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.
The New York Times DealBook blog just put out a fine piece on the collapse of MF Global: A Romance with Risk That Brought on a Panic by Azam Ahmed, Ben Protess, and Susanne Craig (December 11, 2012). It’s the most comprehensive summary of the events that led to the firm’s bankruptcy that we’ve seen so far. Until the investigations are done and the books are written, it’s a good source for thinking about the credit risk lessons to be learned in MF Global’s sad story.