June 12, 2008 / 3:04 PM / 12 years ago

Wall St hasn't fixed its bubble problem: experts

NEW YORK (Reuters) - Chastened financial firms are destined to repeat their mistakes in a few years unless they overhaul risk management practices and rethink compensation for employees who are supposed to blow the whistle, financial market experts said on Thursday.

Larry Tabb, founder and Chief Executive Officer of TABB Group, speaks during the Reuters Investment Outlook Summit in New York, June 12, 2008. REUTERS/Chip East

Now that the U.S. Federal Reserve is able to provide emergency cash to a wider range of companies, another Bear Stearns debacle is unlikely — but the next cycle peak will inevitably bring new excesses unless the model is changed — the experts said in a panel discussion on risk management.

“We’re starting to see the risk managers have a seat at the board. We’re seeing them be respected much more. They’re being paid attention to,” Larry Tabb, founder and chief executive of Westborough, Massachusetts-based research and advisory firm TABB Group, said at the Reuters Investment Outlook Summit in New York.

“When we get into another bull cycle, we’ll see what happens then. Everyone likes the risk manager when there’s problems. When things are going well, human nature is not to pay attention to them,” Tabb said.

Wall Street firms have always struggled to strike the right balance between making money and managing risk, and blowups like the global credit crisis push the pendulum the other way.

While the latest episode is likely to bring greater regulation and oversight, meaningful change will have to come from within, said Tad Rivelle, chief investment officer at Metropolitan West Asset Management in Los Angeles.

The trouble, Rivelle said, is that top executives have little or no incentive to stand in the way of the latest market obsession — particularly when competitors are profiting from it. Annual bonuses tied to share price encourage short-term risk-taking. CEOs who refuse to go with the tide risk incurring the wrath of shareholders and ultimately the board of directors.

“Capitalism is such a potent force, it makes these periods of time happen,” Rivelle said. “Woe betide the individual who gets in its way.”


The panelists expected tighter regulation in the aftermath of the credit crisis, and said the Fed’s stronger oversight of primary bond dealers should ensure that there is no repeat of the Bear Stearns collapse in March.

But no amount of regulation can take the place of companies listening to their own risk managers and having the courage to slow the pursuit of profits, the panelists said. That will never be popular on Wall Street, although in crises it becomes more palatable.

Terry Marsh, president and CEO of Quantal Asset Management in San Francisco, said that companies all over the world mismanaged risk from the U.S. mortgage market because they relied on trends going back only a couple of years — when the housing market was booming and default rates were low.

The housing market began to fade in 2006 and there were plenty of experts warning of the impending bust, but it was at least another 18 months before ratings agencies, banks and investors finally accepted that losses were going to be far more severe than they had expected.

“Things were very predictable this time,” Marsh said. “People just weren’t adapting correctly. Did anyone have an incentive to adapt correctly? Around the world everybody had low interest rates, and they were all trying to make a few little basis points” in profit.

The short-term response to the newfound admiration of restraint will be a spike in demand for risk-management software as firms scramble to improve operations now that shareholders, directors and regulators are watching closely.

In the longer term, companies must find a way to make sure those given the job of managing risk have enough incentive to make their voices heard, even during the boom times.

“The whole reason that you compensate the senior management of these organizations is not to parrot to you that the ‘value at risk’ model says everything is going to fine, but rather to say these deleveragings occur. This is the nature of it. Let’s not pretend that they don’t,” MWAM’s Rivelle said, referring to times when companies are purging risk.

“Think like Warren Buffett, a guy who makes money during the deleveraging.”

(For summit blog: summitnotebook.reuters.com/)

Editing by Jonathan Oatis

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