In his new book The Accidental Investment Banker, Jonathan Knee introduces us to the phrase IBG YBG, which means “I’ll be gone. You’ll be gone.” This might be whispered between investment bankers when an inconvenient fact comes to light during due diligence on a company they are about to float. “Don’t sweat it” is the implication. Investors may be burned. The investment bank itself may be burned, but by then, the bankers themselves will have cashed their bonuses and be long gone.
IBG YBG comes up all too often in financial risk management. This past week, an inexperienced risk manager posted to the forum riskchat.com to get advice on how to deal with an options trader who’s portfolio is so huge and convoluted that he can’t perform basic analyses on it. The risk manager isn’t provided essential tools to perform his job, and the trader refuses to work with him.
For anyone who has worked in risk management a few years, the situation sounds familiar. It has IBG YBG written all over it. The novice risk manager doesn’t tell us what firm he works for. Let’s suppose it is a hedge fund. Hedge fund managers routinely pay themselves 2% of assets plus 20% of profits annually. On a multi-billion dollar fund, that could easily amount to $100 million a year. What do managers care if a trader’s activities or reported profits are questionable? IBG YBG. The managers just have to hang in there for a year or two, and they will all retire multi-millionaires. Why investigate? Instead, they can hire a novice risk manager, don’t support him, don’t give him resources, and don’t back him up when he complains he can’t get answers from a trader. Plausible deniability; look the other way; IBG YBG—it’s all the same thing. As long as they can avoid actual fraud, managers will be safely out of the way when investors are picking up the pieces.
The 1995 Barings debacle was a classic case of IBG YBG. Managers loved the bonuses they were earning due to Leeson’s reported earnings, and they were careful not to investigate the hundreds of millions of pounds they were sending him in Singapore to cover margin calls. The Joseph Jett affair also reeked of IBG YBG.
Enron was a case of IBG YBG in which—and this happens often—managers went beyond avoiding explicit fraud and started engaging in fraud so long as they felt it wouldn’t be discovered. Things got out of hand.
Risk managers tend to distinguish between market risk, credit risk, operational risk and liquidity risk. I guess we could add IBG YBG risk to the list, but this would be misleading. Market, credit, operational and liquidity risk, more often than not, are just symptoms of IBG YBG risk. Firms that run on IBG YBG are the ones that suffer crippling losses due to market, credit, operational or liquidity risk. At well run firms, IBG YBG isn’t a factor. Those firms monitor market, credit, operational and liquidity risks, but they aren’t going to suffer crippling losses from them. In such firms, these risks aren’t so much risks as they are details to be monitored and managed in a professional manner. Only at IBG YBG firms is there a real risk of things blowing up.
This isn’t news for experienced risk managers. I am just putting words to what is common knowledge.
IBG YBG risk often is an issue with low-probability, high-impact risks. Responsible parties may ignore such risks, hoping to be long gone by the time a crisis actually hits. Studies indicated that New Orleans would fill up like a soup bowl if it were directly hit by a major hurricane. Politicians didn’t fund the expensive levy work that was required because, well, you figure it out …
Economists have their own terminology for IBG YBG. For them it is a type of “agency problem”—the problem that in a principal-agent relationship, the agent is likely to pursue his own interests instead of those of the principal. The agency problem exists between government officials and their electorate. It exists between corporate managers and shareholders. In that context, the solution economists often turn to is improved corporate governance.
Financial risk management, as it is practiced today, is powerless to address IBG YBG. Where IBG YBG reigns, risk managers (if they exist at all) report to managers involved in the IBG YBG. No, a better solution is corporate governance, and this is why serious discussions of risk management so often become discussions of corporate governance. I will discuss that in my next posting.
Glyn that’s the best blog I have read for months! Thanks! Since you mentioned briefly hurricanes and politicians, i would like to add a minor off-topic point (I am europe-based and have no particular opinions on US politics). However, I think the probability that we (the humans) contribute a lot to the processes causing frequent hurricanes of extreme power and other natural catastrophes is too high to be ignored. A couple of weeks ago, I asked on this forum the off-topic question if somebody knows about good ideas and practices applicable to the risk management professionals which may help to reduce the evironmental problems we all have. The answers I got were in the IBG YBG style: ‘probably you are right, however, let’s stick to finance’ (that’s were our bonuses come from). I really do not what to turn this blog comment in a bad discussion on ‘the global warming business’. However, I would certainly like to take my question in the large ‘better corporate governance’ framework. To your core comments, I would like to pose the questions ‘Are the risk managers really so powerless in a IBG YBG corporate environment?’ and ‘What alternatives the inexperienced risk manager has? — job change? attacking fronthead? unwinding somehow the portfolio and showing the key wrong points? How?’
If you have not yet already done so, you should read my paper *Investor Suffrage Movement*, which appeared in the Nov./Dec. 2006 Financial analysis Journal: http://www.glynholton.com/wp-content/uploads/2006/10/suffrage.pdf With regard to a risk manager working in an IBG YBG environment, there aren’t a lot of options. You could leave. If you stay, you have to walk a tightrope between speaking out and not speaking out too loudly. To protect yourself, you need to create a paper trail. You will not be popular. You will need to be patient, thick skinned, politically savvy and smart. I have known risk managers who have done it. They are admirable, ethically motivated people. No one ever thanks them, and they eventually may be eased out and replaced by some one incompetent. I have seen it all before.
Very interesting article, exact and on the point!
I agree with everyone else — good article. You mention that academics call this the Agency Problem (sometimes the Principal-Agent Problem) and that their solution is better corporate governance. There are actually two approaches that academics use to solve the problem. The second is to give the agent a contract that is aligned with the interests of the shareholders. This is exactly where investment Banks fail. They are too often rewarded for doing the wrong thing. You brought up the Joe Jett case. I’ve mentioned here, before, that there was something else going on at Kidder at the time. They had a huge inventory of MBS that were not hedged properly. When interest rates went up, their incentives told them to double down and leave the risky position unhedged rather than hedge. If rates went back down — they make a profit and get a big bonus. If rates go up, the company loses more, but their income is unaffected. Rates went up. The other thing that happened at Kidder that I have never seen in the press is that the Fixed Income Compliance Officer was fired in January of 1994. This was months before the Jett scandal broke (in fact — it was at the time that he was honored as GE’s employee of the year). I don’t remember them hiring a replacement before the firm fell apart. I often wonder what would have happened if she had stayed — or if they brought in someone who really knew what he was doing.
Yes, that is a very good article. Mark brings up an interesting point about aligning employee interests with those of the shareholders. However, the IBG/YBG may operate at that level also. Lots of shareholders only own for a short period of time, so they are gone also. If a shareholder is unhappy with an equity, generally they sell because they have too small of a percent holding to impact management. An Enron or WorldCom shareholder may have benefited greatly by the questionable management as long as they were “gone” at the correct time.
I would say a holder of Worldcom stock who got out at the right time didn’t benefit from the questionable management. They benefited from luck. There is a big difference between selling a stock at the right time because you got lucky and selling it at the right time because you are a sleazy manager with inside information about your own fraud.
Thank you for your great family of websites and for your contributions to the world of investing. They are not going unnoticed.
Glyn. First and foremost thanks for you years of dedication to our side of the industry. You have given many of us much with your sites and your book. I have your book and love it. As a Risk Manager working in the Alt. Investment industry for 20 years working with some of the best firms CT., I would have to agree with you 100% Risk Managers are used more for marketing purposes than anything else, especially on the buy side. Risk Management is not a high priority on management’s list in most firms because they feel it will diminish returns and exposes practices that are outside the scope of normal portfolio management. But, clients want to feel as though there is someone over-seeing the portfolio that will provide parameters and controls. Sure they are hired, sure the controls are put in place but rarely are they followed. This is for the hedge funds that actually spend money on hiring the risk manager and the systems to support them!!! Most of the 9,000+ firms out there don’t even have that! They feel the risk reports they get from their prime broker is enough. But, the PM doesn’t even read them; they would rather look at alpha generating research. Sure, there are exceptions. But, those firms on the buy side who have a risk manager rarely pay much attention to them. The Risk Manager should report to the Head of Marketing. We as risk managers have to sell to the PMs that we are not inhibitors, but contributors to the returns.
Thanks to both you and Dana. It is rare that I get such kind feedback. I appreciate it. – Glyn
Allow me to give a few thoughts on buy-side risk management: (1) Traditional “accounting” does not provide sufficient “accountability” (www.bis.org/publ/work213.pdf). Ideally, every transaction is linked not just to a valuation model, but also to a risk model. This risk model is purely based on the past (and on exogenous credit ratings). It should one day be driven by standards, run by professionals, much like the accounting profession currently works. Ideally, however, we can tailor the amount of transparancy / accountability to an externally validated statement about the complexity of the underlying investments. This is because accountability has clear costs and benefits will differ depending on the process and stakeholders. We should also provide standard statements about the value of the portfolio for which no reliable risk models are available. I think this is where the benefit of standard risk models like Barra / Riskmetrics comes in, and where the benefit of outsourced risk measurement (prime broker, custodian, ..) comes in. The role of subjectivity is limited. This kind of risk measurement is driven by clients / regulators and the like. They should not expect perfection here. Accounting and risk standards always bound to be behind new developments. And, yes, we should continually improve this. (2) Then there is risk control. Buy-side risk control is vastly different from sell-side risk control. That is because the client (the fund board) is the owner of the parameters. Compliance ensures that the sell-side does what is sold and sells what is done. It ensures that regulatory requirements (providing transparancy about risks) is met, most likely in a rather simple manner. Limit monitoring is a compliance responsibility. (3) Then there is risk management. Yes, risk managers can support decisions. And, yes, internal models can be useful for this. But these internal models are ad-hoc, proprietary and subjective. They are tools, they need not be relied upon. The difference is like the difference between accounting and management information. Management information (ex-ante decision support and ex-post performance attribution) needs to be continually linked to the internal organisation and decision procedures and needs to change with it. It is an art to decide what elements of the complex world to spend time on modelling. Be glad that someone spends time on it. This is better than people taking ad-hoc decisions. We don’t want internal controls around these things. Of course, when management information is routine, it may be worthwhile to document it and surround it with controls. But the business typically changes so rapidly that this is not worth it. (4) Counterveiling power. Within Banks, risk managers are often positioned as counterveiling power. Much like the court has two sides. As we know from the US, this is an extremely expensive resolution of possible conflicts, but provides an extremely valuable ‘second opinion’. I think in many cases a standard ‘risk – accountability report’ is all that is needed. We only want American type legal situations for more complex / new transactions. Don’t forget, we are not talking about financial risks, but we are talking about the myriad other kinds of risk as well. Should we have ‘competition risk management’, to monitor that the business has the right perspective on the competition? Running a business is taking risks. The business is the risk manager. A good business man knows when to ask for a second opinion … but it seems too much to have too many procedures and controls around that.