Let's try to learn from two main major accidents:

I. The Challenger shuttle disaster (1986)
The accident was caused by failing O-Rings. Warnings of many engineers were overruled and ignored. This crash was the consequence of a typical effect called GROUPTHINK. Groups naturally look for consensus and will often come up with a false consensus, even when individual members disagree.
Watch a video of the space shuttle Challenger disaster that illustrates this GROUPTHINK phenomenon.

Other examples are the Columbia shuttle disaster and the 9/11 attacks. In all cases Management failed because the information suggesting a disaster was weakly transmitted within an bureaucratic system, and managers failed to authorize action because of bad communication and performance or time pressure.

II. The 2008 credit crisis
  • Underestimating early signals
    The first indication of the coming credit crisis was the collapse of Enron in 2003, uncovered by whistleblower Sherron Watkins.

    After the collapse, the FED refused to come out with new 'rules based' guidelines . A Senate investigation showed that - starting already in 2000 - some major U.S. financial institutions had "deliberately misused structured finance techniques". But the Fed and the SEC underestimated the situation, kept to their 'principles based' system and consequently missed the opportunity to to flex their muscle by regulating market conditions for subprime mortgages.

    Lesson: It's not about 'rules OR principles', Football Or Soccer, but it's about 'Rules AND Principles'.

  • Mixed Central Banks (FED) responsibilities
    Central Banks, The Fed in particular, have at the same time two main responsibilities with regard to (other) financial institutions:
    1. Supervision
    2. Providing financial (banking) services

    Those two functions clearly conflict with each other. It's impossible to independently supervise the financial company you're financing at the same time. Supervisory advises will be suspicious by definition.

    Secondly you can't supervise yourself as central bank. Therefore, every country needs an independent (that is 'without central bank board members'), professional supervisory board, that audits and supervises the central bank and the national bailout plan(s).

  • Whistleblowers
    How could the credit crisis technically happen?
    Not an official, but a more outside kind of whistleblower, businessman Warren Buffet, warns in a 2003 BBC article that “Derivatives are financial weapons of mass destruction and contracts devised by madmen". The financial world isn't listening.

    Derivatives like Collateralised Debt Obligations (CDO's,) were developed to (re)fund the subprime loans. CDO's are packaged portfolios of credit risk, made up from different sliced and diced loans and bonds. They were hard to uncover without a whistleblower. At last an anonymous banker e-mails journalist Gillian Tett of the Financial Times about the situation. Only after she publices early 2007 what's wrong, the dices start rolling. This case also stresses the important role of journalism and whistleblowers in our aim for a healthy transparent financial market.

  • The Greed Game
    One can argue about the roots of the credit crisis. However, essential in the 2008 credit crisis were, or still are, the excessive remuneration practices at private equity companies, hedge funds and banks. They encouraged unhealthy and excessive risk-taking. Key is the lack of balance between possible earnings and possible losses of board members.

    To prevent unhealthy pressure management (with groupthink effects), board members' total rewards should always be in line with the long term realized added value of the company and not be based on yearly P&L profits or short term added value.

Manage the unknown risks
Risk Management is not a static, but a dynamic process.

To gain and behold control of the unknown risks, it's necessary to create a transparent organization and company-process that guarantees whistleblowers' and whisperers' (= whistleblowers, that wish to stay anonymous) safety and encourages and even rewards compliance reports from employees, clients or any other stakeholders.

Because of GROUPTHINK and - on the other hand - possible negative employee outcomes (demotion, dismissal, etc) in case a reported compliance issue turns out to be compliant after all, it's important that whistleblowers are always given the opportunity to report directly, anonymously and safely to the independent federal Supervisor. Employees must have the choice to report internal within their company (small compliance matters) or to report directly to the federal Supervisory board.

  • Separate the Supervisory and Financial Services functions of the central banks (FED)

  • Redesign whistleblowers management
    Whistleblowers should have the opportunity to report compliance issues directly and anonimously to an independent federal Supervisory board.

    Whistleblowers that choose to report within a company, should always directly reporte to the compliance officer, the executive board and the supervisory board. On top of this they should always, especially in case of discharge, dismissal or demotion, have the right to escalate to the federal Supervisor.

  • Change supervisory procedures and criteria
    Approval of (company) board members by the federal Supervisor should als be based upon:
    1. The 'ethical track record' of a candidate
    2. The feasibility of, in macro economic perspective, "realistic and balanced" board member performance parameters.

      The federal Supervisor should audit and approve the existence of a consistent 'company reward plan' that guarantees a sound and measurable balance between long term company results and board member rewards.

      CEO's that haven't established measurable long term added value for their company, shouldn't receive any bonus or golden parachute at all.

Nov 12, 2008

The Actuarial Black Eye

In his blog David Merkel gives a fabulous book review of the book:

The book and blog show that actuaries (and accountants as well) were not disciplined enough to resist politicians pressure and large companies board (and shareholder) short-term result demands. As a direct consequence those companies got into serious trouble.

Stick to one's guns, and keeping a save eye on the future, is one of the essentials of the actuarial profession.

Training (not just study alone) in giving the right push back on board level, should therefore be an obligate part of the education (and accreditation) of actuaries and accounts.

As (UK) Sir Derek Morris stated in his "review of the actuarial profession: interim assessment" (2004):

Too much has been expected of actuaries and, explicitly or otherwise, too much has been promised by them.

Clients have looked to actuaries to provide certainty, and actuaries have often appeared to provide it.

For Dutch actuaries, see also Willemse and Wolthuis in: "On the practical meaning of probability based solvency".

Actuaries are almost just like real human beings: after a few years successful studying and modeling, they gain confidence. They start to believe that reality will also act according their models. Moreover, they might get overconfident and think that their view and expertise on reasonably well predictable issues like life, death and disability are - with the same amount of certainty - also applicable on other issues like 'inflation' and the development of the 'stock market'.

This it typically a case of :

That what develops you, eventually might kill you

Practice hasn't shown that good actuaries are,by definition, also good weatherman.

The book also shows that self-regulating without clear targets and constraints is a fairy tale.

Keep in mind the Mongolian Proverb:

Of the good we have an understanding,
for fools we keep a stick upstairs

Success in being a PBA (Push Back Actuary)!

Nov 10, 2008


Bloomberg's Fred Pals reports on Oct. 29 that Rijkman Groenink, the former chief executive officer who earned about $33 million from the sale of ABN Amro Holding NV, said he regrets the takeover and wants to work again for the Dutch lender.

Groenink stated:

  • he would really like' to become a supervisory-board member at ABN Amro
  • "There is no one else in the Netherlands with as much banking experience and specific knowledge of ABN Amro as me,''
  • "I'd be more than willing to put my knowledge and experience at the bank and my management experience in the service of the new bank and therefore of the Dutch people.''
  • "My reality is one of loathing, sadness, I didn't need the money, I didn't want it. But the reality of public opinion is that I'm a money-grubber and I bargained away the bank.''


Nov 5, 2008

Value for Money!

Now that Obama will be the next (44th) US president, confidence will rise and we'll get value for money......

That leads to the question of how you measure the Purchasing Power of Money?

The measure most often used, is the Consumer Price Index (CPI).

Other comparison series might be preferable, depending on the context of the question.

In fact there are:

Calculate the actual value of a original year 1900 Dollar, Euro, Guilder or Pound and see how you get value for money.

Nov 3, 2008

Shareholder or Stakeholder model?

Does the corporation exist for the benefit of shareholders, or does it have other, equally important stakeholders, such as employees, customers and suppliers?

In a study titled, "Stakeholder Capitalism, Corporate Governance and Firm Value" (2007), finance professor Franklin Allen (e.a.) tackles this issue. In showing the various benefits of the stakeholder approach, he demonstrates that the issue is not as settled as some researchers and business people in the US or the UK might think.

Several conclusions emerge from the study, which uses a mathematical model to explore the advantages and disadvantages of stakeholder-oriented firms. First, stakeholder-oriented companies have lower output and higher prices, and can have greater firm value than shareholder-oriented firms. Second, firms may voluntarily choose to be stakeholder-oriented because it will increase their value, according to the study.

In a recent study (2008) called, "Rhineland Exit", Dutch (CPB) researchers Bovenberg and Teulings defend the victory of the Shareholder model over the stakeholder model (Rhineland model). They also state that the principle of maximization of shareholder value, being the ultimate goal of the firm, is at odds with the Rhineland philosophy of a balanced treatment of the interests of all stakeholders.

Why arguing so much about share or steak? By choosing the "stakeholdermodel with weights" it's simple to accomodate and optimize the final model to the company goals.