The Bank Calculator

ShipOfFools_web_07292016“Afterward Moses and Aaron went and said to Pharaoh,
Thus says the LORD, the God of Israel,
Let my people go, that they may hold a feast
to me in the wilderness.” (Exod 5:1 ESV)

The Bank Calculator

By Stephen W. Hiemstra

My transfer in 1995 to the economics department in the Comptroller of the Currency (OCC) initiated a period of intense learning, productivity, and networking. My particular unit, Global Banking and Financial Analysis (GBFA) developed a relational database in SAS to store and more easily retrieve call report data on commercial banks and thrifts and more generally tasked with financial analysis of community banks. Because most economists have some facility with using SAS, this database enabled our unit to undertake routine oversight of the financial condition of the banks.

My initial work in GBFA involved supporting advanced risk analysis research being undertaken by my colleagues, Tom and Swamy. Swamy developed an econometric approach at the Federal Reserve which was implemented in FORTRAN and ran on the UNIX operating system called the Stochastic Coefficients Estimation Program (SCEP). My task was to migrate this software over to run on Microsoft Windows and to make it accessible to researchers not familiar with FORTRAN. The migration to Windows was fairly straightforward. I then wrote a Windows program in C++ which prompted the user with menus to fill in the required variables and run the FORTRAN as a background process. The harder part was writing the hypertext documentation to explain to users how to understand and user the procedure.

This new program cut the time required to compete an estimation from weeks to a couple hours, making research substantially easier. Tom Lutton and Swamy Paravastu completed a number of journal-quality research papers over the next couple years. Meanwhile, I became acquainted with the procedure and became good friends with mathematician and programmer at American University, Ilok Chang, who had developed the FORTRAN program. Over nights and weekends during the next several years, we collaborated on development of an assembly language implementation of a matrix class for interval mathematics (1996-97).[1] As part of my validation work on this matrix class, I developed a small calculator program to speed up the computations.

In addition to our research work in GBFA, we were encouraged to support the work of the bank examination staff with both macro-economic reporting and financial analysis. For the most part, our macro-economic reporting was ignored, which was a source of much consternation because a monetary crisis was developing in Asia. At one point, we were called upon by a large New York City bank to assist with working on the Asia issue and traveled to New York to brief and be briefed on the issue, but there was little appetite in our office to follow up.[2] When several weeks later the Thai Baht crashed, the attitude about macro-economics did not change and we gave up on our reporting.

The support for financial analysis was different, in part, because everyone was convinced that they could do themselves, even if inadequately. The breakout project in financial analysis came when we were asked a second time to assist in reviewing liquidity risk. Liquidity risk kept coming up because there was an examiner with a special interest in liquidity issues who would periodically worry people enough to have management request an assessment. The first time this happened, we undertook a lengthy literature review and attempted to measure liquidity risk with a research effort—no one understood our work and it was dropped. The second time we received a request, I proposed a brief study of the liquidity ratings given by examiners to each and every national bank.[3] With our new data system, this study was easily undertaken, briefly summarized, and widely cited. This liquidity study was ignored by the economics staff, but was loved by management so we found ourselves fielding more questions about the financial condition of national banks.

Because of my background in agricultural economics and bank examination, I found myself undertaking quarterly studies of the condition of agricultural banks. In response to this requests, I developed a databook of all the agricultural indicators found in the call reports. This databook was warmly received and I was invited to participate in an agricultural oversight committee which met from time to time with examiners from across the OCC. Eventually, I was able to convince OCC managers that, unlike in the 1980s, agricultural banking no longer posed a systemic threat to the national banking system and routine reporting on agricultural banks went from quarterly to annually and then to being dropped. The largest agricultural portfolio in the nation was held by the largest bank, but for that bank it was less than one percent of assets—in other words, agricultural credit risks were being adequately managed.

Between our research work on bank risk taking and our reporting on the financial condition of banks, it became obvious that economic research seldom had an impact on the culture of regulation while financial analysis, even if indefensible in an empirical sense, was routinely influencing administrative decisions. This problem caused our team great consternation, because we believed that our work was both theoretically and empirically sound. In the midst of this frustration, I began to see a disconnect between the contractual risks (credit and interest rate risk, in particular) which regulators followed with great interest and threats to the firms’ survival (liquidity and failure risk) which were often neglected. I coined the term, whole bank risk, to highlight this disconnect.[4] Tom, Swamy, and I began to call ourselves the whole bank risk team.

The whole bank risk project had two primary components, one headed by Swamy and other I headed. My project involved improvements to a bank failure model which we developed in cooperation with the Federal Deposit Insurance Corporation (FDIC) and the Office of Management and Budget (OMB) using Swamy’s econometric approach. This initial failure model yielded a probability of failure which tracked the historical performance of commercial bank failures reasonably well, but the number was lower than FDIC was accustomed to seeing and they rejected the model. The model was accordingly written up and then ignored.

Later on, GFBA was tasked with developing new models for the OCC. A week-long series of meetings were planned in which staff unfamiliar with modeling sat and talked for days about how to develop models. This was extremely frustrating for those of us accustomed to modeling and being ignored. At that point, I had an idea—why not take our existing bank failure model and develop it into a Windows program which allowed the user to simulate bank failure probabilities in a calculator format, as I had done earlier with my interval mathematics validation? I skipped out of the meeting on Monday and returned on Wednesday to demonstrate my “Bank Failure Calculator” program.

The name changed to “Bank Calculator” to placate sensitivities, but the program itself was a great hit. Over the next 7 years, I spent about half my time estimating new failure models to add additional explanatory variables, validating the results, doing supporting studies, and porting the program to other computing environments, like SAS, Excel, and hypertext. I also gave demonstrations to numerous agencies across government interested in our approach. In its hay-day, the bank failure probabilities were updated for every bank in the national system and available along with supporting analysis to examiners across the OCC through the agency intranet.

[1] We envisioned this project accelerating the Human Genome project computations ( However, in my validation work I discovered a weakness in the Pentium processor which would have required years of effort to resolve. At that point, we abandoned the project.

[2] Frustrated by the response but intrigued by the developing storm, I opened a commodity account and taught myself options trading and technical analysis nights and weekends.

[3] Bank examiners rate banks with 5 indicators each year: capital, assets, management, equity, and liquidity (CAMEL).

[4] Other people talk about enterprise risk.

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Land of BOS

I am the LORD your God, ShipOfFools_web_07292016
who brought you out of the land of Egypt,
out of the house of slavery.
You shall have no other gods before me.
(Exod 20:2-3)

Land of BOS

By Stephen W. Hiemstra

In January 1993, I applied for a position in the Comptroller of the Currency (OCC) which was the office in the U.S. Department of Treasury responsible for national bank supervision.[1] This particular office was called the office of Bank Organization and Structure (BOS) and it oversaw national bank applications for organizational changes (licensing), like new bank charters, conversions from state to national charter, mergers, failures, and opening of new automated teller machines (ATMs). I had a rough idea of BOS’ business function from my work in bank examination in the Farm Credit Administration (FCA), but it did not matter to me. They needed a financial economist and I wanted to get back into economics. My work on the McLean Team in FCA in examinations required more travel than was consistent with my family situation—my son had had surgery the previous October and required follow up surgery in January.

The interview process for this position went quickly. I met with my supervisor and, after that, my second level supervisor took me to lunch. They were pleased to have an economist, like myself, with experience both with computers and with working in examinations. My position involved financial reporting based on a customized licensing database—a network database which required queries in the structured query language (SQL) and the ability to read a data schema. Only one other member of the staff was able to request data from the system and she was not an economist able to interpret the data. Missing from my interview was an opportunity to visit with the staff.

The lack of staff input into the hiring process should have been a red flag. In prior interviews in the Economic Research Service, in USDA, for example, an interviewee might be required to visit with the review committee, managers, and each member of the staff, and to make a presentation to the entire department. This sort of intense vetting process was also typical for many firms and academic departments that hire economists, in part, because of the extensive need for team work. However, FCA also did not require this type of extensive interview so I was off my guard in interviewing at OCC. In fact, I was relieved not to have to deal with a lengthy process, in part, because of the stress at home with my son’s medical situation and having two other kids in diapers.

I started work late in January. The office seemed congenial enough because both my supervisor and his boss were both economists. My opinion was frequently asked in staff meetings and all seemed copacetic as I learned my new position. But everything was not as it seemed.

In early February, my supervisor announced that he was leaving. He was quickly replaced with a professional OCC manager who was not an economist and was new to the group. The staff was icy cold in their interactions with me because my departing boss had brow-beat them for years complaining about their lack of analytical skills. When I was hired and brought those skills to the group, their silent resentment was given a concrete focus—me. The new manager picked up immediately on the staff resentment and offered me no shelter from the storm. I was alone in the group and persona non grata. My new station in life became even more conspicuous when the office was invited to a dinner party at the old supervisor’s home and I found myself there with my wife, Maryam, and shunned the entire evening. Maryam picked up on the tension that evening and came away distraught knowing, as a stay-at-home mom, that our entire livelihood was in jeopardy with nowhere to run. The darkness in my life grew darker still when soon thereafter Maryam was diagnosed with breast cancer.

The emotions associated with breast cancer pillage both husband and wife, but the sympathy and care extended focuses on the wife. Most people close to you offer sympathy and assistance for a few weeks, but after that you are on your own. Others close to you shut down emotionally and withdraw having no reserve to draw on to lend to you. Maryam quickly went through a lumpectomy with radiation and was put on a hormonal treatment tamoxifen. I felt shamed and abused by doctors examining and diagnosing my young wife with no outward appearance of disease and by being robbed of the prospect of having more children. While I did not miss a day of work, at one point I had a bad day in the office only to find my boss threatening to fire me—these were cold, hard days.

Still, I had an unexpected ally at OCC from early in my tenure. The Comptroller of the Currency distinguished himself as being a lawyer who was computer literate and brought a laptop to meetings. This created a big stir in an agency that prided itself on teaching bank examination conducted with nothing other than a legal pad. One morning I helped a man with a brief case and a laptop to get on the elevator. Seeing the laptop, I knew immediately who it was, pushed the button to the top floor, and introduced myself to Eugene Ludwig, the Comptroller of the Currency, for the first time.

After the Comptroller of the Currency himself, I was the second one in the building (in an agency of about three thousand) to request and receive a 486 desktop computer. My computer skills became well-enough known in the office that my second level supervisor asked me to upgrade him to Windows 3.1, while the computer support personnel remained in the MS DOS world, even though new computers came with Windows installed (they un-installed it). This embarrassed them enough that they refused to offer me any technical support. When I requested additional computer memory, they simply dropped the memory cards on my desk and walked away. I ended up loading my own copy of MS Office on my office computer, in part, because the computer support simply refused my request.

Nevertheless, my computer skills continued to open doors. At one point, my second-level supervisor was tasked with organizing a fundamental re-organization of the OCC from top to bottom. Being a pariah in the office, I volunteered to assist with this re-organization and quickly found myself assisting teams from across OCC in process-mapping their business functions. Over the next several months, I constructed roughly 150 process maps covering every single business activity deemed important and worked closely with the rising stars in the agency who would soon form the new senior management structure. Because of these insights and connections, I was soon offered a transfer to the economics department to work for a very ambitious female manager with a data management background and a need for programmers who were comfortable building financial models.

According to Shakespeare, all’s well that ends well. Yet, the scars of those days remain. Maryam cannot shake the memory of family members who remained aloof during her breast cancer episode; I buried myself in my work and, when I was not working, I was adding to my programming skills. After learning Windows programming in C, I went on to become expert in C++, FORTRAN, and assembly. My programming skills gave me the prospect of earning more money as a programmer than as an economist, but I stuck to building financial models where I increasingly became known as a financial engineer.

[1] A national bank is a bank with a federal charter and identified by having a name including the term, national bank or national association (NA). Banks are financial institutions that take deposits and make loans.

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Stress and Stress Modeling

ShipOfFools_web_07292016“When I look at your heavens, the work of your fingers,
the moon and the stars, which you have set in place,
what is man that you are mindful of him,
and the son of man that you care for him?”
(Ps 8:3-4)

Stress and Stress Modeling

By Stephen W. Hiemstra

At some point in 1991, the Office of Financial Analysis (OFA) in the Farm Credit Administration (FCA) was re-organized and placed under the Office of Examination (OE). The objective of the economics group shifted from policy research to risk analysis and support for the examination function. To facilitate this transition, OE offered examination training to anyone interested in taking it and I signed up for all the training that I could get. Because I knew nothing about the examination function, I could only support it if I learned what it was. Over the next year, I spent as much as two weeks a month taking training courses offered both internally by examination supervisors and externally, often at the Federal Deposit Insurance Corporation’s (FDIC’s) L. William Seidman [training] Center.

While policy research focused heavily on legislative and regulatory performance, examination focused on the financial performance of Farm Credit System associations and banks. A typical association examination might last 2-3 weeks, depending on the chief examiner’s off-site risk analysis. Because the primary business of the associations was making agricultural production and farm real estate loans, much of this time was devoted to reviewing individual loan files to see if they conformed to association policies and FCA regulations, and rating loans as to their credit status. FCA examiners were typically credit and interest rate experts, knowing the business of agricultural lending almost as well as the lending officers themselves.

By contrast, FCA economists typically focused on market conditions and financial performance in the aggregate, not being nearly so focused on the business side of the associations. Assigning us to support the examination function was hugely educational, but it was also forced us to play by unfamiliar rules with unfamiliar staff. My plunge into examination training, of course, helped alleviate this problem, but the threat of failure was ever-present and my own paranoia was stroked when we were assigned interior offices half the size of the offices we were accustomed to.

One morning in June 1992, a stranger walked into my office and announced that I had been RIFed. RIF stands for reduction in force and usually meant that your position had been eliminated. In the middle of this stressful conversation, he told me that when human resources reviewed my file they discovered that I had more examination training than many of their professional examiners. Consequently, while my economics position was eliminated, I was being offered a position in the McLean examination team at my current salary and I had two years to complete certification as an examiner. If I completed the certification, I would retain my salary and begin a new career as an FCA examiner. So with two kids in diapers and my wife, Maryam, six months pregnant with my son, that morning I began a new career in examination. I ended up traveling about 80 percent of the time.

At the time when this RIF occurred, I was working as an analyst attached to a new Office of Secondary Market Oversight (OSMO), tasked with supervising Farmer Mac. OSMO consisted of a director, an analyst (me), and a secretary. OSMO’s budget was cut roughly in half that year leaving no room for an analyst at a critical time—OSMO was tasked with building a stress model for Farmer Mac which by law had to be made available for public review. While I built a balance sheet and income statement model in Excel for this purpose, public release suggested a more formal approach. Consequently, I proposed to program this stress model in the C programming language built on the Windows operating system. The director liked this proposal and sent me out for training in C and in Windows programming.

My RIF initially slowed progress in developing a Farmer Mac stress model, but after a time on the road it became obvious that van travel consumed a substantial portion of the work week on examination. And what do you do in the evening in a hotel? I proposed to the OSMO director to program the stress model during such down-time and the director arranged for me to get one of the first laptops available in FCA. At the time, even exam managers did not have laptops and my laptop was the envy of my new peers and managers. The first version of the Farmer Mac stress model was completed while riding in the back of a van in rural Virginia.

After several months of examination work in the McLean team, I applied for a licensing position in the Office of the Comptroller of the Currency (OCC) in the Department of Treasury. I succeeded in interviewing for the position because the position required working closely with licensing analysts who were typically certified national bank examiners. Ironically, my credit experience working as an FCA examiner helped me land this new position.

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