Transcript of the interview with Joachim C Bartels, managing director of the Business Information Industry
Association Asia Pacific on December 02, 2008 with Dr. Willi Bredemeier, Editor-in-Chief, Verlag PASSWORD –
Redaktionsbuero Dr. Willi BREDEMEIER, 45527 Hattingen, Germany
THE CRISIS IN FINANCIAL SERVICES
Password-Interview with Joachim C. Bartels
The (Subprime) Crisis could have been avoided
through the proper use of available information tools.
Joachim C. Bartels is Managing Director of the Business Information Industry
Association Asia Pacific – Middle East (Hong Kong) and is one of the leading
experts in Credit and Financial Information Services. The length of the interview
– the longest so far printed by PASSWORD – is an indication of the severity of the
current problems which confront Financial Services, the Economy and
Information Services
Dr. Bredemeier: For more than a half of a century we had learn a lot from the
Americans. Europe is now being hit by brute force of the financial crisis – do we
have to learn from the Americans how not to do it.
Joachim C. Bartels: Dear Dr. Bredemeier, why being so focused on America?
Perhaps one should name them „Anglo-Saxons‟! Let‟s not forget there is the financial
center of London, where much of the „financial wizardry‟ originated long before the US
gained that status. Anglo-Saxons always had an equity culture, as compared to
Germany, which used to have a savings account culture. Financial wizardry became
global when the expertise migrated around the world to other financial centers.
America became, over time, the largest economy; most of the financial power appeared
to concentrate there. However I believe in the last 20 years a lot of capital is moving
from one financial center to another at remarkable speeds, always seeking higher
returns or safe havens. Yes, the US subprime mortgage situation triggered the crisis,
but please bear in mind that a lot more collateral debt instruments were „cobbled‟
together in other financial centers, not just in America.
Do we have to learn from it? Of course we have no choice, however please remember
America had many financial disasters in its history. It has always learned from it,
created new regulations and mechanisms, which were designed to prevent history from
repeating itself. In my opinion legislators and regulators have not learned the lesson
that financial innovation, aided by technology, always appears to be ahead of regulatory
regimes, the only difference being that the numbers (in terms of risk) seem to get
bigger, and so are the disasters.
Joachim C. Bartels
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Page 1
Transcript of the interview with Joachim C Bartels, managing director of the Business Information Industry
Association Asia Pacific on December 02, 2008 with Dr. Willi Bredemeier, Editor-in-Chief, Verlag PASSWORD –
Redaktionsbuero Dr. Willi BREDEMEIER, 45527 Hattingen, Germany
Dr. Bredemeier: What has gone wrong in Financial Services? Was a failure of
markets, government, in particular the wrong regulations?
Joachim C. Bartels: Certainly both of these factors have contributed to the problem.
Based on what we know today, there were a number of negative factors that appear to
have compounded the problem.
The Federal Reserve Bank, under Mr. Greenspan kept the world awash with too much
easy money for far too long. Until recently he staunchly tried to defend his reputation,
but when he appeared in front of a congressional committee recently he came clean
with his statement of „mea culpa‟ and “I am shocked by the extent of predatory lending
….”
Deregulation: Politicians (Clinton and the Congress) further deregulated the financial
system and felt they had a social responsibility to put poor people into home ownership.
Hence Freddy Mac and Fannie Mae were told to underwrite subprime mortgages. Mr.
Greenspan supported these moves.
Sub-prime mortgages were designed to lead to higher returns: To underwrite the
mortgages the „sub-prime‟ mortgage securities were invented, with a high risk premium.
During the era of cheap money Wallstreet and banks eagerly picked up the idea to
create subprime mortgage backed debt instruments.
Regulation failed: Regulators permitted a „shadow financial system‟ to emerge literally
parallel to the regulatory system; it circumvented Basel II, which was designed to
prevent banks from becoming illiquid. Since all regulators and legislators around the
world permitted such „shadow financial system‟ to exist, you can hardly put the entire
blame on the Americans or the Anglo-Saxons.
Skewed incentives and greed contributed to much of the crisis. Mortgage brokers went
to work to generate sub-prime mortgages. They got paid regardless of the outcome,
and the real estate bonanza lead to a lot of misrepresentation (people got mortgages
who could not afford them), as well as fraud, by misrepresentation of incomplete or
imperfect information.
Shoddy risk management: Banks who took on these mortgages were accused of
shoddy risk management, since they knew from the beginning that these „sub-prime‟
mortgages would eventually be securitized and removed from the bank‟s balance sheet.
Again, the originating banks got paid up front for processing the mortgages without
having to retain part of the risk.
Joachim C. Bartels
- [email protected] - All Rights Reserved - www.intrepidex.com
Page 2
Transcript of the interview with Joachim C Bartels, managing director of the Business Information Industry
Association Asia Pacific on December 02, 2008 with Dr. Willi Bredemeier, Editor-in-Chief, Verlag PASSWORD –
Redaktionsbuero Dr. Willi BREDEMEIER, 45527 Hattingen, Germany
Rating shopping: Arrangers of the secured assets were permitted to manipulate the
creation of secured assets by mixing good assets with high risk assets to the point of
getting a triple-A rating. If they did not get a triple-A rating, the securitized assets were
withdrawn, reconfigured and resubmitted. Such practices lead to an overload at the
rating agencies, substandard procedures and lack of transparency.
Imperfect information: Ignored was that fact that many mortgage applicants never had
a mortgage and therefore had no credit history, hence the information, which brokers
and bankers relied upon was imperfect (thin file reporting) and to pushing mortgages
through the pipeline lead to a lot of misrepresentation.
Imperfect assumptions: Credit rating agencies used models and assumptions gained
from experience with other mortgage backed securities. However these were not
subprime, but based on borrowers who had significant equity in their homes. Their
credit behavior was different from those borrowers who had 100% subprime mortgages.
This revelation came relatively late, led to changes in the rating models and subsequent
down-grading of the subprime collateralized debt instruments.
Devin Sharma, President of S&P stated in the congressional hearing: “While we
endeavored in good faith to assess what we thought would occur in a variety of future
economic conditions so that our ratings might withstand the stresses of economic
cycles, events have demonstrated that the historical data we used and the assumptions
we made significantly underestimated the severity of what has actually occurred.”
Lack of oversight over accuracy of information: The SEC failed to commit the parties to
conduct due diligence on the underlying information of the secured assets. Hence no
one in the value chain was required to check the validity of the data submitted to the
rating agencies.
Dr. Bredemeier: No other economic sector spends so much money on
information as the Financial Service sector does. Nowhere else are the systems
as sophisticated. Did the Financial Sector ignore its own information? In view of
the magnitude of the risks, were risks ignored or incorrectly assessed?
Joachim C. Bartels: The quality of credit information In the USA and in Western Europe
is relatively high and thus if used correctly could have prevented the crisis. Credit
information companies have no control in how their information is being used.
Joachim C. Bartels
- [email protected] - All Rights Reserved - www.intrepidex.com
Page 3
Transcript of the interview with Joachim C Bartels, managing director of the Business Information Industry
Association Asia Pacific on December 02, 2008 with Dr. Willi Bredemeier, Editor-in-Chief, Verlag PASSWORD –
Redaktionsbuero Dr. Willi BREDEMEIER, 45527 Hattingen, Germany
As we know today there was a lot of misrepresentation, and people got mortgages who
could not afford them. The final decision, however, was made by banks who accepted
the risk. It had nothing to do with information. The consumer credit information
industry, has always maintained that the cause of the debacle was not an information
deficit. It was the case of an information disconnect since the mortgages were
packaged and sometimes repackaged (sliced and diced) into different financial
instruments and thus disconnected from the original source of the risk and underlying
credit information.
The practice of portfolio management and
applying alert services tracking the
“Rating agencies
performance of risks within the portfolio
and investment
was not used. Hence rating agencies and
bankers were
investment bankers were ‟flying blind‟ until
flying blind”
the actual performance (late payments or
no payments) filtered down from the
origination point. The SEC criticized that
the surveillance of the risk within the portfolios was not as robust as it should have
been.
Sloppy risk management, or irresponsible lending, contributed much to the debacle. It
was suspected that banks did not care very much about the quality of the information
submitted by the broker since they did not intend to hold on to subprime mortgages. If
regulators would have required the originating bank to retain a certain amount of the
debt on its books, it can be assumed that the bank probably would have applied more
scrutiny to the origination process.
Over reliance on financial modeling also appears to be a contributing factor. Bankers
relied almost blindly on FICO Scores (Fair Isaac) and rating agencies on their vast
historical data and models. In the end, nobody questioned the fact that subprime risks
may behave differently.
What one cannot comprehend is the fact that the same banks, who removed subprime
mortgages from their balance sheets through securitization, bought the subprime
collateral debt instruments. These banks should have known about the inherent risks
in the first place.
Joachim C. Bartels
- [email protected] - All Rights Reserved - www.intrepidex.com
Page 4
Transcript of the interview with Joachim C Bartels, managing director of the Business Information Industry
Association Asia Pacific on December 02, 2008 with Dr. Willi Bredemeier, Editor-in-Chief, Verlag PASSWORD –
Redaktionsbuero Dr. Willi BREDEMEIER, 45527 Hattingen, Germany
Dr. Bredemeier: European information suppliers in Europe appear not to be
implicated in the crisis? Is this correct? Could this aspect change? Do they have
to be concerned about their image?
Joachim C. Bartels: Apart from the US and UK, I believe the European consumer credit
information providers were not involved. However consumer credit information industry
has become a victim of the crisis, because when banks stopped lending, they stopped
buying information. The US and European credit information businesses have the
qualitative and timely information, and if properly used would have prevented the
disaster of today‟s proportions.
Dr. Bredemeier: Value added information providers, especially the rating
agencies are being reproached, perhaps justifiable so. At least this is the
assumption in Europe.
Joachim C. Bartels: Fair Isaac (consumer credit scoring) had to defend its image
because in many cases the FICO score turned out to be imperfect (lack of sufficient
data). The FICO score was one of the primary risk assessment instruments in the
origination process of subprime mortgages.
The Rating Agencies have to bear a lot of responsibility, but they are not the only key
players in the value chain of originating subprime mortgages. The FBI is now
investigating brokers, banks and investment houses for potential fraud and misleading
investors.
The Rating Agencies came into the limelight because of the sudden steep downgrading
of the subprime collateral debt instruments. That brought also into question the ratings
of commercial collateralized debt instruments [some of which were rated in London and
not in New York). The SEC went into action and investigated the practices of the Rating
Agencies and exposed inefficiencies, sloppy rating work, imperfect models and
questionable practices which it classified as potential conflict of interest.
The SEC report also exposed other deficiencies in the process of creating the subprime
collateral debt instruments, which unfortunately received scant attention. Most of the
SEC recommendations are now being implemented and the rating agencies are working
hard to repair their reputation and restore investor confidence. Notwithstanding these
efforts, tightened regulatory regimes are inevitable. The regulators, in particularly in
Joachim C. Bartels
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Page 5
Transcript of the interview with Joachim C Bartels, managing director of the Business Information Industry
Association Asia Pacific on December 02, 2008 with Dr. Willi Bredemeier, Editor-in-Chief, Verlag PASSWORD –
Redaktionsbuero Dr. Willi BREDEMEIER, 45527 Hattingen, Germany
Europe, have tasted blood and are seeking revenge. What these new regulations will
consist of will be anyone‟s guess. The EU Commission will issue its report in November,
the SEC in December.
As a result of the SEC investigation a lot has changed already within the rating
agencies: S&P took the lead last year and announced 27 initiatives designed to
increase quality and transparency.
There are some concerns amongst consumer credit information executives in Europe
that they will be impacted as well and may come under a stricter licensing scheme.
Why the EU wants to put consumer credit information into the same pot as rating
agencies is hard to fathom.
It also has to be seen to what extent regulators will be qualified to check the methods
and models of the rating agencies and the credit scores of consumer credit information
companies. Perhaps one should also ask the question: Who will audit the work of the
regulator?
Dr. Bredemeier: Is our crisis management functional? How does the evolving
global recession impact the global information industry?
Joachim C. Bartels: This is a global financial crisis of a scale never experienced before,
for which nobody appeared to be prepared. Everything so far was done ad-hoc by
Central Banks. All regulators are bound by local jurisdictions, and up to now only the
IMF is able to intervene in local and regional financial crisis. Nevertheless governments
and Central Banks are consulting each other to solve the current crisis.
The negative impact on the information industry is already manifested by a significant
loss in shareholder value. Revenue declines in certain product lines were masked by
acquisitions in the prior year. However third quarter results indicate that the negative
trends persists.
Rating agencies show the largest declines in revenues, consumer credit reporting firms
start to report low organic growth or declines in certain consumer credit reporting
product lines. Financial information providers such as Bloomberg and Thomson
Joachim C. Bartels
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Page 6
Transcript of the interview with Joachim C Bartels, managing director of the Business Information Industry
Association Asia Pacific on December 02, 2008 with Dr. Willi Bredemeier, Editor-in-Chief, Verlag PASSWORD –
Redaktionsbuero Dr. Willi BREDEMEIER, 45527 Hattingen, Germany
Reuters will feel the pinch of bank consolidations and failures. Most industry players lay
off people, slashing operating cost and defer expense investments.
However information is critical in risk assessment,
therefore once the financial system is returning to
business as usual, the situation will improve for rating
agencies, consumer credit information and financial
information providers. The question is when?
Perhaps the answer to the question “when” may lie in a
comment by Winston Churchill at the beginning of WWII:
“Now this is not the end. It is not even the beginning of
the end. But it is, perhaps, the end of the beginning”.
“The crisis
has only
just begun”
Dr. Bredemeier: What changes must be made long term by all parties involved in
the crisis?
Joachim C. Bartels: Legislators, regulators, the financial services community and
information providers need to be vigilant, not to allow untested innovation to get too far
ahead of regulations as it happened in the subprime crisis. Investors must learn again
to rely on prudent risk management and not blindly
trust opinions or financial models.
One needs to return to responsible lending,
notwithstanding the noble cause of putting poor
people into home ownership. Consumers need
training in financial literacy to avoid overindebtedness.
“We have to return to
responsible lending
and to educate
consumers in
financial literacy”
Rating agencies must change their culture from
being secretive, arrogant and aloof organizations,
to becoming transparent institutions. This process
is already underway as a result of the SEC study. Rating agencies need to train users
in the use of their information products to avoid misinterpretation.
A lot of conversations are going on between all actors and no doubt new and better
relationships will emerge between the financial services sector, the information industry
and regulators.
Joachim C. Bartels
- [email protected] - All Rights Reserved - www.intrepidex.com
Page 7
Transcript of the interview with Joachim C Bartels, managing director of the Business Information Industry
Association Asia Pacific on December 02, 2008 with Dr. Willi Bredemeier, Editor-in-Chief, Verlag PASSWORD –
Redaktionsbuero Dr. Willi BREDEMEIER, 45527 Hattingen, Germany
Dr. Bredemeier: Will there be specific opportunities for compliance and
regulatory information services? …
Joachim C. Bartels: Whenever there are new regulations there will be opportunities for
those firms who can supply such services. What
these services will be depends on the new regulatory
environment and perhaps we will learn from the SEC
and the EU commission what the new regulatory
Opportunities to
regimes going to be.
reposition
Dr. Bredemeier: … and for credit information and
expanded business information?
information
Joachim C. Bartels: Every crisis represents a challenge and opportunity to provide
better services. The subprime crisis has exposed deficiencies in „thin file reporting and
modeling‟ (not sufficient information on borrowers). The consumer credit information
industry is now exploring the use of non-financial data to augment its files (for example
data from utilities etc.). Empirical studies indicate the validity of such a concept.
Regulators, banks and rating agencies will have to rely on portfolio management tools
and alert services to prevent information disconnect as experienced in the subprime
crisis.
Notwithstanding the severe declines in new bond issues and structured finance ratings,
the rating agencies report an increase in revenue for analytical products and indices
indicating a growing need for more refined analytical data and benchmarking.
Dr. Bredemeier: Are radical changes in compiling and adding value to
information services necessary?
Joachim C. Bartels: Not really. As indicated before, the quality and timeliness of credit
information is already at a relatively high standard in North America and Western
Europe. The rest of the world is trying to catch up with the help of the IFC (World Bank
Group). Emerging markets have a lot of work cut out for them to make information
more accurate, reliable and timely.
The world continues to need risk and fraud prevention products. The biggest problem
for the consumer credit information, as well as business information providers today is
data security to prevent identity theft, the destruction or manipulation of data by
hackers.
Joachim C. Bartels
- [email protected] - All Rights Reserved - www.intrepidex.com
Page 8
Transcript of the interview with Joachim C Bartels, managing director of the Business Information Industry
Association Asia Pacific on December 02, 2008 with Dr. Willi Bredemeier, Editor-in-Chief, Verlag PASSWORD –
Redaktionsbuero Dr. Willi BREDEMEIER, 45527 Hattingen, Germany
The rating agencies have to repair their reputation and to make their rating methods and
models more transparent. More intensive user training will be essential to avoid
misinterpretation of data and opinions. The rating agencies are instituting measures to
improve quality: to quote S&P: “We are expanding our surveillance by obtaining
updated underlying information loan data in certain structured finance securities during
the period we monitor our ratings, in addition to continuing to analyze detailed loan data
in the initial ratings process.” S&P has also established a „Model Validation Group‟.
Dr. Bredemeier: Are radical changes necessary in the use of information services
and in the relationship between information and decision making?
Joachim C. Bartels: Risk managers need to resort to prudent and responsible lending,
based on factual information. Blind reliance on credit scores from consumer and
commercial information providers needs to be avoided. The same applies to opinions
expressed by rating agencies.
Regulators and industry must work together to achieve a balance between privacy
concerns and the need to pool critical information for the purpose of risk assessment,
fraud prevention etc. Allowing consumers to opt out from credit information systems
does not help transparency. Consumers must also become financially literate and to
avoid over-indebtedness. The financial services industry and the information industry
should invest in respective training. The IFC (World Bank Group) strongly
recommends consumer training in financial literacy and a number of countries have
already included such training in national education curriculums.
Regulators must insist on due diligence of the underlying information used to evaluate
financial instruments.
Regulators, the financial services sector and the information industry need to avoid the
misrepresentation of information, and disconnect of information during the life cycle of a
loan or financial instrument. Robust monitoring and surveillance of the risk will prevent
surprises in regard to potential shifts in risk.
Dr. Bredemeier: On behalf of PASSWORD I thank you for your time and valuable
insights.
Joachim C. Bartels
- [email protected] - All Rights Reserved - www.intrepidex.com
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