What does risk really mean anyway?

By Brett Sherman, The Sherman Law Firm

 

Here is a nice compact definition of risk I like:  Risk equals the inherent chance of a bad result from a decision or course of action.

 

Here is a bit more comprehensive explanation: Risk is a foreseeable possibility that an uncertain future will produce an unexpected negative outcome.  The more risk a given action carries, the greater the chance for bad results and/or increased negative consequences.  

  Amazing that more than a year has passed since the Bear Stearns went up in smoke.  Even more amazing are the hundreds of articles that describe Bear Stearns as having a reputation for maintaining one of the saviest risk management operations around.  There is no doubt that risk management was a priority for Bear in decades past, particularly when Bear Stearns was led by former Managing Partner and CEO Ace Greenberg. In fact, Greenberg chaired the Risk Management Committee while he was CEO.  His devotion to that role was the primary reason Bear Stearns gained a reputation for excellent risk management.

 

  After Jimmy Cayne ousted Ace Greenberg from the CEO spot in a bloodless coup in 1993, Greenberg surprised some observers by electing to remain with the company.  One of the roles Greenberg retained was head of the Bear Stearns Risk Management Committee.  Unfortunately, Cayne was a salesman.  The only risks he understood were the risks of failing to do enough business.  And Cayne never thought Bear Stearns did enough business.  

 

  Character reflects leadership.  The character of Bear's risk management function was eroded by the leadership style of CEO Jimmy Cayne.  Risk modeling systems aged and became anachronisms.  Personnel responsible for monitoring risk were not properly trained.  In sum, the decline of risk management at Bear Stearns resembled the fall of the Roman Empire. 

  Even though Ace Greenberg is credited with establishing Bear Stearns so-called strong culture of risk controls, the ever-increasing complexity of investment products on Wall Street during the 1990's and 2000's exposed Greenberg's risk management style as a relic from a simpler era.  The raw truth is that Ace Greenberg was a hopelessly overmatched Risk Committee Chairman.  Nevertheless, he held that job until 2007, when he was 80 years old.  

  By the time mortgage-backed securities became the centerpiece of Bear Stearns's business,  Greenberg continued prominence in Bear's risk management function was an inexcusable and reckless act of gross negligence. During the current decade, the era CDOs, CDSs and equally opaque derivitives, how could anyone argue that Ace Greenberg was even remotely qualified to lead Bear Stearns' Risk Management Committee.  

  Ultimately, CEO Cayne and the Board of Directors had a legal duty to shareholders to pay much more attention to managing Bear's risks.  They cannot justify their repeated decisions to leave Greenberg in charge of risk control.

  Ace Greenberg deserves a lot of credit for Bear's rise.  He was and is well-liked and respected by many on Wall Street.  But he deserves his share of the blame for the collapse of Bear Stearns.