The New York Times-20080126-Societe Generale-s Sales May Have Incited Market Plunge
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Societe Generale's Sales May Have Incited Market Plunge
Full Text (1151 words)As panic swept European markets on Monday, word spread that a big hedge fund was in trouble and dumping stocks.
Someone was selling, all right -- Societe Generale. The French bank was frantically unwinding an estimated $75 billion of bad bets on European stocks placed by a rogue trader, Jerome Kerviel.
As the bank struggled on Friday to determine how Mr. Kerviel could have run up $7.2 billion in losses before anyone caught on, the scope -- and global impact -- of his fraud began to emerge.
From his desk in the middle of the trading floor on the sixth floor of Societe Generale's Alicante building in the La Defense business district outside Paris, Mr. Kerviel, 31, took huge bullish positions on the Dow Jones Euro Stoxx 50 index and the German DAX in particular, according to a fellow trader still working there who insisted on anonymity.
Societe Generale rushed to unwind those trades during Monday's market plunge, and trading in those futures contracts soared to record levels. The bank's abrupt reversal contributed to a decline that snowballed into an avalanche of sell orders around the world, some traders said. The ensuing turmoil helped prompt the Federal Reserve to orchestrate the surprise cut in interest rates announced Tuesday.
I have little doubt that Societe Generale's unwinding of those positions absolutely pressured indexes worldwide, said Barry L. Ritholtz, chief executive of FusionIQ, a New York-based investment research and money management firm. And wouldn't it be embarrassing if the Fed had to make one of the biggest emergency rate cuts ever because of some rogue trader?
Granted, fears of a recession in the United States and continuing worries about the spread of the subprime mortgage collapse were also responsible for the market downdraft in the last 10 days. But Mr. Ritholtz argued the rapid move by Societe Generale to close out tens of billions in futures positions might have been a major factor in pushing an already nervous market into an outright panic.
Mr. Ritholtz is not alone in his suspicions. I definitely think there is a link, said Byron R. Wien, chief investment strategist at Pequot Capital Management and a 40-year Wall Street veteran. This precipitous unwinding created the negative momentum that spread around the world.
Mr. Wien also singled out the Federal Reserve chairman, Ben S. Bernanke, for criticism. Bernanke has been reacting to events, rather than anticipating them, he said.
On Monday afternoon, with United States markets closed for Martin Luther King's Birthday, Mr. Ritholtz said, many Wall Streeters were struggling to figure out just why Europe and Asian markets were off so steeply. Instant messages were lighting up, and people were saying 'This looks like a big European hedge fund blew up.' Indeed, there was little market-moving data before the plunge.
He was quick to add that the French bank's rapid turnover of the positions assembled by Mr. Kerviel would not have been enough to push the German market down 7.2 percent Monday. But in today's fast-paced markets, hedge funds and investment firms often pile on once the selling starts. These things take on a momentum of their own, he said.
On Tuesday, the volume on the DAX and Euro Stoxx 50 contracts was twice that of open futures contracts, suggesting that the bank was having to sell and then buy back contracts to cover leveraged positions. Ten percent of the volume on DAX futures on Tuesday alone was 9.2 billion euros.
On a typical day, the total open interest on the Dax futures market is roughly $50 billion, according to Helyette Geman, a professor of mathematical finance at ESSEC business school in Paris. Although the exact positions are not known at this moment, she said, it was quite likely that Societe Generale's trades would have accounted for a major portion of DAX futures activity in recent weeks. She added that settling those positions might have created some downward pressure in the market.
The trader said that Mr. Kerviel, a member of Societe Generale's Delta One team, frequently worked late into the night after other members of the group had gone home. He added that it appeared the pace of Mr. Kerviel's trading picked up toward the close of 2007. Many of the trades were placed on near-term futures contracts, the trader said.
Jean-Pierre Mustier, chief executive of Societe Generale's corporate and investment banking division, declined to identify which particular indexes formed the bulk of the specious trades, but insisted during an interview that closing the positions early in the week did not cause the steep plunge in markets across Europe.
Meanwhile, the legal noose appeared to tighten around Mr. Kerviel, as French police raided his apartment in the suburban Paris neighborhood of Neuilly-sur-Seine Friday evening.
A spokeswoman for the Paris prosecutor's office, which on Friday opened a preliminary investigation into the case, declined to comment on the raid. An investigation is under way, said the spokeswoman, Isabelle Montagne. We must let the police do their work.
At the same time, French government authorities signaled growing frustration with Societe Generale.
Indeed, Paris appeared to be putting pressure on Societe Generale to come forward with a more detailed accounting of how Mr. Kerviel could have racked up the staggering losses by himself over the course of a year without raising any red flags among either his supervisors or the internal auditors of the bank.
Francois Fillon, the French prime minister, expressed frustration Friday at having been kept in the dark about the unfolding crisis until Wednesday -- four days after Societe Generale's chief executive, Daniel Bouton, informed the governor of the country's central bank, Christian Noyer.
Speaking to reporters at a briefing in Luxembourg, Mr. Fillon conceded that as a private bank, Societe Generale was not obliged to inform the French government. He said, however: It's an affair of such an importance for the French financial system, that maybe the government could have been informed earlier.
Mr. Fillon said that he had asked the finance minister, Christine Lagarde, to conduct a separate inquiry into the affair and report back to him within eight days.
A spokesman for Ms. Lagarde could not be reached for comment.
The bank, meanwhile, identified four other individuals, in addition to Mr. Kerviel, who had been dismissed in connection with the scandal and would face disciplinary action: Marc Breillout and Gregoire Varenne, co-heads of fixed-income trading; Christophe Mianne, global head of market activities; and Luc Francois, global head of equities and derivatives activities.
[Illustration]PHOTO: French police raided the apartment of rogue trader Jerome Kerviel in a suburb of Paris Friday. (PHOTOGRAPH BY BENOIT TESSIER/REUTERS)(pg. C4)GRAPHS: Unwinding Its Position On Monday and Tuesday Societe Generale sold tens of billions of euros of futures contracts in the Dow Jones Euro Stoxx 50 and DAX stock indexes. The bank said its trades those days accounted for no more than 10 percent of total volume. (Source: Bloomberg)(pg. C1)