The New York Times-20080128-A French Style Of Capitalism Is Now Stained

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A French Style Of Capitalism Is Now Stained

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In a country where the hurly-burly of market capitalism has long been viewed with suspicion, Societe Generale was a rare Gallic success story -- the Chanel or Chateau Margaux of French banking.

The bank pioneered some of the most complex instruments in international finance, earning billions of dollars and the grudging respect of its American and British rivals.

So it was a shock to their national pride when top executives of Societe Generale found themselves on the seventh floor of the company's ultramodern headquarters a week ago Saturday interrogating a 31-year-old trader named Jerome Kerviel, and discovered just what their innovations had wrought.

Mr. Kerviel acknowledged placing more than $70 billion in secret, unauthorized derivatives trades, according to Societe Generale, saddling the bank with a $7.2 billion loss, the biggest ever caused by a rogue trader.

Now the bank, and the broader world of French business, finds itself shamed in the very arena where it had taken pride in being one step ahead of its Anglo-Saxon rivals that dominate financial niches like investment banking and securities underwriting.

Even worse, Mr. Kerviel took advantage of the very technological sophistication French banks are known for to hide his tracks.

I have to admit this event is a massive shock for us, said Jean-Pierre Mustier, who as a 26-year-old helped midwife equity derivatives trading at Societe Generale in 1987 and is now one of the bank's top executives as head of the corporate and investment banking division. I was speaking to a competitor, this competitor called me and said, 'You are living what is a banker's worst nightmare.'

Indeed, the debacle has so embarrassed Societe Generale that Mr. Mustier and other top executives of the bank may not survive in their jobs.

It was only last May that Christian Noyer, the governor of the Banque de France, the nation's central bank, promoted the country's competitive edge in equity derivatives, an arcane universe that allows investors to take risky bets on future movements of stocks or markets. With a 25 percent global market share, Mr. Noyer boasted at a banking conference in Mumbai, French expertise in this field is founded on a solid teaching in math and finance, the key to excellency in financial fields, and on an important hive of university-level talents.

Now, critics at home have been quick to seize on the many paradoxes implicit in a tale that has riveted France and the rest of Europe, especially because Societe Generale has been associated with the creme de la creme of the French banking world since its founding by Napoleon III in 1864.

What is more, the scandal is likely to confirm the suspicions of ordinary French citizens, who in recent days have echoed the famous observation attributed to Honore de Balzac that Behind every great fortune there is a crime.

Facing persistent questions about how the trading could have gone undetected, the bank acknowledged Sunday that Mr. Kerviel's activities prompted inquiries from risk managers several times last year, but that the bank never began an investigation because it accepted Mr. Kerviel's explanations.

Societe Generale is a pioneer, so it is not surprising that the most creative fraud would take place within the bank's most creative activity, said Elie Cohen, a French economist and researcher at the Centre National de la Recherche Scientifique. You don't have big frauds like this in routine banking activities. Accidents happen in the borderline businesses.

Within the ranks of Societe Generale, what makes the activities of Mr. Kerviel even more humiliating is that he was able to cover them up for so long, without tripping the vaunted risk-control systems that Societe Generale has long been known for.

Melody Jeannin, a spokeswoman for the Societe Generale, insisted that the bank moved quickly to stop the fraudulent trades after they were detected and devised a solution in just three days. We took immediate measures to strengthen the internal risk controls, and proposed a solution to restore balance sheet strength and reassure investors, she said.

Mr. Mustier, a native of Clermont-Ferrand in the Auvergne region of France, has become the bank's point man on the scandal, shepherding reporters through the details of Mr. Kerviel's trades while frequently conferring with his boss, Daniel Bouton, the bank's chief executive.

And as a former student at two of France's most elite engineering schools -- the Ecole Polytechnique and the Ecole des Mines -- Mr. Mustier, 47, exhibits the cool, disciplined style that alumni of those institutions are known for.

When asked what his personal reaction was to the rogue trades, he said, It was not the time for personal feelings, but for actions.

Although the local cemetery that abuts Societe Generale's mirrored headquarters on the outskirts of Paris might give more superstitious employees pause, the bank's traders have long been known for the cockiness that comes with high salaries and pedigrees from France's best engineering schools. (In fact, Mr. Kerviel's salary of roughly 100,000 euros, or $147,000, would have put him at the low end of the bank's pay scale for traders.)

And Societe Generale traditionally has shown more boldness than other, more conservative giants of French industry. When French banks were privatized in the 1980s, Societe Generale was the first to emerge from government control, starting in July 1987. Mr. Mustier's innovative derivatives trade on the Paris Bourse, in fact, took place just two months afterward, in September 1987.

Mr. Mustier was recruited to the bank by Antoine Paille, a fellow whiz kid who graduated from the Ecole Nationale de la Statistique et de l'Administation Economique, before starting the bank's derivatives desk in the mid-1980s.

With French banks still sleepy after decades of state control and far behind their more aggressive foreign counterparts in global capital markets, the two men set out to make Societe Generale a world leader in the emerging field of derivatives.

And by hiring young mathematicians and quantitative analysts, or quants, from the Grandes Ecoles, the country's prestigious and highly elitist state schools, to help them create complex formulas that are the bedrock of the trade, they managed to do that.

From just 25 people in 1990, the equity derivatives division at the bank now employs 3,500 people. (Mr. Paille has since left the bank and is a derivatives executive at Commerzbank of Germany.)

In 2006, Societe Generale earned 5.2 billion euros in net income. Its corporate and investment unit contributed 2.3 billion euros to the bank's profit.

Profit in the field pioneered by Societe Generale mounted as swiftly as one of the graphs in of their elegant mathematical models. Over all, the bank's derivatives unit accounts for an estimated 20 percent of the bank's total profit, according to various estimates by analysts.

And until the fraudulent trades, the company's shares had outperformed those of its European peers, including bigger rivals like Deutsche Bank and BNP Paribas, for six of the last eight years.

According to a Merrill Lynch report from December, Societe Generale expected a 10 percent growth in its equity derivatives business this year thanks to retail customers and emerging markets growth. What is more, because it relies so much on computer programs and systems, rather than on manpower, the business is highly profitable.

Mr. Mustier and Mr. Bouton will be spending the coming days answering questions about how Mr. Kerviel could possibly have wagered more than $70 billion without being detected -- and whether he had indeed acted alone, as they both insist. But broader questions are likely to be asked about the safety of the derivatives business and whether French banks have placed too many of their bets on it.

What used to be an excellent management team sitting on an enviable retail franchise and a global leadership position in derivatives is now a management under pressure suffering from a lack of confidence, the Merrill Lynch analysts Antonio Guglielmi and Alberto Segafredo said in a recent report.

Criticism like that, along with additional losses from bad investments in American subprime-mortgage debt, has spurred talk that Societe Generale might be forced to merge with another bank, possibly BNP Paribas, its archrival and France's largest bank by revenue.

But with questions continuing to mount even as the exact trail of Mr. Kerviel's trades is still being analyzed, a more immediate threat is that Societe Generale and other French banks will lose the edge in derivatives trading they worked so hard to establish over the last two decades.

Societe Generale was a superb bank that has done some great things but it is now hard to see how it will get through this on its own, Mr. Cohen said. But what is worrying here is that other banks are not in a much better state. French banks are in the same boat as everyone else here.

[Illustration]PHOTO: The headquarters of Societe Generale in the La Defense business district near Paris. A trader amassed $7.2 billion in losses. (PHOTOGRAPH BY BENOIT TESSIER/REUTERS) (pg. A9)