Category Archives: Financial Crisis

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European Insurers Pass Stress Test

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A report published today by Fitch Ratings claims its stress-testing of European insurers based on their euro-zone sovereign exposures has resulted in no ratings actions. Fitch used the hypothetical scenario of a default on Greek government debt to carry out a stress test on its rated European insurance portfolio.

The agency believes that all companies in this portfolio would be able to withstand an external shock derived from a hypothetical Greek sovereign default, including an assumption of ancillary stress for other key euro zone nations.

And by “other key euro zone nations” Fitch is referring to the troubled economies of Portugal, Ireland, Spain and Italy, whose “sovereign risk may be a particular concern.” Taking this and other economic factors into concern, the ratings agency followed a two-step stress test process.

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First, Fitch identified insurers where sovereign risk may be a particular concern — those insurers with exposure to Greece, Portugal, Ireland, Spain and Italy.

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Second, the agency considered the impact of the implications of sovereign risk — meaning, they applied their stress test to selected companies/groups. Fitch considered the Greek default scenario from two perspectives: economic viewpoint and market value viewpoint.

Direct and indirect (realized and unrealized) investment losses are viewed by Fitch as the primary risks for insurers from sovereign debt. Any insurer rated above Greece’s current ‘BBB-‘ level should be expected to be able to cope with the impacts of a hypothetical Greek default scenario. This was confirmed by the outcome of the stress test: all selected companies/groups passed the test.

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Since Fitch believes the insurers in its portfolio can withstand the economic stress and the impact from potentially more severe mark-to-market movements, they have not taken any rating actions on its European insurance portfolio.

This good news comes on the heel of other optimistic European news that was publicized recently. After the European bank stress tests, only seven out of 91 banks were shown to need additional capital in a worst-case scenario — a shocking surprise. We must keep in mind, however, that these tests, though they consider deleterious situations, may not be rigorous enough and therefore, not the end-all be-all of the economic outlook.

The Next Financial Collapse?

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Well, maybe that’s a bit of an exaggeration. But to some, it’s not far off.

I’m talking about ID theft and how it poses an enormous risk to the nation’s credit system.

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Apparently, ID thieves are now targeting children’s Social Security numbers. According to a recent article from the Associated Press:

Hundreds of online businesses are using computers to find dormant Social Security numbers — usually those assigned to children who don’t use them — then selling those numbers under another name to help people establish phony credit and run up huge debts they will never pay off.

What’s worse is that authorities have not quite figured out a way to prosecute these people since they never actually use the stolen Social Security numbers. Instead, thy refer to CPNs — or credit privacy numbers, which are set up using a Social Security number.

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And presently, federal law allows the ability for someone to legally use a private ID (CPN) for financial reporting purposes instead of a Social Security number.

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Apparently, online companies are using the internet to find random Social Security numbers. The numbers are then “run through public databases to determine whether anyone is using them to obtain credit. If not, they are offered for sale for a few hundred to several thousand dollars.”

The businesses that sell these numbers have been compared to drug dealers.

“There’s good stuff and bad stuff,” said Julia Jensen, an FBI agent in Kansas City. “Bad stuff is a dead person’s Social Security number. High-quality is buying a number the service has checked to make sure no one else is using it.”

This is an enormous problem that, because of its difficulty to detect, is growing at an alarming rate. In fact, some are worried about another financial collapse because of this fraud.

“If people are obtaining enough credit by fraud, we’re back to another financial collapse,” said Linda Marshall, an assistant U.S. attorney in Kansas City. “We tend to talk about it as the next wave.”

It’s an invisible crime, as some are calling it. And as we all know — it’s not so easy to stop something you can’t see. Check your credit report often, and that of your children — your 4 year-old could have a dreadfully low score.

Credit Fraud

The 255 Bank Failures Since 2008

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David Hood has been one of the many people noticing the huge uptick in love for risk management of late. And while doing so, he points out something salient about the banking sector.

See, one of the fallouts of the financial crisis has been a return to basic banking practices. Banks, fearing the world of complex securities and swaps that nearly brought the system to collapse, have been running towards “vanilla.” They needed a new influx of capital after finding out just how toxic their balance sheets were and saw checking and other traditional bank products as a safe haven to keep revenue coming in.

Hood explains:

I was reminded of this by a recent article in BAI Banking Strategies titled, Online Account Opening Needed To Fuel Growth. The article rightly pointed out that many banks are going back to basics, building revenue by adding checking accounts and other more traditional products.  However, the recommendation of the article is to embrace the online channel and open accounts for customers outside of a more constrained geographical footprint.  In my opinion this has the potential to materially impact the risk presented to the financial institution.

It made me think about a couple of data points from my research. Namely that accounts opened online are 5x riskier than accounts opened through more traditional channels and that check fraud topped $1 billion dollars in 2008. The online channel represents a huge opportunity, but blindly chasing the revenue opportunity without regard to how an FI will manage the resulting risk can end badly. If the opinions of the risk managers at your institution haven’t been considered when evaluating strategic decisions such as pursuing online growth, it’s time to make room at the table and embrace them.

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Ironic that, in fleeing risk, the companies ran smack dab into risks of another flavor. Vanilla, it turns out, can be just as problematic.

Really, however, this should be obvious. We know risk is everywhere, and thinking that the downside of “safe” products doesn’t need to be analyzed is just as silly as the widespread, 2007 belief that algorithms had made the downside of complex securities disappear.

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There is no way to make risk disappear.

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 There is only a way for it to be managed.

And as we can see here from this map of bank failures since 2008, that’s a lesson many had to learn the hard way. If more attention isn’t paid to the risks of the financial world — both the complex and the “safe” — expect this Wall Street Journal list of failures to grow.

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AIG: A Timeline to the End of the SEC Probe

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It had to happen sometime. This morning it was announced that U.S. regulators have closed an investigation of AIG and some of its executives over the insurance giant’s near collapse that led to a $182 billion government bailout.

Let’s take a look at the timeline of many of the events surrounding the AIG disaster (with help from ProPublica, the New York Fed and Bloomberg).

  • August 5, 2007: During a conference call with investors, various high-ranking AIG officials stressed the near-absolute security of the credit-default swaps. “The risk actually undertaken is very modest and remote,” said AIG’s chief risk officer. Joseph Cassano, who oversaw the unit that dealt in the swaps, was even more emphatic: “It is hard for us with, and without being flippant, to even see a scenario within any kind of realm of reason that would see us losing $1 in any of those transactions…. We see no issues at all emerging. We see no dollar of loss associated with any of that business.” Martin Sullivan, AIG’s CEO, replied, “That’s why I am sleeping a little bit easier at night.”
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  • October 1, 2007: Joseph St. Denis, the VP of Accounting Policy at AIG Financial Products, resigns after Cassano tells him, “I have deliberately excluded you from the valuation of the [credit-default swaps] because I was concerned that you would pollute the process.”
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  • November 7, 2007: In an SEC filing, AIG reports $352 million  in unrealized losses from its credit-default swap portfolio, but says it’s “highly unlikely” AIG would really lose any money on the deals.
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  • December 5, 2007: In an SEC filing, AIG discloses $1.05 billion to $1.15 billion in further unrealized losses to its swaps portfolio, a total of approximately $1.5 billion for 2007. During a conference call with investors, CEO Martin Sullivan explains that the probability that AIG’s credit-default swap portfolio will sustain an “economic loss” is “close to zero.” AIG’s risk-modeling system had proven “very reliable,” Sullivan said, and since the transactions were so “conservatively structured,” AIG had “a very high level of comfort” with its risk models.
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  • February 28, 2008: In its year-end regulatory filing, AIG sets its 2007 total for unrealized losses at $11.5 billion. AIG also discloses that it had thus far posted $5.3 billion in collateral. It’s the first time the company has disclosed the amount of posted collateral. AIG puts the notional value of the entire swaps portfolio at $527 billion. But as we said above, about $61 billion of the swaps had exposure to subprime mortgages. AIG also announces that Joe Cassano, the chief of the unit that dealt in the swaps, has resigned. What AIG doesn’t disclose is that he’s kept on under a $1 million per month consulting contract.
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  • August 6, 2008: In its second quarter filing, AIG ups its unrealized loss in 2008 from the credit-default swaps to $14.7 billion, for a grand total loss of $26.2 billion. It also discloses another impressive number: It’s posted a total of $16.5 billion in collateral.
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  • September 16, 2008: The Federal Reserve Board saves AIG by pledging $85 billion [11]. As part of the deal, the government gets a 79.9 percent equity interest in AIG.
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  • October 8, 2008: The Fed pledges another $37.8 billion to AIG.
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  • November 10, 2008: Board of Governors and Treasury announce the restructuring of the government’s financial support to AIG. The restructuring includes a Treasury purchase of AIG preferred shares through the Troubled Asset Relief Program (TARP), reduction of $85 billion revolving credit line to $60 billion and the creation of two limited liability companies (LLCs) to lend against AIG’s residential mortgage-backed securities (RMBS) and collateralized debt obligations (CDOs).
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  • March 15, 2009: AIG, under pressure from regulators, releases a statement that discloses the names of its counterparties, which includes banks such as Goldman Sachs and Deutsche Bank AG. The counterparties received about $50 billion in forfeited collateral postings and Maiden Lane III payments since the Sept. 16, 2008, rescue, the statement says. The statement lists a sum of payments to each bank. It doesn’t identify the securities tied to the swaps or list the value of individual purchases by the banks.
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  • March 18, 2009: AIG Chairman and Chief Executive Officer Edward Liddy testifies before House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises.
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  • March 24, 2009: Federal Reserve Chairman Ben S. Bernanke and New York Fed President William C. Dudley testify before House Committee on Financial Services.
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  • May 7, 2009: AIG reports first quarter 2009 earnings. (Risk Management Monitor coverage)
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  • May 21, 2009: Edward Liddy leaves AIG after eight grueling months acting as chairman and CEO with no pay. (Risk Management monitor coverage)
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  • December 13, 2009: Eli Lehrer writes an editorial entitled “Kill AIG Now.” (Read Risk Management Monitor’s reaction to the piece, plus an in-depth comment from Lehrer himself)
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  • Jan. 7, 2010: Bloomberg reports that e-mails obtained by Representative Darrell Issa show the New York Fed pressed AIG to withhold details from the public about the insurer’s payments to banks.
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  • March 1, 2010: AIG agrees to sell its subsidiary American International Assurance Company Ltd. (AIA) to Prudential Financial, Inc. for approximately $35.5 billion.
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  • March 8, 2010: AIG agrees to sell its subsidiary American Life Insurance Company (ALICO) to MetLife, Inc. for approximately $15.5 billion.
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  • June 10, 2010: A Congressional watchdog criticized nearly every move the Fed has made during the AIG fiasco. “The government’s actions in rescuing AIG continue to have a poisonous effect on the marketplace,” said the congressional oversight panel led by Harvard University law professor Elizabeth Warren.
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  • June 17, 2010: The SEC ends its probe of AIG and its executives.

No charges were ever filed against AIG or its executives, and since the Justice Department’s probe ended and May and the SEC’s probe ended today, no charges will likely ever be filed.

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