Subprime losses hitting the painful $100 billion mark have focused Wall Street's best minds on the dangers of excess. The result is new thinking about the role of risk managers. Till now, most have been midlevel functionaries powerless to curb the reckless tendencies that got the Street into this mess.
At the biggest banks, change is under way. John Thain, the new CEO of Merrill Lynch (MER), has created two high-profile risk-management positions reporting directly to him. Morgan Stanley (MS) has created a new position of senior ris officer for sales and trading. Citigroup's (C) freshly minted CEO, Vikram Pandit, vows he'll be a "hands-on participant" in risk management. In the past, "banks have seen risk management as an industrial process where you have the machine, you have the data, and then you crank the handle," says Alan McIntyre, a managing director at consultant Oliver Wyman. (MMC) "There's been no judgment."
It's not as if banks didn't have people and procedures in place before. Nearly every Wall Street firm had an executive in charge of risk management when the subprime crisis hit. And after Enron's misdeeds, financial companies spent billions ensuring that their books met new compliance standards. According to Deloitte & Touche, costs in this area grew 159% from 2002 to 2006—rising faster than profits in some cases.
Still, the mortgage implosion and the startling damage caused by a rogue trader at Paris-based Société Générale have put a spotlight on risk managers' shortcomings. Most simply haven't had the wide-angle view of their companies to keep high-wire behavior in check. Many, in fact, were walled off in single departments like trading. "With so many entities taking risk, you need to have one group looking at it from a macro level," says Robert Kapito, president of BlackRock (BLK), who oversees risk at the money manager. "Wall Street is waking up to that."
A PLACE AT THE TABLE
Lack of clout was another problem. Risk managers usually reported to the head of trading and had limited access to CEOs and board members who could cool combustible operations once they were discovered. The hope now is that at Morgan and other banks where risk managers have risen to the C-suite, the new prominence will translate into more authority. "The chief risk officer needs to be given a seat at the table," says J.H. Caldwell, a Deloitte partner.
Just a few months into their jobs, the new risk cops are still getting settled. But already changes in banks' risk operations are emerging. For one, they're paying up for the position. According to Alan D. Hilliker, a partner at executive search firm Egon Zehnder International, the going rate for top risk managers two years ago ran from $2 million to $2.5 million. Today the salary is twice that.
At Merrill, Thain insists on holding weekly risk-management meetings with his two new risk officers as well as the heads of the fixed income and equity businesses. In November, Citigroup's Pandit set up an advisory committee of senior executives that focuses on strengthening risk protocols.
As they rethink risk, many chastened banks are looking to the operations of Goldman Sachs (GS) and BlackRock, which avoided the big losses. At Goldman, risk pros routinely rotate between jobs on the trading floor and managing risk. With a better read on the gathering instability in the mortgage markets, Goldman traders flagged their concerns to the firm's top executives. The Wall Street giant ultimately placed hugely profitable bets against subprime securities.
BlackRock, meanwhile, had technology that X-rayed complex collateralized debt obligations, exposing flaws in the underlying mortgages. The money manager largely exited the risky securities two years ago, limiting losses when the subprime mess hit. "It's not that we don't take risk," says BlackRock's Kapito. "It's that we understand risk."