To model correctly one tranche of one CDO took about three hours on one of the fastest computers in the United States. There is no chance that pretty much anybody understood what they were doing with these securities. Creating things that you don’t understand is really not a good idea no matter who owns it.

Former Merrill Lynch CEO John Thain admits that he really had no idea what the CDOs on their balance sheet were worth. Felix Salmon quite rightly blasts him for changing his story, having previously claimed that he knew exactly what the positions were worth. If I were a Merrill shareholder I’d expect my $80million/year CEO to have a decent understanding of what’s going on.

This isn’t a new revelation. Michael Lewis’s 1989 novel Liar’s Poker pointed out that Salamon Brothers Chairman John Gutfreund didn’t understand the risks his firm was taking. The securities they were dealing with were way simpler back then - I don’t think we should be surprised that today’s top Wall St executives have totally lost touch with the details of their complex derivative portfolios.

I’m with Warren Buffett - every CEO of an investment company should also play the role of their firm’s Chief Risk Officer, taking responsibility for understanding and managing the risks in their portfolio. I think things would be quite different if CEOs didn’t delegate this responsibility.
Tags: finance 1 note | | Oct 11, 2009
  1. alexjcampbell posted this