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In the throes of distressed credit markets, lenders have had to take deep losses in their mortgage-backed securities (MBS) and asset-backed securities (ABS) portfolios. Lenders and investors alike have had to come to market for additional operating capital. According to Bloomberg News, banks raised $120 billion in capital from August 2007 to July 2008 to offset billions of dollars of write-downs and diminished earnings capacity.



The mortgage industry has seen businesses scaled back significantly since mid-2007. Many businesses were no longer viable or posed significant market, credit or operational risk. There just was not enough technology to cope with unresponsive and illiquid credit markets in the United States and abroad.

So what is the technology angle in all of this? That lenders are responding to this crisis by increasing the amount of money they are investing in their risk-management technology. What is surprising is that up until now most lenders have not had a technology infrastructure for managing risk. Based on our MORTECH surveys, I would say that 70 percent of lenders had no protection against an adverse turn in mortgage market conditions. They never installed automated risk-management systems.

The State Of Current Models And Systems For Measuring Risk Management

Large financial institutions-and I would include not just commercial and investment banks, but large hedge funds as well-evaluate the risk of their portfolios on a daily basis. They use standard metrics such as value at risk, decompose their exposures into tranches of maturity and credit exposure, and perform daily stress tests on their derivative positions. The systems and models they employ for these tasks are well developed; they are adequate for the risks they are designed to measure.

The problem is that the systems are not designed to measure-and in the current state of the world, perhaps cannot be designed to measure-the risks we care the most about: the risks related to market crises. The best we can do at this point is recognize, as my current firm does, that these risks can only be dealt with through true market insight and experience. The final solution is to apply common-sense rules that overlay the traditional risk metrics.

Subprime Fallout

According to The Economist magazine, Credit Suisse Group, Zurich, Switzerland, cannot pinpoint when in 2006 management became alerted to signs of the subprime problems in America. Culling data from the bank's trading desks and from mortgage servicers, Credit Suisse began to reduce its exposure to the subprime market. At the same time, it began to suffer a problem with the amount of risk-adjusted capital allocated to its leveraged loan portfolio. It established hedges against its leveraged loan portfolio. But it was too little, too late.

Credit Suisse may be a good case in point. Conservative and tightly run, Credit Suisse unexpectedly had to write down 5.3 billion Swiss francs in its investment banking businesses in the first quarter of 2008. As others have as well, it lowered its exposure to residential finance by 37 percent and to leveraged loans by 41 percent.

The problems of the financial sector are far from over, as the $2.8 billion second-quarter loss at Lehman Brothers Holdings Inc., New York, illustrated. There have been few bond defaults as yet, but Stephen Dulake, a credit strategist at JPMorgan Chase & Co., New York, reckons investors may be looking in the wrong place for trouble; there already have been 26 defaults in the American corporate-loan market this year.

Denver Mortgage- Seth Taylor

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