The IMF put out the Global Financial Stability Report last week and it contains a very accurate and sobering description of the systemic failures involved in the Subprime Financial Crisis. It has an institutional focus, and makes some solid observations and recommendations.
The entire report is worth a read, but the Executive Summary contains most of the key points if you just want the meat of the matter:
I will summarize the findings and recommendations that have Data Governance implications:
"The events of the past six months have demonstrated the fragility of the global financial system and raised fundamental questions about the effectiveness of the response by private and public sector institutions. While events are still unfolding, the April 2008 Global Financial Stability Report (GFSR) assesses the vulnerabilities that the system is facing and offers tentative conclusions and policy lessons.
Some key themes that emerge from this analysis include:
• There was a collective failure to appreciate the extent of leverage taken on by a wide range of institutions—banks, monoline insurers, government-sponsored entities, hedge funds—and the associated risks of a disorderly unwinding.
• Private sector risk management, disclosure, financial sector supervision, and regulation all lagged behind the rapid innovation and shifts in business models, leaving scope for excessive risk-taking, weak underwriting, maturity mismatches, and asset price inflation."
What follows are a number of short- and medium-term recommendations relevant to the current episode. Several others groups and for a—such as the Financial Stability Forum, the Joint Forum, the Basel Committee on Banking Supervision—are concurrently developing their own detailed standards and guidance, much of which is likely to address practical issues at a deeper level than the recommendations proposed below.
In the short term...
The immediate challenge is to reduce the duration and severity of the crisis. Actions that focus on reducing uncertainty and strengthening confidence in mature market financial systems should be the first priority. Some steps can be accomplished by the private sector without the need for formal regulation. Others, where the public-good nature of the problem precludes a purely private solution, will require official sector involvement.
Areas in which the private sector could usefully contribute are:
• Disclosure. Providing timely and consistent reporting of exposures and valuation methods to the public, particularly for structured credit products and other illiquid assets, will help alleviate uncertainties about regulated financial institutions’ positions.
• Overall risk management. Institutions could usefully disclose broad strategies that aim to correct the risk management failings that may have contributed to losses and liquidity difficulties. Governance structures and the integration of the management of different types of risk across the institution need to be improved. Counterparty risk management has also resurfaced as an issue to address. A re-examination of the progress made over the last decade and gaps that are still present (perhaps inadequate information or risk management structures) will need to be closed.
• Consistency of treatment. Along with auditors, supervisors can encourage transparencyand ensure the consistency of approach for difficult-to-value securities so that accountingand valuation discrepancies across global financial institutions are minimized. Supervisorsshould be able to evaluate the robustness of the models used by regulated entities to value securities. Some latitude in the strict application of fair value accounting during stressful events may need to be more formally recognized.
• More intense supervision. Supervisors will need to better assess capital adequacy related to risks that may not be covered in Pillar 1 of the Basel II framework. More attention could be paid to ensuring that banks have an appropriate risk management system (including for market and liquidity risks) and a strong internal governance structure. When supervisors are not satisfied that risk is being appropriately managed or that adequate contingency plans are in place, they should be able to insist on greater capital and liquidity buffers.
In the medium term...
More fundamental changes are needed over the medium term. Policymakers should avoid a “rush to regulate,” especially in ways that unduly stifle innovation or that could exacerbate the effects of the current credit squeeze. Moreover, the Basel II capital accord, if implemented rigorously, already provides scope for improvements in the banking area. Nonetheless, there are areas that need further scrutiny, especially as regards structured products and treatment of off-balance-sheet entities, and thus further adjustments to frameworks are needed.
The private sector could usefully move in the following directions:
• Standardization of some components of structured finance products. This could help increase market participants’ understanding of risks, facilitate the development of a secondary market with more liquidity, and help the comparability of valuation. Standardization could also facilitate the development of a clearinghouse that would mutualize counterparty risks associated with these types of over-the-counter products.
• Transparency at origination and subsequently. Investors will be better able to assess the risk of securitized products if they receive more timely, comprehensible, and adequate information about the underlying assets and the sensitivity of valuation to various assumptions.
• Reform of rating systems. A differentiated rating scale for structured credit products was recommended in the April 2006 GFSR. Also, additional information on the vulnerability of structured credit products to downgrades would need to accompany the new scale for it to be meaningful. This step may require a reassessment of the regulatory and supervisory treatment of rated securities.
• Transparency and disclosure. Originators should disclose to their investors relevant aggregate information on key risks in off-balance-sheet entities on a timely and regular basis. These should include the reliance by institutions on credit risk mitigation instruments such as insurance, and the degree to which the risks reside with the sponsor, particularly in cases of distress. More generally, convergence of disclosure practices (e.g., timing and content) internationally should be considered by standard setters and regulators.
• Tighten oversight of mortgage originators. In the United States, broadening 2006 and 2007 bank guidance notes on good lending practices to cover nonbank mortgage originators should be considered. The efficiency of coordination across banking regulators would also be enhanced if the fragmentation across the various regulatory bodies were addressed. Consideration could be given to devising mechanisms that would leave originators with a financial stake in the loans they originate."
New standards and banking practices will clearly be needed moving forward. But we already have most of the regulations we need to mitigate most risks identified in the report. Indeed, one of the great ironies of the crisis is how little Banks used their own fraud and risk management systems to catch underwriting errors and omissions in Loan Origination applications, House Assessments, risk capitalization, etc.
I suspect that the IMF's warning on regulation will not be heeded in Washington, though I do hope regulators will listen to the seasoned advice of some Data Governance veterans because this is a crisis with so many Data Governance challenges.[Read More]
Adler on Data Governance
From archive: April 2008 X
DataGovernor 120000GKJR 986 Views
Denmark is always at the vanguard of new trends and if you are into free music Denmark is the place to be, though you won't have to wait all that long for this trend to cross the Atlantic. In the battle to win broadband customers, TDC (formerly TeleDanmark), has signed deals with major recording companies to provide free access to MP3 files over its network. In a way, all that TDC is doing is paying the music companies a volume royalty on their music portfolios - just like radio stations do today to BMI and ASCAP, as intermediaries to the recording industry.
But of course, by selling music for broadcast royalties, TDC is not equating broadband to radio. Rather they are shrewdly taking advantage of a reality the music industry is just acknowledging - the price of music data people are willing to pay today is next to nil when it is infinitely redundant, of consistent quality, and immediately available.
If you can read Danish, have a look, though I doubt you will have to wait too terribly long to discover an ISP in your neighborhood making the same announcement in your native language...
Last week I was in Hamburg Germany teaching my Data Governance Course with my friend Christa Menke-Suedbeck at the Bucerius Law School (www.law-school.de). One evening, I went to the Deichtorhalle to see a lecture from one of my old Hamburg friends, Tom Holert. His lecture was part of a larger panel discussion on modern photography, focusing on the 19th Century artistic techniques photographers use to "stage" their photos, blurring both photo journalism and art.
Tom Holert is one of Germany's most prolific and well-respected art and music critics, and his presentation left me deeply concerned. Have a look at this photo that Tom presented. It is by Eric Baudelaire and it is called "The Dreadful Details."
At first glance, it looks like any other horrific photo from the Iraq War that we have all become uncomfortably comfortable viewing. These depictions of fear, death, power, and dread no longer shake the subconscious as they once did during Vietnam.
However this one should, because it is entirely fake. The photo was taken on a Hollywood backlot and all the people in it are actors. It is a modern example of staged art to resemble reality. But you will think it is reality unless you are aware of this context - unless you know the provenance.
Yesterday, the NY Times reported that 16 retired US Generals working as military analysts on Fox, ABC, NBC, CBS, and CNN News had been secretly collaborating with the Pentagon to shape US public opinion in the most brazenly documented form of government propaganda I have certainly seen in my lifetime. These military analysts acted as supposed "impartial" experts on network TV but in reality were toting the Pentagon public line.
Again, staged reality. We all believe this stuff unless we are informed of the context, the provenance of this data.
Whether you support the war or not, you have to recognize that these distortions have an enormous cost. A recent Harvard University study put the direct and indirect costs of the Iraq War at $1 trillion, a figure I'm sure the Pentagon has already developed analyst talking points to refute.
Of course the loss in human life on all sides of the conflict outweigh the economic costs. But I would argue that the most enduring damage is in the global brand of the United States of America, whose public image around the world has been so tarnished.
In the Information Age, we are all victims of Toxic Content in our data streams. This Toxic Content makes the truth the most endangered data asset in the world and I fear that what we have lost so far we will struggle to regain against new data distortions that will make old lies seem like quaint nostalgia.
And if you think propoganda only invades public data streams, read my articles on Subprime...[Read More]
DataGovernor 120000GKJR 1,043 Views
A colleague wrote to me today with the following question:
"Would you be able to point me to information that describes what can make a data governance effort fail? Points about technology problems, organizational politics, a lack of organizational leadership, etc. come to mind. Are you able to expand this list or explain how to avoid failure in a data governance program?"
I get asked this question often and my answer is an easy elevator pitch for anyone looking to explain Data Governance:
"Two things always lead to failure:
- Lack of outcome oriented programs
- Lack of power and accountability in the data governance board.
Of course, no one has a monopoly on screw-ups so there are innumerable additional options for modest and wholesale disaster in any organization run by human beings. Important thing is to be ready for failure and catch them when they are small, institutionalize the learnings, adjust and move forward."
People who say that failure is not an option are dangerous fools. Statistically, failure has the same odds as success, and if you plan for both your program will grow in wisdom and effectiveness - which is the very best from Data Governance that we can all plan for.