From an economic, interest-rate and banking perspective, 2007 will be remembered for a lot of reasons, including the credit crunch, the implementation of SFAS 157 and SFAS 159 (remember how much fun that was?), and stock and bond markets acting in odd and volatile ways, particularly during the second half of the year. Now that 2008 is well underway, we can ask ourselves how long this difficult and confusing environment will continue to look like last year. And if it does continue, what measures should your bank take?

Financial institutions invest in a variety of fixed-income securities, including Treasuries, agencies and municipal bonds. Banks also invest in mortgage products, such as mortgage-backed securities (MBS) and collateralized mortgage obligations (CMOs), as a way to pick up additional yield or spread. These products include a wide variety of issuers, collateral, maturities, weighted-average lives, coupons (fixed and floating) and cash flow structures. In today’s investment climate, agency-backed MBS represent good relative value due to wider starting spread, solid credit quality, favorable cash flow characteristics, and lower prepayment risk.

Few companies have had as difficult a time as the muni insurers during the past 12 months. Their stock prices fell sharply amid deteriorating subprime and CDO conditions. In addition, their AAA ratings have been threatened. To shore up their capital cushion and protect ratings, insurers have sought capital and reinsurance. Market conditions have hindered the ability of the insurers to raise capital.

Difficulty in raising capital and the deterioration in the housing market have resulted in downgrades and warnings by the ratings agencies.

It is still surprising to see the range of perspectives among bankers as to what they expect from their asset/liability committee (ALCO). For many banks, ALCO is strictly a financial reporting process focused on regulatory appeasement. At the other end of the spectrum are those banks that view ALCO as a holistic, integrated risk management process focused on managing all the risk/return aspects of the balance sheet?