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Will the risk models ever be able to estimate the impact of major public of private intervention? Can we allocate funds to cover political interests, central bank intervention or public sentiment? Last week saw extreme fluctuations in the market valuations of financial institutions, fluctuations which reputedly cost private and institutional investors billions of pounds.
In the USA, the Federal Reserve had intervened to arrange the take-over of the ailing, and possibly failing, Bear Stearns by Wall Street giant JP Morgan Chase (JPM) at a price of $2 a share – a thumping loss for shareholders who had seen their investments at $30 a few weeks previously and at $167 just over a year ago. One shareholder, a football club investor, is reported as losing half a billion dollars. Now we hear that either JPM got the price wrong, that the lawyers got the conditions wrong, or that the shareholders made their voting powers tell – and the offer was suddenly revised to $10 a share! A 500% change does not sound like the result of detailed financial modelling.
At the same time reported stories that HBOS was in liquidity trouble caused its share price to fall dramatically, only recovering when the FSA and HBOS both issued statements that there was no truth in the rumours, and that the FSA was launching a market abuse investigation – but not soon enough to prevent another football club investor to reputedly lose over £1 million.
Today, the Financial Times leads with a story that the FSA is about to admit to mistakes in its supervision of Northern Rock, the UK’s Bear Stearns and another source of loss to shareholders, and to develop a new risk management team under recently recruited former IBM risk expert, Colin Lawrence. However most in the market consider the nationalisation of Rock to be a political rather than a supervisory decision.
Can the market ever model, and can stress testing ever include, the impact of political interests (Rock), central intervention (Bear Stearns) or market rumour (HBOS)? Market and, to a lesser extent, credit risk models are proving themselves in a stable environment – but the rest?
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