Managing Operational Risk
First published:
ISBN: 9781782722861
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First-Order Effects: Transforming Credit Defaults and Market Turmoil into Operational Risk Losses
First-Order Effects: Transforming Credit Defaults and Market Turmoil into Operational Risk Losses
Introduction
Three Historical Spikes in Operational Risk Losses
First-Order Effects: Transforming Credit Defaults and Market Turmoil into Operational Risk Losses
Second-Order Effects: Transforming Rising Unemployment and Falling Interest Rates into Operational Risk Losses
Conclusions and Root Causes
Regulatory Change: Part of a Perfect Storm
Macroeconomic Threats: Tax, Rising Interest Rates and New Asset Bubbles
New Technology: Changing Business Models and Risk Profiles
Three Horsemen: Societal, Political and Environmental Change
Backtesting to the Mid-1990s and Conclusions
Defining and Cascading Operational Risk Appetites
Aligning Operational Risk Management Frameworks to Appetites
Estimating Exposures to Tail Events
Solutions for a Triumvirate of Seemingly Intractable Problems
Conclusions
This chapter considers a series of case studies of operational risk losses that arise from rising credit defaults and/or market turmoil. The case studies include litigation associated with MBS and CDOs; improper foreclosure; mismarking; benchmark rigging; and different investment issues eg, Madoff and “breaking the buck”. For each case study the causes, as well as the drivers for the scale of the losses, are considered.
MBS LITIGATION ABOVE US$80 BILLION
“If you owe your bank manager a thousand pounds, you are at his mercy. If you owe him a million pounds, he is at your mercy.”
attributed to the economist John Maynard Keynes
As delinquency rates for US residential mortgages began to increase during the second half of 2006, as illustrated in Figure 2.1, the impacts were first felt by the borrowers themselves, and then by their banks, with initially increased provisions, leading to some firms filing for Chapter 11 bankruptcy protection. Subsequently, the losses spread to investors through mortgage-backed securities (MBSs), with, in September 2008, Fannie Mae and Freddie Mac having to be rescued by the US government by being placed in a temporary “conservatorship”, overseen
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