Now He Tells Us

All you bankers, traders, and fund managers smarting from losses on C.D.O.'s, C.M.O.'s and other alphabet-soup structured finance products, listen up!

Federal Reserve Governor Randall S. Kroszner wants you eight-figure heavy hitters to start looking yourself before you leap into the next big thing. Don't leave the looking to others.

At the Global Association of Risk Management Professionals' annual convention in New York on Monday (the Fed released the transcript today), Kroszner noted that there are a lot of complex financial products out there. Many are new, untested, and not well understood — even by the credit-rating agencies.

Therefore, he suggested, "market participants must ensure that they do not make valuation decisions based solely on excessive reliance on external ratings or evaluations, but that they also undertake their own assessment."

Too many of you saw only the fat returns promised by these tasty new morsels and you gobbled them up without remembering that high rewards come with high risks. But did you take the time to really investigate those risks? Based on the beating you're taking now, the answer is probably no. As Kroszner noted, "you cannot manage your risks if you do not know what they are."

"Conducting due diligence about new products can be costly and take time, but it is usually worth it," Kroszner added. "Unfortunately, in some recent cases new products were developed very quickly and not properly road tested."

Sounds a little like that Ferrari 599 GTB Fiorano that you trashed on the Merritt Parkway last summer, doesn't it?

Maybe, as Kroszner concluded, it's time for the masters of the universe to start taking calls from the boring, old risk-management department again.

"The next crisis could come precisely in the area where they are most exposed or have weaknesses," Kroszner said. "That is, a certain degree of humility is wise, because all firms have a limited understanding of what might happen next.

by Mark Stein