Risk Models Are Not to Blame for Financial Crisis
December 8, 2009
RMA and the Securitization Risk Roundtable told a Congressional panel that the leading causes of the current crisis are government policies, the regulatory framework, financial market structure, and profit sharing/incentive structures. Philadelphia, PA (December 9, 2009)--The Risk Management Association (RMA) and the Securitization Risk Roundtable told the chair and ranking member of a Congressional panel that risk models were not to blame for the current financial crisis. Rather, the leading causes of the crisis are government policies, the regulatory framework, financial market structure, and profit sharing/incentive structures, they said. The eight-page comment letter addressed to Rep. Brad Miller, chairman, and Rep. Paul Broun, ranking member, House Committee on Science and Technology, was in response to a September 10, 2009 hearing on risk models conducted by the Subcommittee on Investigations and Oversight. The panel is investigating the role risk modeling played in the global financial crisis. Taking issue with those whose testimony blamed risk models, particularly value at risk (VaR) models, the letter explained, "Risk models are meant to prepare us for anticipated future states of reality. It is not a model problem that no major financial institution, regulator, or legislator was able to anticipate a future state in which house prices drop 20--70% and credit card default rates hit 13%, all within a very short period of 18--24 months. Therefore, no risk models were developed to simulate the world in that particular future state." The letter describes risk models as tools used by business managers, risk managers, and regulators to assess overall risk and avoid undesirable risk concentrations and excessive risk taking. "As with any financial instrument, risk models may be misused, mishandled, or abused. For example, risk cannot be fully represented if all of the risky positions are not included in the analysis." The letter addresses the following issues:
- What were the strengths and weaknesses of the models in handling the tasks for which they were designed?
- Were the models used in ways for which they were not designed? If so, what were the consequences?
- Were there significant limitations or flaws in model design when seen from the point of view of effective risk management?
- Was the degree of faith placed in the models by various groups within financial institutions appropriate?
- How do incentive structures influence the use of models and/or the risk manager's ability to do his or her job?
- How does the information derived from models complement, or conflict with, judgment based on individuals' experiences?
The entire letter is posted on RMA's website, http://www.rmahq.org/RMA/MarketRisk/. About RMA
Founded in 1914, The Risk Management Association is a not-for-profit, member-driven professional association whose sole purpose is to advance the use of sound risk principles in the financial services industry. RMA promotes an enterprise-wide approach to risk management that focuses on credit risk, market risk, and operational risk. Headquartered in Philadelphia, Pennsylvania, RMA has 3,000 institutional members that include banks of all sizes as well as nonbank institutions.
They are represented in the Association by 20,000 risk management professionals who are chapter members throughout North America, Europe, and Asia/Pacific. About the Securitization Risk Roundtable The Securitization Risk Roundtable consists of a group of risk professionals meeting on a regular basis to discuss key aspects of risk modeling and securitization. Risk Management Association Contacts: Kathleen M. Beans
kbeans@rmahq.org
215-446-4095 Kevin McLaughlin
kmclaughlin@rmahq.org
215-446-4137
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