SocGen unhedged
I’m not sure whether yesterday’s “explanatory note” by Societe Generale about what it describes as its “exceptional fraud” was supposed to be reassuring.
But it didn’t do the trick with me. It left me feeling more anxious than ever, not only about how SocGen got into its mess but about whether controls are appropriate at other large banks that are stewards of our cash.
Here’s why.
As I explained last week on łÉČËÂŰĚł television, Jerome Kerviel’s alleged method was to take very big bets on the direction of markets, and then only pretend to hedge them by making fictitious bets in the other direction.
This fictitious hedging made it look to his employers, for a year or so, that his net trading position was close to neutral – or that if that one bet swung massively out of the money, it would be offset by a swing into the money by the matching bet (and vice versa).
Let’s push to one side, for now, the mystery of his motivation. And that is perhaps the most gripping mystery of all, because even if – as his lawyers claimed yesterday – his real trades were in profit to the tune of €1.5bn (£1.1bn) at the end of last year, there was no way he would ever have trousered any of this: that gain would have been sitting in his employer’s account, not his.
Also, let’s not fixate at this moment on what may enrage SocGen’s shareholders, which is the bank’s disclosure that as of mid-day January 18, M. Kerviel’s position was in balance – but that the massive loss of £3.7bn was only made real by the bank’s actions of selling M. Kerviel’s positions into a declining market.
Now I have been told by a banker advising SocGen that the Banque de France, France’s central bank, instructed SocGen to close out the position as quickly as possible.
But the official explanation from SocGen is that its chairman, Daniel Bouton, opted to sell tout de suite.
If so, SocGen’s shareholders may well be feeling less than enamoured of M. Bouton.
And, I have to say, if SocGen were a British bank, my instinct is that M. Bouton would already have been ejected from the boardroom.
But all of that, to an extent, is a sideshow.
The only thing that really matters is how M. Kerviel was able to bet his entire bank on the direction of stock markets and whether the flaws in SocGen’s controls also exist in other big banks.
What doesn’t provide comfort is that a senior banker with one of the world’s largest and most respected financial institutions – who has been drafted in by SocGen to help sort out its mess – told me he didn’t think SocGen’s risk-control techniques were any different or worse from most other banks.
The point is that SocGen’s method for controlling the risk to the bank from the activities of traders like M. Kerviel relied on controlling their respective net exposures to markets, rather than taking into account their respective gross exposures.
In fact, SocGen’s latest statement says that M. Kerviel was encouraged to engage in a “very large amount of operations involving very high total nominal amounts”.
SocGen probably thinks it is just stating the bloomin’ obvious, given that M. Kerviel’s official job was in equity-markets arbitrage.
And the various traders who read this column will probably accuse me of being needlessly alarmist.
They will point out that M. Kerviel was supposed to generate profits for the bank by exploiting minute differences in the buying and selling prices of almost-identical financial instruments, in his case European stock index futures or instruments with near-identical characteristics to those futures.
And in order to do that, he needed to trade on an enormous scale.
If done properly, they’ll say, the risks are minimal.
Perhaps it’s understandable that SocGen hadn’t properly allowed for the mad-genius risk, that a trader should have the desire and ability to gull the bank for no apparent personal gain.
But my fear is that SocGen, and possibly other banks, may be unduly optimistic about their ability to hedge a large position so that it becomes, in net terms, a small position.
Here we have to get into the detail of what M. Kerviel did.
According to SocGen, his fictitious hedging portfolio consisted of “very specific operations with no cash movements or margin call and which did not require immediate confirmation”.
The relevance of this is that it shows how M. Kerviel sustained his alleged game for so long.
If M Kerviel had hedged his bets in a normal way, there would have been margin calls – or demands for cash from those he was dealing with, known as counterparties – when those hedging bets moved against him.
So alarm bells should have rung at SocGen when there were no margin calls.
However, M Kerviel silenced the alarm bells by putting in place special hedges which involved no margin calls.
Now, his ability to do this is troubling enough.
But I find it difficult to believe that even if those hedges had been real, as opposed to figments constructed in SocGen’s computers, they would have been safe.
A hedge requiring “no cash movements, or margin call” doesn’t sound like a very liquid hedge, or one that could have been traded out when needed.
Forgive me for this long pre-amble, but we are now at the nub of what worries me – that SocGen was allowing its traders far too much exposure to liquidity risk.
Let’s just say that everything M. Kerviel had done had been real, can we really be confident that his portfolio would have withstood a drying-up of liquidity of the sort we have experienced in the credit markets since last August?
Was there a degree of naiveté built into SocGen’s assessment of the risks being run by all its traders?
We need to know a great deal more about the hedges it permits in its arbitrage department.
In particular, we need to know that when a trader legitimately makes a €50bn bet, his or her hedge really will behave in the way that it says on the label – because if it turns out to be an illiquid hedge, it might well be no hedge at all.
These may sound like technical issues. But they matter to all of us, because they directly concern the robustness of the controls imposed by all the banks on which we rely.
PS. M. Kerviel’s day job in equity index arbitrage sounds complicated, but it’s not really.
Think of it as buying a load of apples at 50p a pound from market-trader Fred on one side of the street, and then selling them to trader Boris on the other side of the street for 50½ p per pound.
If you sell enough apples to Boris before he reduces his price to 50p, you will have pocketed a few pennies.
In fact, what M. Kerviel did was a little bit more complicated than that. He was dealing in futures.
In effect, he made a deal with Fred that he would buy a load of Granny Smiths from him at 50p in the pound in two weeks time, and he simultaneously agreed to sell Boris an equivalent amount of Grannies at 50 ½ p, also for future delivery.
Now you can’t get rich by selling ten apples at a ½ pence profit.
But if a bank buys and sells 50 billion apples, that’s a lot of ½ pences.
Which is why M. Kerviel had a licence to take enormous “nominal” positions.
M. Kerviel was allowed to buy 50 billion apples from one group of traders, so long as he simultaneously sold 50 billion apples – or some similar fruit, exhibiting similar price behaviour to apples – to another set of traders.
Unfortunately what M. Kerviel actually did was buy all those apples, while only pretending that he matched all those purchases with sales.
And that’s how he upset the apple cart.
I'm 
°ä´Çłľłľ±đ˛ÔłŮ˛őĚýĚý Post your comment
The Buffoonery with which the French conduct their business is second to none. recently crowned derivatives house of the year Soc Gen expect us to believe that a man with 2 years trading experience managed to accumulate 50 billion Euro's of open positions without detection by simply writing fictitious trades on the other side. This highlight several issues:
1 - how on earth did a junior trader managed to get authorisation to trade 50 Billion Euro's of real trades and 50 Billion Euro's of fake trades therefore 100 Billion overall going through Soc Gens systems for 1 trader, 2 years experience at a back whose size is only 33 Billion.
2 - who was paying the margin? Surely even the most incompetent treasury desk in Europe ( an honour I expect Soc Gen to know hold) would have raised the question of paying across at a minimum 2.5 billion Euro's margin not including loses to the exchange thus 1 traders margin call alone was nearly 10% of the banks capital.
3 - Reconciliations, ok we have 50 billion Euro's of real trades we have 50 Billion Euro's of fake trades a strait forward position rec would highlight 50 Billion Euro's of unmatched trades. What Rec's manager would not escalate unmatched trades to the value of almost double the banks size.
4 - only 2 months ago the Chairman of Soc Gen stated that the banks subprime exposure was zero and that they were in fact positioned to profit from the situation. during last weeks announcement they also threw in a 2 billion USD write down in subprime exposure. does this mean that the culture of Soc Gen is built on lying at the very top all the way down or is it just that from the very top of the organisation they are just to stupid to know the difference of a profit and a loss. I would not like to bet either way as it is just to difficult to tell.
"and that's how he upset the apple cart"
*mirth*
Great analysis as always
Cheers
The łÉČËÂŰĚł Website highlighted that Mr Kerviel gambled 50bn dollars but what it doesn't say is within what time frame.
Another thing, what if Mr Kerviel had of succeed in his 'bet' would he have been appaulded or sacked and charged?
Finally, isn't his job playing the future market...isn't this what he's paid for?
Soc Gen took the rap but any bank could get itself into the same popsition anywhere and the problem needs to be addressed asap.
It isn't difficult, clearing bank operations are managed on one side and all investment operations by another with both being autonomous and not using clients funds or each others capital to bail out the other.
All directors at al levels will be held accountable and there will be no mitigating circumstances acceptable.
With these basics in place the world will be a lot safer place from the demented greed which has engulfed the banking system.
One other thing the FSA needs to realise that this is totally the wrong time to instal its principal based regulation.
What it needs are good managers who understand the problems befalling them and not how to apply the problems to a set of useless ill thought out regulations.
Will that happen? of course not because the FSA has no leadership any more. The new CEO is limited in what he can do because there is a lame duck chairman sitting it out. How can they be taken seriously when any regulated company or member of the public will now have to question whether a body now seen to be not fit for purpose (given its pitiful performance on so many issues) actually serves any purpose.
Until it operates like its American equivalent all we can expect are more problems and less solutions. Yet whilst they FSA derserves its criticisms and much more, the primary culprit for this mess is the present incumbent at 10 Downing Street who unfortuantely has shown a singular inability to grasp the problems, much as the spin machine seeks to continue to churn out the same old drivel opposite to that conclusion.
If he was over ÂŁ1bn in profit at one point in time, why on earth didn't he close out his positions at that point? That would have been the sensible thing to do. At that time, it should not have given the same enormous loss as closing them out in a weak market.
Also, I am somewhat disappointed that you have not picked up on the one fundamental issue here. Analysts are blaming last monday's losses on SocGen closing out its positions. IF this is true, and the actions of one bank to hedge €50bn of bets is enough to wipe 5-7% off the worlds markets, then the question of whether we are in a bear market is no longer relevant. We are. The question now becomes how long, and how severe this bear market will be.
Arbitrage is a clever adjunct of the instant-information global economy, which has without doubt made profits for its practitioners. But I've always thought it suffers from the same potential flaw as the well known casino method - the one where you keep doubling your stake every time you lose. In theory your eventual wins will cover all your losses, but of course there are practical snags. To start with you need a theoretically infinite source of funds, and when you work out the maths your expectation of gain is a very small function of the amount you have available to stake. And the casino will not necessarily permit the rather large bet you will at some point need to make.
In theory arbitrage is much less risky than this as it supposedly balances the risks all the time, but the similarity is that both systems require very large amounts of funds to produce very small profits, and both are therefore susceptible to low-probability events. Effectively, you cannot ignore the low-probability events in your risk-reward calculations because they still add up to a significant sum at the end (what is almost-infinity times almost-zero?).
Among the low-probability events that should be considered are the failings of the systems that are constructed, and the human beings involved in implementing them and following them. And credit crunches, and fraud, of course. It is understandable that the young financial whizz-kids who are employed to play these casino games with other people's money aren't terribly good at assessing risk and don't worry too much about it either, but shouldn't somebody in the organisation be thinking about this?
A similar lack of understanding occurs in other fields. Probabilities of errors in finger-prints (DNA and conventional) are frequently quoted without any appreciation of the actual liklihood of even basic mistakes having been made. In reality there is often a far higher chance of a given result being the result of errors than by the real events suggested. As a species we seem very keen to gamble but very reluctant to assess correctly the many chances of failure. We seem to construct more and more complex systems to make a profit and forget both the unproven assumptions we make along the way and the enormous risks that result from them.
Northern Wreck was far from the first, and the SocGen scandal will not be the last. Perhaps events like this are inevitable. But the key issue for me is the way in which those who take the risks and get the rewards of the institutionalised financial gambling are separated from those who end up paying when the risks go bad. This prevents the natural feedback mechanisms from working properly. Is this basic principle not understood? Why have so many of the recent failures showed this discrepency still to exist?
It all sounds like fiction and perhaps he had hopes of being like the hero in my novel "One Step to Danger" who said:
"We fuelled rumours of forced sales by the fund at the insistence of their bankers.
Wall Street fell sharply on fears of market unrest. The markets were uneasy. Our companies fell through the floor. Panic bred panic yet again. The bulls became bears. The buyers became sellers. The fund was now worth only three hundred million.
We started rumours of other hedge funds with big positions bought on margin. We said those funds were rumoured to be close to bankruptcy. In the state of near panic that then existed in the market, they believed the news. Bad news was received without question. The market was falling. Bad news was needed. We invented some more stories. Some were laughable. Others were simply outrageous. No sane person would have believed half of them. But the market was falling and keen to fall further. So they believed the rumours.
And, all the time, we sold stock we did not own into this falling market. Then we bought it back at a lower price after the market had fallen further. We ran the market. We were like a casino owner with a rigged roulette table. There was only one thing we could do. Make money. And then more money as our success bred credibility.
The markets listened to us. We had the Midas touch. We had big money. We had to have connections. And nobody knew the link between us and the mystery fund that was the source of all the market unrest. The whole illogical fabric of the markets played into our hands."
Rather reminiscent of LTCM. All goes well until the flaw in the underlying assumptions of the hedge are exposed by turbulent market conditions.
Like your analysis 'upsetting the aple cart.' Although given current market conditions the 'apple cart' had already lost one wheel, broken it's back axel and most of the apples were infected with worms.
The most fundamental issue to arise from this is the extent to which the US central bank (the Fed) will go to bail out the markets for issresponsible risk taking. The 'Greenspan Put' has unquestionably become the 'Bernanke Put' and the moral hazard has just become real. This is particularly worrying because the actions of the Fed are only going to leave the US economy (and the world for that matter) worse off in the long run.
Interesting analysis and good analogy to make subject more accessible.
Makes a pleasant change from the Northern Rock chess game drivel.
There's a second problem, that of the ripples: why didn't anyone laying off that volume of dossiers sound alarm bells anywhere else? And that opens a third can of worms, why didn't laying that lot off within the banks he dealt with do the same again? That MUST have aleted central authorities, and why didn't they react either?
Given that the Governor of the Banque de France was in on the unwinding, was he in on the start?
At the heart of these French and world wide Banking problems lies the layered commission format which stimulates company commission whether it finally turns out to be mythical or real.
From the front line advisor upwards to General Management every layer takes a slice from commission earnings,so this in turn automatically spurns an uncontrollable company wide drive towards ever more commission.
I have been present at financial sales meetings where the higher the commission earnt the more it is 'whooped' up, alongside little reward or concern for long term cautious advice and control.
Only if you have participated in this is it possible to truly comprehend the tidal flow of greed generated by commision driven business.
'C'est la vie' unless someone somewhere installs non-commission based top management.
Well put Robert, just the other day you were reminding us of how finance authorities had direct responsibility for supervising the health of banks, then straightaway we have a spectacular instance of where the stripping out of supervision is taking us…no risk management, no internal controls, no compliance testing and control, no internal audit.
How they can now argue that regulators have to have a more indirect relationship with banks, or that responsibility for the stability of the financial system rather than the health of individual institutions, when banks themselves cannot or will not put compliance procedures into practice.
SG’s disclosure more than anything reinforces the fact that finance authority auditors have to go into banks etc., examine balance sheets and operating methods and so on, and write up the business requirements that have to be in place by their next visit.
Only then will you guarantee independence and transparency in the process. That is the way it used to be, keeping management on its toes, and that is the way it will be in the future since obviously they themselves cannot or will not be trusted.
This all argues for the ending of markets in non-real items, in my opinion. Futures, along with betting on stock market values, should not have a place in a bank's core business. Or if it does, a very minor one. It is another example of 'clever' people thinking up new and exciting ways to just make profit without actually producing anything or providing a tangible service directly to their customers.
Ironically, UBS has been out an about this morning downgrading all in sundry. This is the same UBS whose own spot of liquidity bother nearly saw it floored. It is no surprise that SocGen is holed given the indifference of so-called senior management to controls once the quarterly margins are 'good'. All major banks and funds take hits. Some are small, some one hears about but the really colossal ones are the only ones to stir regulatory fever. The fact that anyone in a big high street bank could take a position with €50 billion without others in the food chain knowing is not that strange now is it?
Slightly off message I know, but you brought it up so here goes. I may be missing something, but what do people expect the board of SocGen to have done? You're sitting with a potential loss of 50 billion Euros, thus wiping out the bank and causing severe (to say the least) problems to the overall banking system and you dont want Soc Gen to close the position as fast as possible? I know they lost billions of Euros more than the original possible loss - thanks to the bad luck of selling in a falling market, but surely that is better than not covering your position and just......hoping?! You can bet your bottom Euro that rumours of SocGen's position would have leaked and thus made total meltdown all the more likely. Incompetent monitors they may be - but as a damage limitation exercise this is surely the best of a (very) bad hand!
So his trades didn't have confirmations - sorry immediate confirmations. Surely all trades, of this size. need to be confirmed through an independent back-office function. this was going on for a year - a year of no confirmations?
This is basic stuff, ignoring the broader position risk management.
If this is not happening then the bank is at risk from rough traders - like this.
So how did this happen - your article makes it sound as though you have no idea????
What about the bankers on the other side of these bets? If the whole system works on every trade being economically hedged, what happens when a loser does not have the funds to deliever? Would this not upset the apple cart completely and catostrophically, as one person's losses domino round the whole system?
I wholeheartedly agree with the above analysis of the situation, which is very concerning indeed.
As a financial controller working for a major investment bank, I can say that the control failures must have been shocking. I find it hard to believe that a fictitious hedge of this magnitude was allowed to have no margin calls because, as you quite rightly point out, this would massively increased the credit risk of the position (it is the job of clearing houses to reduce credit risk by demanding sufficient margin from counterparties at inception, and on an ongoing basis, as collateral for any mark to market movements). Also, that no counterparty verfication of the position took place for over a year. A common control in finance is to substantiate external positions by tracing them to the original legal documents underpinning the trade. This control must have clearly lapsed. Also that there was no oversight by his superiors for so long - review and authorisation procedures should have been in place for such large positions.
Come back Captain Mainwaring, all is forgiven!
The banks excuse is very lame. Let's say he did put on false hedges, the fact of the matter is that each side of this 'hedge' was far too large for a 31 yr old junior trader to handle. There is no way that such a postion went unnoticed for a year, especially THIS year when banks were forced to drastically reassess their liquidity situations. Eau de rat is wafting from the SocGen boardroom!
I can't help but wonder whether Robert Picks is playing a similar game to M. Kerviel in the hope of being rewarded as the first journalist to report the downfall of not just of Northern Rock but the entire banking system.
He probably did it to generate a bonus. The practice of bonuses is malevolent.It is unjustified:
1. Bonuses are paid largely to folk who risk shareholders money, not theirs. Some get such large bonuses they share risk with their employer but only to the extent of money they have earned thru no risk operations.
2. If I, as a shareholder chose a good guy, good for me more profit.He can share in the reward by buying shares anyway if he's so damned confident of his talents.If the Talent thinks his salary is insufficient, he should apply for a different job 9if he's too frightened really to go into business on his own account.
3.Bonuses do provide an appreciable risk of mis motivation.
4. the shareholders have in general no idea of how much goes in bonuses; they should be transparent.Sure the employer appears to pay a modest salary and saves pension and NI costs, but mere deviousness is hardly a justification.
5 You can't stop bonuses but you can tax them - in the hands of both the recipient and the employer. I'd suggest at 120% each, no set offs.
Why start selling the apples when only half the shops are open ?
Are you not simply devaluing the remaining apples you already have agreed to purchase ?
cheers
...at a ½ pence profit.
...that’s a lot of ½ pences.
I'd like to point out that the word "pence" is already pluralised - it's the plural for "penny".
So what you really meant was:
...at a ½ penny profit.
...that’s a lot of ½ pennies.
Sounds more like William Hill than Societe Generale
Being old and ordinary and ignorant, I don't understand who is the winner of the ÂŁ3.75 billion bet. OK, so the Frenchman lost it, but where is the money now? It can't have vanished - or did it never exist?
An explanation would be much appreciated
Presumably if Kerviel's gamble had paid off he was hoping for a big fat bonus at the end of the year.
However when it didn't work who is it who will lose out? - the pension holders and private shareholders who were unlucky to be holding SG's stock.
This is a story repeated everywhere in the banking industry, no different in essence from Northern Rock. The only difference here is that Kerviel exceeded his financial authority.
We are never going to break the boom and bust cycle unless this culture of bonuses based on short-term gain is stopped.
So if SocGen are down EUR 7billion, doesn't that mean everyone else in the market is up a total of EUR 7billion between them?
Seems to me that as long as you don't work for/have shares in SocGen you're laughing, right?
All this being said, does it then follow that an apple a day may not, in fact, keep the doctor away?
Isn't 'car safety' a useful analogy ?
As cars became larger and safer in the 1970s, people drove faster, and the improvement in safety was negated.
It seems to me, that whenever the banks find a new way to hedge risk, or predict market behaviour, or another cunning wheeze to make money, they just increase the amount and number of transactions.
Rather like taking one's 'safe' Volvo which has crumple zones which will protect the occupant very well at speeds up to 30 mph, and driving it a 70mph on a country road.
Sooner or later, there will be a crash...The question is, how many other 'rogues' are out there, and now that the roads are becoming icy, how long will we have to wait before one more loses control ?
Interesting read. I call on banks/money handlers to highlight shortfalls and exposure risks with their internal systems, ahem, I TRY and speak with those who you would think are responsible or interested in hardening internal control and auditing.
The issue is no one wants to accept they have a problem or invariably claim to have all the back doors closed off.
I look forward to news of the next 'rogue' doing my job employee /financial catastrophe within the next 6 months.
This would make a brilliant Hustle episode.
Robert Vaughn persuades naive trader (Tom Holland would be good) to 'forget' to hedge his arbitrage trades as you describe, maybe to get a huge bonus. Everyone in the know then makes those hedging trades, as much as they can. M. Naive goes on buying futures, hustlers go on selling.
Then, aaargh, the market goes up. M.Naive Tradeur in massive profit. Hustlers facing calamity. But they persuade NT to hang on a bit for even more bonus. Market then falls bigtime, and the Sting is on...
SocGen lost, but someone must have gained - cherchez la femme?
The issue here is more the credit aspect than liquidity (which is second-order in this case).
See
So Kerviel entered into fictitious trades which were apparently not discovered owing to the back office being snowed under. Or just plain asleep.
Can't say that's altogether surprising. My audit people tell me of institutions out there that have a turn-around times averaging 2 months for finalising their OTC derivative contracts.
I expect they're all rushing around at the moment hoping to verify that their trades are real.
Cut-price back office and control strategies need a major rethink.
Finally Robert, this came across my desk today. Hope you enjoy it, even if you can't publish it!!
--------
FRENCH TRADER WAS FORCED TO WORK 30 HOURS A WEEK
FRIENDS of rogue trader Jerome Kerviel last night blamed his $7 billion losses on unbearable levels of stress brought on by a punishing 30 hour week.
Kerviel was known to start work as early as nine in the morning and still be at his desk at five or even five-fifteen, often with just an hour and a half for lunch.
One colleague said: "He was, how you say, un workaholique. I have a family and a mistress so I would leave the office at around 2pm at the latest, if I wasn't having a strike day.
"But Jerome was tied to that desk. One day I came back to the office at 3pm because I had forgotten my stupid little hat, and there he was, fast asleep on the photocopier.
"At first I assumed he had been having sex with it, but then I remembered he'd been working for almost six hours."
As the losses mounted, Kerviel tried to conceal his bad trades by covering them with an intense red wine sauce, later switching to delicate pastry horns.
At one point he managed to dispose of dozens of transactions by hiding them inside vol au vent cases and staging a fake reception.
Last night a spokesman for SĂłcĂĂ©tĂ© GĂ©nĂ©rálĂ© denied that Kerviel was overworked, insisting he lost the money after betting that the French were about to stop being rude, lazy, arrogant barstewards. . . .
Seems like eau de rat is wafting from the SocGen boardroom. A junior is allowed to hedge 50bn and did so for an entire year unnoticed? That's garbage. Especially this year when banks were forced to drastically reassess their liquidity.
As I passed a Northern Rock Bank in Newcastle today I couldn't help hearing a party going on inside. When I asked what it was all about they asked hadn't I heard, ~ young Peston hasn't mentioned N.R. all day!
As I passed a Northern Rock Bank in Newcastle today I couldn't help hearing a party going on inside. When I asked what it was all about they asked hadn't I heard, ~ young Peston hasn't mentioned N.R. all day!
"And, I have to say, if SocGen were a British bank, my instinct is that M. Bouton would already have been ejected from the boardroom."
Except that following the liquidty problem last autumn, the head of NR didn't go.
There is too much of this complacent experience around. If you can create enormous fictitious trades, then your bank is in no better state than Barings (hence Nick's appearnaces last week). Why not have a limit above which a tarde has to be signed off by a manager - or are they too "experienced" to think of that?
"And, I have to say, if SocGen were a British bank, my instinct is that M. Bouton would already have been ejected from the boardroom."
Except that following the liquidty problem last autumn, the head of NR didn't go.
There is too much of this complacent experience around. If you can create enormous fictitious trades, then your bank is in no better state than Barings (hence Nick's appearnaces last week). Why not have a limit above which a tarde has to be signed off by a manager - or are they too "experienced" to think of that?
If our Gallic friend managed to lose so much of his bank's money , who won?. Surely there must be verifiable counterparties to the trades?
I am a little surprised that we have not yet seen the appearance of a number of 'Evil Kerviel' type headlines and a lot of Photoshopped pictures of Monsieur Kerviel in a red, white and blue careering out of control on a motor bike/ into the Grand Canyon / off the Arc de Triomphe..
But there is yet time..
In the 80's & early 90's, the London insurance market got caught pants down in a similar way, it was called the lmx spiral and was due to arrogant/spiv/incompetent underwriters writing too much of the same thing - lack of controls, bravado, high on the good times. It's why the market now watches risk accumulations like mad. Quite why the cocksure banking geniuses haven't cottoned on, especially after Barings, I cannot fathom - the parallels seem obvious. It's criminal madness the way banks seem to be running round off the leash, not the first time recently. Northern Rock and SocGen are from different (EU) countries, so doesn't this send a worrying signal about the absence of morals in people who affect everyone's lives internationally. Lessons of the past all too readily forgotten it seems.
Excellent article Robert. Tony in post No. 6 is also spot-on.
I have a further question to ponder: counterparty risk.
Why would counterparties allow SocGen to build a 50 billion position, either hedged or unhedged (even if was hedged, the counterparties would not necessarily be able to verify that)?
Shouldn't the counterparties have been worried the bank could go under and take them with it?
This is not a real loss, no ships full of products made with sweat and toil have sunk. It is merely a transfer from one institution to others.
SocGen lost a bet, but who who it? Which institutions are sitting on a €5bn windfall profit?
Soc Gen fallout - Russian problems ?
I understand that Soc Gen is due to take a controlling stake (50.1 pct)in one of Russia's leading private banks (Rosbank)at a cost $1.7 billion on Feb 11. The deal was approved by the Russian authorities at end 2007 despite some opposition. My questions are
(a) Can Soc Gen still afford to go ahead with the deal ?
(b) Will the Russian authorities put the deal on hold or possibly even try to stop it, using the Kerviel saga and its related governance issues ?
All the banks are bust. So are their insurance companies. Most pension funds have gone too.
This is what we are not being told.
We are being kept in the dark for fear of an total world economic collapse that would make the 1930's look like a nice place to holiday.
hahahahahahahahahahahahahahahaha!
You said:
"Perhaps it’s understandable that SocGen hadn’t properly allowed for the mad-genius risk, that a trader should have the desire and ability to gull the bank for no apparent personal gain."
Lets see! Global catastrophe associated with traders and sub prime debt. No genius here just madness.
Jerome vous êtes un héros national!
Your apple cart helps to explain the theory of what these "traders" attempt to do. However, the following (self-evident?)questions spring to mind:-
1. If you make a huge bet in one direction and hedge with another in the opposite direction, then your net exposure and potential profits are very small, especially when expressed as a proportion of the total trade. Why not take a much smaller but much less risky position without a hedge?
2. If global liquidity had not dried up, would these positions still be in place like rocks below the surface? Will the lack of cash expose more of these feckless gambles?
3. In the real world, real people make real things to sell to other real people. The loss of confidence engendered by Northern Rock, Alistair Darling, Soc. Gen. etc. has now crippled investment. Every purchase, whether it be a printer, lorry, machine, building or aquisition of another company, is now under increased scrutiny. The default poition on industrial investment is now "WAIT". The Masters of the Universe have played their hubristic games. The price is recession!
4. How long will it be before the real weakness of our economy is illustrated by the family silver being sold to a rash of Middle and far Eastern organisations?
Come on Messrs. Brown and Darling- the man in the street has little confidence in you and non whatsoever in the financial sector. You need to formulate and execute a real defence against the inevitable recession. It's not good enough to blame it all on "sub-prime lending".
What will you DO to protect us all against the consequences of the next, inevitable round of financial incompetence?
What Kerviel was doing doesn't sound like Fraud to me.
It sounds very 'Wall St' and I suspect that had markets behaved a bit differently he would be picking up a huge bonus instead of a spell in a police cell.
What other 'unknown unknowns' are lurking in the banks? Given the heady atmosphere of the last few years, perhaps there are many more Kerviels out there, with other clever practices that may bring down the whole house of cards.
According to SocGen, his fictitious hedging portfolio consisted of “very specific operations with no cash movements or margin call and which did not require immediate confirmation”.
Margin calls are a safety measure put in place to prevent a position incurring a huge loss in one go (basically any loss is paid out on a daily basis as it accrues). If safety measures are removed then there shouldn't be any surprise when there is a nasty crash. As such, the Futures Exchanges must also share some responsibility. A pertinent question, therefore, would seem to be "did SocGen use its position and influence to persuade the Futures Exchanges to waive the requirement for margin calls when marking the positions to market?"
FIRST the word of HEDGE is an Institutionalized lie as they are two legs crossing into two opposite directions ( apples and oranges or GM and VALEO ) creating two losses potentially contrarily to a proper hedge ( GM stocks and GM futures ).
SECOND Huge bets with banks money have to be highly controlled but no TREASURER knows what traders minds are thinking during seconds, minutes, hours and days.
THIRD A gambling culture of course can generate profits and losses but why are the profits easy to allocate and the losses often in suspense or pending accounts ?
FOUR How come Casinos in Vegas, Macau etc... are rarely caught wrong footed by their croupiers, gamblers and Banks are so often ?
If SG Board is keeping his CEO that means all the Board is an accomplice of the SG culture.
Robert, Your article was very informative, but please tell us, is it all real or is it
monopoly staff, I mean if S.G. lost all of that money were has it gone, it did not just disappear, so some institutions must have gained the equal amount of the bank's losses, so why is it supposed to have upset the markets, the money remains in the market it does not matter by whom, that is to say someone must have gained the Bank's losses, please enlighten us.
The whole episode smacks of 'COVER UP and kill a scapegoat'. Ever since the news broke we expected a junior trader, a rogue and an insider with awesome computer system knowledge. He was supposed to have compromised systems and done a lot of bad things.
Every day the story twists and turns. There was no hacking. He has been messing around for more than a year ! Hey wasn't he moved into trading last year according to the first statement ?
Turns out he made 1.5 bn for the bank last year, and the chairman doesn't know him. Whoops, this Chairman is surely one big guy.
Then the bank supposedly has state-of-the-art controls - 6 levels ( I read someplace). And all the kings men did not know someone was playing with enough bank money to wipe it off the face of the earth.
And when someone says fictitious trades, I want to ask every banker how are these done ? Isn't there some receipt someplace ?? Some third party communication (a buyer or a seller acceptance of the trade), or a margin payment or receipt.
Oh man, does this Chairman guy and his cohorts (in the bank and in politics) think everyone in the world is as naive as their countrymen.
Society Generale should be fined by their financial service Authority for market abuse.
They had possession of inside information that they used on their own account before making that information public know the value of their investment would fall when they made their announcement.
If what you say is true, that Kerviel's position was in balance when discovered by the firms auditors then surely the logical step would be to Hedge their position with a similar spread bet in the oposite direction rather than to have closed Kerviel's position?
Regards,
Trebor Jaydaman
Great '35'! and if you compare with SG 'explanation' where the Bank apparently checks the honest trades but fails to check the fraudulent seems like the Bank would be a risk for anyone either with money in it or anyone wanting to take it over! When I removed my money from NR I put it in the other bank owned by the Spaniard but now found this lot not only had no method of correcting an internet mistake by me immediately but also later sent a verylarge sum of money to the WRONG account in Canada causing ÂŁ15k costs - do they have any controls on their retail side - NO. can you get a manager on their retail side - NO. The only answer is the banking business should be transparent and have audited external rules and controls by an effective regulator who can cause pain if needed.
As a doctor the same 'lack of confidence'applies and we have the GMC for our sins!
I think all savers with Northern Rock and Shareholders have forgot about the staff at Norhern Rock. We are all Shareholders and Savers. Why not ignore the speculation and get behind the bank. Your money is Safe with Northern Rock and all funds are gaurenteed with Northern Rock. You can help the bank by sticking with us.
Maybe it's time for a general financial services sales tax? The City claims, for example, that the OTC derivatives trades alone are >$600bn per day so a .005% tax might generate >$10bn annually on that activity alone.
With a predicted cash flow shortfall looming, if I were the Chancellor, I would look carefully at raising a small indirect turnover tax on as many kinds of financial trades as possible.
I guess it might not be popular in the City but might be very popular with everyone else in UK. Such a tax might go go down well with other G7 governments that need extra tax income too. Every time we get into economic crisis it seems that excesses in financial services are part of the problem. Maybe it's time to shift some of the general tax burden in that direction.
Regulation to try to choke off dangerous excesses doesn't seem to be working too well, but the online, real time reporting such a tax would imply could generate the data needed to see what is going on.
Maybe the proposed Project Rainbow, for example, could lead the way in developing a real time full disclosure system?
Tim C (58),
SECONDED!
Slainte!
ed
#58 such trades will be finely balanced between the cost of doing them and the profit to be made (after capital gains tax, which is already charged). Start trying to skim more off each trade, and more trades become unprofitable, volumes go down (but only in London) and you not only don't make as much "sales tax" as you thought, you also lose CGT.
At the same time it will become more profitable to do the same trades somewhere else, and these financial centres will make more tax for doing absolutely nothing.