By the time they grew to $1.5 billion, Michael Roseman, MF Global’s Chief Risk Officer, was concerned about the firm’s positions in bonds of Italy, Spain, Portugal, Ireland and Belgium. He was worried the trade might endanger the entire firm if the financial problems in Europe got too tough. Roseman believed MF Global didn’t have enough liquidity to withstand a credit rating downgrade.
Roseman joined MF Global in 2008 to improve risk-management culture after a rogue trading incident cost the firm $140 million. As the Euro sovereign positions grew to $6 billion, they blew through trading limits that he had helped put in place before John Corzine, MF Global’s new CEO, became his boss.
It was Roseman’s job to get the directors to approve any increases in those trading limits. He made at least three separate requests to increase sovereign debt exposure. Each time, directors asked him about the risks of the trade. And each time, in spite of the fact it challenged the CEO’s pet strategy, he did what he was supposed to do: he outlined the risks as he saw them.
But Corzine insisted on maintaining the trade, even threatening to resign if the board did not back him. So Roseman was replaced, and a new risk officer, Michael Stockman, took over in March 2011. But he was not allowed to weigh in on the broader implications of the sovereign debt trades, including the risk of ratings downgrades, loss of investor confidence, and funding problems.
Which, of course, is exactly what happened. By October, MF Global had succumbed to a liquidity squeeze and filed for bankruptcy. This sad story prompts lots of questions, but for us the most interesting one is, “Could a better risk culture have protected the firm and its clients from Corzine’s bullying and blunders?”
Lack of an effective risk culture has been cited as a factor in the collapse of Bear Stearns and Lehman Brothers and troubles at many other firms. But what is risk culture? And what are the signs an outside analyst can use to tell whether a firm’s risk culture is strong or weak?
We have our own ideas, which we’ll share with you later. But first we’d like to hear from you. How do you define risk culture? How do you evaluate it? We look forward to getting your comments, and, in the meantime, happy New Year.
Super. Just the kind of article needed. It would be even better if you had more specifics on the specifics of the risks and what each party did about them.
Without more information its hard to know what the right approach would have been to MF Global. It sounds like there was at least one person who identified the risks, but the board was a push over. This reminiscent of some of me of the problems at Tyco and Enron (management style). Was this trade outside of policy and the company’s risk tolerance? Hard to know from the information provided above. Were the board members truly independent members or where there conflicts of interest? Was this really a “pet strategy” or did the CEO feel the risks were properly mitigated for other reasons? Is the CEO properly incentivized to make good long term decisions? How is top management compensation structured? Does the company have an ethics and compliance program in place?
Awesome post.|