The Wall Street Journal-20080125-breakingviews-com - Financial Insight- French Bank-s Elusive Truth- In Wake of --36-7-2 Billion Loss- Societe- Generale Lacks A Suitable Explanation
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breakingviews.com / Financial Insight: French Bank's Elusive Truth; In Wake of $7.2 Billion Loss, Societe; Generale Lacks A Suitable Explanation
After a day of painful excuses and embarrassing statements, Societe Generale's top managers still haven't offered a persuasive explanation of what went wrong at an institution in which a low-level employee was responsible for losses totaling 4.9 billion euros ($7.2 billion).
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 bank's managers first heard about it Jan. 18. They spent Jan. 21 and 22 unwinding the positions as European markets endured their biggest dive since September 2001.
The story has been understandably greeted with disbelief. SocGen still must provide answers to basic questions. It says the unauthorized trades began "in 2007" but not more specifically when. Yet it would be good to know whether its failed internal safeguards enabled the rogue to book his trades for several months, which seems to be implied by SocGen's acknowledgment that it caught the fraud only "by chance."
Furthermore, SocGen hasn't provided the market with any information about what drove his actions, though officials at the firm did work with him to unwind the trades. It would be interesting to know whether any disenchanted staffer can find ways to play with the bank's computer system.
SocGen hasn't come up with the amount of exposures the employee really took -- the loss suggests it was in the range of 50 billion euros to 70 billion euros. Nor has it said why no one noticed earlier something had gone awry.
The credibility of SocGen Chairman Daniel Bouton is on the line. The board has rejected his resignation. But if he can't come up with a better explanation of what went on, why and when, he still might need to go -- and the bank would have a freer hand in pursuing the truth.
Rogue Traders
If Dante were to rewrite the "Divine Comedy" today, he almost certainly would find a special torment in Hell for rogue traders. The Tuscan poet would have no trouble populating the eighth circle of the Inferno -- the preserve of fraudsters in the epic 14th-century poem -- with financiers who have willfully deceived their masters. Now, the eighth circle, called Malebolge, would have a new, French master.
Societe Generale trader Jerome Kerviel's stunning loss upsets all previous records. Though it isn't large enough to destroy his employer, it bests the $1.4 billion loss of Nick Leeson at Barings. It is even bigger than the $2.6 billion that Yasuo Hamanaka, aka Mr. Copper, evaporated while trading on Sumitomo's account a little more than a decade ago.
While details of Mr. Kerviel's actions aren't fully known, he appears to have followed his rogue predecessors to a T. Like them, he layered one bad trade upon another in the pursuit of either doubling or quitting with the house's money. Yet despite the lessons of the past and the increased controls many banks instituted in their wake, it is perhaps not surprising that it is a large bank like SocGen that now finds itself in such a cornichon.
The quantum of Mr. Kerviel's losses reflects two basic risks of the financial industry. First, it highlights the increased capital intensity of the business. Second, it underscores the industry's perverse incentives. Traders are paid only for their profits and can walk away from their losses. Such asymmetry creates a moral hazard for traders to bet the farm, especially when already in the hole.
For that reason, the circle of rogue traders still may deserve its place a full plane above the ninth and final circle of Dante's Inferno. Of course, as the place crowds up, it may not be long before the rogues are cast down to the level of the truly treacherous.
-- Pierre Briancon and Rob Cox
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This column is by breakingviews.com, an online financial commentary site.
