I came across an article in the “Daily KOS” today regarding AIG and it’s role in the glbal recession. Here’s a short excerpt:
The size of our [editor's note: the US] national economy this year is roughly $15 trillion. The size of the Credit Default Swaps (CDS) market is $64 trillion. The whole world GDP is about $56 trillion. How could the CDS market be larger than the world GDP combined?
More analysis after the break:
It is frightening to think of how management of AIG managed to let the company leverage itself into such a difficult position. Their auditors (PwC) might agree: “material weaknesses” were uncovered in AIG’s subsidiary that stands in the middle of the crisis (Check out this resignation letter from one of the VP’s of AIG Financial Products Corp). The audit firm found weaknesses in “financial reporting and oversight related to the valuation of a derivatives portfolio”. The story reports that AIG-FP had a net exposure of $505bn in CDS’s, $62bn of which related to CDO’s in the US mortgage markets.
Looking at AIG’s chart in Google Finance, AIG’s share price was 50.68 (Feb-2008) at around the time of the disclosure – a market capitalisation of approx US$136bn .The peak immediately before AIG’s slump to $1 per share was approx $22.34 per share (Sep-2008). That’s a market capitalisation of approx. US$60bn. Over the last 10 years, AIG’s highest share price was $103.68 (Dec-2000) – a market capitalisation of approx US$279bn.
To put it in perspective then … the report of net exposures of $505bn CDS’s was nearly double the company’s entire market capitalisation at it’s 10-year high in December 2000, and was nearly 4x the company’s entire market capitalisation during the time of the disclosure. And that’s “net” exposure, not “gross” exposure, so presumably that’s already after netting off insurance, stop-loss contracts etc (if any!)
So where do we go from here? Wired magazine suggests a way to reboot the financial services industry: radical improvements in transparency. Wired’s Daniel Wroth makes a very valid point – that while financial services powerhouses have gotten increasingly complex over the years, regulation may not necessarily have grown in sophistication. While financial institutions employ quants to develop new financial modelling techniques, can you name some innovations brought on by the SEC? OK – to their credit they have recently required information be filed in XBRL and by 2011 we expect all publicly traded companies to publish reports in XBRL.
So how can we learn from these controversies in Brunei’s climate? Take an example: How do local economists understand what Brunei’s financial services industry’s exposure is to say … flash floods in Tutong and Sengkurong? Do we have the data to crunch and estimate an answer? If not … and if we think it IS important, to improve transparency and how we analyse risk profiles … how do we develop the systems, processes and institutions to do so?
I think the answer to that may be in radical improvements in transparency, in XBRL-based systems and a concept called “Straight through reporting”, which is more or less what Wired’s Daniel Wroth is advocating. Raise the standard for public interest companies – make them publish data on a near real-time basis, in easy-to-analyse formats (XBRL). Because in today’s complex environments, management need this kind of information as a matter of course anyway when performing their normal duties. By aligning information for the use of internal management (what we now call MIS), with external corporate reporting (we now use financial statements for shareholders) and analyst use (analysts crunch a lot of data in spreadsheets and custom systems, but wouldn’t it be great to drag & drop feeds from an XBRL page into a spreadsheet to avoid all that lame data entry?) we can encourage a whole new way of thinking and running our businesses.
The last Great Depression (1930′s) was caused by hubris, the madness of crowds and the bursting of the bubble. President Roosevelt saw the wisdom in the words “Sunlight is said to be the best of disinfectants. Electric lights the most efficient policeman.” The problem now isn’t the lack of transparency – but the lack of transparent, easy-to-analyse and manipulate information. Analysts are being buried under the weight of all those regulatory filings. Which is where XBRL comes in.
Say for example we adapted some of these ideas into our industry. If say, the finance industry unknowingly builds up an exposure to risk from a particular event … the idea is that with this level of transparency would facilitate analysts and economists to raise the right red flags where necessary. Maybe re-insurance contracts unknowingly concentrated risk in a small number of reinsurers, and a single catastrophic event wiped out those reinsurers. Or maybe financial products sold to the public were changed to avoid rigid borrowing limits – and cutbacks in government spending resulted in a large number of borrowings to default. With “straight through reporting”, the idea is that such risks would be transparent to management, shareholders and regulators.
I don’t know about you … but I’m optimistic that the industry and the profession will make a comeback in time.
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