Where were all the Risk Managers when Investmen Banks started investing in Sub Prime?

G

gymratnyc

I mean seriously, they must have recognized the risk of using leverage to invest in subprime. Anyone with fundamental financial knowledge would know that investing using leverage is a recipe for disaster especially when using $$$ amounts, i.e. Long Term Capital?

I saw the Ameritrade CEO on CNBC in the Morning and he said that they took a look at investing at subprime and they concluded that the risk-versus reward was too high. They would gain a few percentage points in earnings versus catastrophic losses. Luckily for him, they didn't end up like ETRADE.

http://www.cnbc.com/id/24235030
 
It is basically a situation where the risk managers were ignored as the Wall Street firms opened the greed spigot...

One classic analogy is below...

Summer 2005 – Wall Street
“All swans are white” shouted the leader of the investment banking crowd.
“and what if a black one shows up,” countered the risk manager.
“Do you know how much money we are making on these CDOs? How can there be any risk. Risk is a thing of the past. This is the new generation of banking, risk is distributed," cried the room in chorus.
“The black swam is stalking you, and it is just a matter of time till it makes its appearance,” shouted the risk manager over the din.
“The quants have modeled this stuff over the last ten years. They assure me there is no risk and we are going to make a ton of money in fees. Don’t rock our rice bowl,” stated the lead derivative banker as the crowd rose to leave the room, “Let’s go make some bonus money!”
The risk manager sadly shook his head while staring directly at the black swan that was obviously sitting on the table.

The risk manager resigned the following week and was quickly replaced by one more pliable to the demands of the derivative structure crowd. The figurine of the three monkeys on the new risk manager’s desk was an evident sign of the impending future.

http://hingefire.blogspot.com/2008/01/redefinition-of-risk.html
 
Clearly you have never dealt with risk managers if you are surprised by this. They are almost always measurably underpaid, relatively inexperienced in trading, and are only listed to when senior management find it convenient. In some cases they are actually used as risk maximizers, as in how large of a position can we have to maximize our revenue and still be within the particular regulations.
 
Yes your point is valid if it relates to my point, there would likely have been pressure from above, where the real money is made, to stretch things as far as possible. I should have clarified more.
 
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