Take one big investment bank. It employs, amongst other people:
- traders: who follow market movements and book the deals;
- salespeople: who manage the relationship with counterparties and talk to them about what sort of business they want to do;
- research analysts: the economists, who tend to specialise in particular business sectors and analyse developments in the financial world (and also political developments) which are likely to affect commodity prices, equity prices, currencies, and so on;
- credit risk analysts: who assess the creditworthiness of potential counterparties and factor this risk into the price of a trade (this is partly based on ratings given by credit ratings agencies like Moody's and Standard and Poor, but they also carry out their own research)
- market risk analysts: the so-called 'rocket scientists', who use sophisticated financial modelling to predict future market movements and factor this risk into the price of a trade (here's an example - the Black-Scholes model for options pricing)
- lawyers: who document the trades to allow for netting of obligations, which significantly reduces exposure, and ensure compliance with regulatory requirements
- accountants: who monitor capital adequacy requirements (i.e. that the bank has the required capital set aside in order to meet any likely call on its funds - this figure is reached by looking at the credit rating of counterparties, market risk, existence of netting agreements, diversity of portfolios, etc), and
- settlements team: who arrange for payment of monies (i.e. settlement of trades), and (usually automatically generated) confirmations of individual trades;
- senior management: not quite sure what they do, but they get paid a lot for doing it.
And of course there are also the external regulators, like the SEC and the FSA, and bodies involved in monitoring the stability of the financial system, like the Fed, the Bank of England, and the Bank for International Settlements.
So for a top player like Lehmans, there are checks and balances built into the system. (This wasn't the case with Barings, when Nick Leeson was more or less allowed to carry out the entire front and back office operation by himself - but that was then, and this is now, and they were a tiny institution by comparison).
So at what stage of the process did this break down? You can't just blame the traders, as they have to get permission to trade from the back-room boys. I suspect it must have been a combination of the research analysts and the market risk guys both wildly miscalculating what was going to happen in the housing market, and the credit risk guys being over-optimistic about the creditworthiness of the sub-prime mortgage lenders with whom the bank was trading. And then the accountants were presumably happy for all those eggs to be put in the property market basket. And the regulators weren't asking the questions they should have been, or were being fobbed off with the wrong answers.
But the buck stops with senior management, doesn't it? So I look forward to seeing how many of them are called to account when the current situation calms down, and how many simply walk away with huge pay-offs...