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Sub-prime has raised concerns regarding credit risk and liquidity risk. Do the models work? Are the ratings correct? Has enough capital been allocated? But what of the question of operational risk? In their enthusiasm to get on the gravy train, did firms simply ignore processes – or, more seriously, has this been a black forest where all kinds of skulduggery has been able to proceed unnoticed?
So far, the sub-prime crisis has caused $100 billion to be written off: and this is only in the major global banks. The amount that has been written off by small lenders, sub-prime specialists, housing associations and construction firms has not been estimated, but must be large. To date much of the blame for this has been placed on poor credit processes at the origination end; inadequate rating when these loans were securitised and resold; or liquidity issues caused by dependency on short-term interbank lending.
On Tuesday the US’s Federal Bureau of Investigation, the FBI, launched a probe into potential trading fraud at 14 of the major companies involved in sub-prime lending and its securitisation. The FBI is said to be looking for possible accounting fraud, insider trading, falsification of collateral and other violations. Potential crimes range from misrepresentation at origination (selling loans to borrowers who did not understand the risks or costs), inflation of these loans in the accounting books, loading high-risk loans onto investment bank customers whilst secretly off-loading these risks from their own portfolios – the whole process is being investigated. Were these all individual cases or was there systematic fraud?
As well as major firms, a wide range of individuals and smaller companies are being charged with fraudulently obtaining money mainly in the form of home equity and business lines of credit. In one case, seven individuals in Newark have pleaded guilt to obtaining over $20M from at least 16 different lenders in New Jersey on the back of less than $300,000 of equity in a local property.
Coupling this with such events as the SocGen trading fraud case, reported by Chase Cooper last week, and it looks like consumer confidence will play a very large part in whether the economy goes into recession or not. Once again, are risk managers proving they are worth their salaries?
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