Risk Management Technology in Financial Services

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92 Risk management technology in financial services

just a couple of young engineers. Not watching a project like that through top-level

design reviews is plainly irresponsible – and its results show up in a big way in the

balance sheet.

Following the significant delivery delays, and their technical problems in the back-

ground, orders for the giant A380 have slowed to a trickle. Total orders of 159 are

100 short of the number at which the company breaks even. And even if Airbus is

sticking to its development figure of $11.7 billion, there are rumours of over-runs.

Moreover, the market for a 555 seater is not self-evident. Boeing reckons that the

big growth in air travel will come from smaller planes, carrying 250–400 passengers.

These will enable people to travel direct rather than changing at hubs. Airbus sees the

value of this, too, but it has been so busy designing the A380 that its smaller models

have been neglected. Lulled by the white elephant:

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EADS ignored demands of its customers, and

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Underestimated archrival Boeing which came up with a new fuel-efficient airplane.

And as if EADS needed more problems, in mid-September 2006 a political challenge

emerged. A Russian state-owned bank took a 5 per cent stake in the Franco-German

airframe, missile and aerospace firm, making it the biggest investor in Airbus’s parent

company outside its ‘core’ group of shareholders. Analysts think that the EADS

equity holding was bought on behalf of a Russian state company set up to coordinate

strategy in the country’s aerospace industry.

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5.6 The product problems of Long-Term Capital Management

On Thursday, September 24, 1998, bank regulators in the United States scrambled

to contain the financial fallout of a hedge fund’s meltdown: the Long-Term Capital

Management (LTCM). That day, under the patronage of the Federal Reserve Bank

of New York, some of the world’s largest commercial and investment banks put

together a $3.5 billion rescue plan. The money was intended to save the highly geared

hedge fund that was rapidly sinking under the weight of its wrong bets.

As in the cases of GM, Ford and EADS/Airbus, the problem was that LTCM’s top

brass had not attended to the problems the firm faced with its products and risks

embedded in them. As first the rumours and then the news spread, the shares of all

sorts of financial institutions fell sharply both in the United States and in Europe.

Investors were concerned that in the end, the effort to keep Long-Term Capital

Management afloat would not bear fruits because of its huge losses.

These losses were the result of very high gearing, to an astronomical 340 per cent

of the capital. Moreover, the oncoming collapse of LTCM was the fall of what many

insiders believed to be the most brilliantly engineered deals by a hedge fund and had

the potential to precipitate a financial crisis. The risk was not managed despite:

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The market skills of three Salomon Brothers alumni: John Meriwether, Lawrence

Hilibrand and Eric Rosenfeld, and

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The rocket science know-how of two Nobel Prize-winning economists: Dr Robert

Merton and Dr Myron Scholes.