Monday, January 28, 2008

Rogue Trader Redux

"Societe Generale SA's [SG] $7.2 billion loss on a series of fraudulent trades is just the latest example of a breakdown in internal controls that are supposed to protect financial firms from disaster. ... 'Until recently, every investment bank believed it had built an outstanding risk-management system,' Ken Moelis, former head of investment banking at UBS wrote in a November letter to his new firm's investors. ... 'Through computer models and endless analysis, the banks believed they could measure every risk to the nth degree.' But reliance on such models and manuals 'overlooked' the importance of 'human judgment and the ability to evaluate the numbers being generated,' he added", WSJ, 25 January 2008.

"The official story goes something like this" A 31-year-old trader with in-depth knowledge of the bank's control procedures took unauthorized positions that he concealed with fictitious countertrades after having fraudulently removed his trading limits in the bank's system. ... The story has been understandably greeted with disbelief", WSJ, 25 January 2008.

"Christian Noyer, governor of the Bank of France [BOF] ... said the [BOF] undertook 17 routine investigations on site at Societe General in 2006 and 2007. Regulators examined the bank's models for evaluating risk, especially in sophisticated financial derivatives and products, and its system of controls. ... One thing regulators and banks can and should do is 'provide incentives for people working with the fraudster to catch the fraud,' said Charles Goodhart, program director of regulation and financial stability at the London School of Economics", WSJ, 25 January 2008.

"Financial service entities are traditionally inundated with systems of internal accounting control and auditors. ... It is just too convenient to saddle one rogue individual at one institution as some isolated incident in the unfolding drama of the worldwide breakdown of our financial system network. I'm just not buying it", Fred Cederholm at, 27 January 2008.

"I find it difficult to believe that a rogue trader can tally $7 billion of losses in a relatively exotic business of a French bank, given the number of margin calls and cash funding requests that would have arisen in the past few months", Chan Akya at, 27 January 2008.

I don't believe the "official story". Having lost $7.2 billion SG apparently decided to "disavow" the trades and claim they were unauthorized. If there were no margin calls by the counterparties to SoGen's trades, we have a new problem: the counterparties accounting systems have problems!

Wow, "provide incentives". What does a BOF "routine investigation" look at?

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