Saturday, December 1, 2007

Risk Management

"Vince Kaminski has seen firsthand how sophisticated companies systematically underestimate and ignore the financial risks they take on until it's too late. ... It is this 'science' of risk management that supposedly gives management the ability to forseee and prevent the kinds of things that brought down Enron and that now befall Citi, Merrill, HSBS and the rest. And it is this "science' that regulators rely on to protect the health of the banking system. So why doesn't it work? ... 'What matters in terms of managing risk,' Kaminski says, 'isn't the model--it's the intuition, judgment and experience to spot risks as they are developing, and the character to be able to stand up to very aggressive and successful commercial people and say, "Enough is enough." ... For years now, I've listened as top regulators have explained to me that it is no longer their role to question banks about certain practices or individual loans--that all that matters is whether the bank has an adequate risk-management system in place", Steven Pearlstein (SP) at, 28 November.

Who did SP talk to? Some AICPA geniuses, Big Four partners or SOX proponents? The public has been deceived about the importance of internal control (IC). Bad IC did not cause Enron. Management "making" its numbers and a CPA firm unwilling to tell Enron, "Take your $52 million a year in fees and shove it" did. CPAs under AICPA and Tredway Commission tutelage push IC as a magic elixir to do away with or mitigate risk. Real corporate risk is not in Susie bookkeeper abstracting checks before initial recording but doing economically stupid things, like Citigroup creating SIVs. Did KPMG tell Citigroup its SIVs were risky and made Citi little money? For $73 million a year in fees what did KMPG do? What did KPMG substantiate at Citigroup? Did it exercise independent judgment and tell Citigroup, "That's economic nonsense", at least with respect to its SIV accounting? In 1997 KPMG came up with a 92-page book, Auditing Organizations Through a Strategic-Systems Lens, which was an apologia for not doing substantive testing. KPMG's "audit process" was attacked by Cullinan and Sutton in "Defrauding the public interest: A critical examination of reengineered audit processes and the likelihood of detecting fraud", Critical Prespectives on Accounting, June 2002, 13, 3, 297-310, available at CPA firm audits are not worth the paper they're printed on if they use KPMG's "audit processes".

As for the models, I've written about them before. Strictly alchemy, see my 23 August post.


Edgar said...


Thanks for visiting my blog. Modern day corporate accounting is intriguing, like watching a snake on a rock. As long as they don't admit they are broke they have lots of money to play with. The shenanigans are endless. Banks in particular fascinate me. The use the "fractional reserve" method, but the reserve requirement is zero! Doesn't that indicate infinite lending potential? Now the government is in bed with the bankers like never before. I am hoping to complete my Mogambo Bunker of Solitude (MBS) before the S hits the Fan. Good luck, I'll try to stop by tomorrow and read the previous post.

Independent Accountant said...

Accounting is intriguing. Industrial accounting, that is, for manufacturing companies is pretty good at "cash flow measurement", the extractive industries are worse, the finance industry is an accounting joke. Does anyone remember the 1979-86 S&L crisis? The S&L industry as a whole was insolvent in 1979, but died in dribs and drabs for seven years. Citibank could easily be insolvent, but its accounting doesn't show it.
Given low reserve requirements as a practical matter, some banks can operate with about a 3% capital to asset ratio. Very low in my opinion.
Are you a fan of the Mogambo Guru at Sometimes he's a scream. You are welcome to my blog visits.

Rob Schaumer said...

Please Delete after reading


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Rob Schaumer