Friday, January 25, 2008

LESSONS FROM THE CHEFS OF FRENCH BANKING

French Bank Links Lone Futures Trader To $7 Billion Fraud

By Molly Moore Washington Post Foreign Service Friday, January 25, 2008; A01

PARIS, Jan. 24 -- For five years, Jérôme Kerviel toiled in the back offices of Societe Generale, learning the intricacies of the six-layer security system that France's second-largest bank used to protect its money, investors and customers from fraud, according to bank officials here.

Kerviel then made an unusual career move. He was promoted to trader -- becoming one of the very employees the security systems are designed to oversee and keep honest.

Over the next several months, his chagrined employer alleged Thursday, Kerviel used his inside knowledge of the security system and his brazenness as a futures trader to pull off one of the largest banking frauds in history, ringing up losses of more than $7 billion for Societe Generale.

. . . Societe Generale had other bad news on Thursday for stockholders: It had suffered nearly $3 billion in losses from investments connected to the subprime mortgage crisis. It will seek an infusion of $8 billion of new capital, it said.

--read entire article--

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The cheap shot is to denigrate Societe Generale for their lapses and the stunning amount of the loss. Whether the bank will survive depends to a significant degree on the determination of the Bank of France to intervene.

But the lesson--and the larger issue--is what can be learned from this that applies to the loose cannon that is the hedge-fund industry in the United States.

(Wikipedia) A hedge fund is a private investment fund that charges a performance fee and is typically open to only a limited range of qualified investors. Hedge fund activity in the public securities markets has grown substantially as it constitutes approximately 30% of all U.S. fixed-income security transactions, 55% of U.S. activity in derivatives with investment-grade ratings, 55% of the trading volume for emerging-market bonds, as well as 30% of equity trades. Hedge Funds dominate certain specialty markets such as trading in derivatives with high-yield ratings, and distressed debt.

"Trading in derivatives with high-yield ratings, and distressed debt" is very nearly a definition of the markets for sub-prime mortgage investments.

(Wikipedia) In the United States, in order for an investment fund to be exempt from direct regulation, it must be open to accredited investors only and only a limited number of investors can belong to it. While there is no legal definition of "hedge fund" under U.S. securities laws and regulations, typically they include any investment fund that, because of an exemption from the types of regulation that otherwise apply to mutual funds, brokerage firms or investment advisers can invest in more complex and more risky investments than a public fund might.

So, essentially

  • 30% of all U.S. fixed-income security transactions,
  • 55% of U.S. activity in derivatives with investment-grade ratings,
  • 55% of the trading volume for emerging-market bonds, as well as
  • 30% of equity trades
are as vulnerable to panic-trading, covering of tracks and the vagaries of Jérôme Kerviel type traders, with one exception. There are no six-level security systems in place, at least not by the Security and Exchange Commission (SEC) or any other government agency.

Add to that the motivation (if not out-and-out willingness) of a hedge-fund manager to lie, cheat, steal and cover his tracks in order to protect not only his reputation, but his $100 million plus annual take in salary and bonus.

Does anyone think that maybe we need more from Pelosi & Co. than a short-term 'stimulus plan?'

It would seem that we are juicing all the wrong motivations, sniffing dangerous white powders and giving the super-rich the keys to unregulated market access. That just might not be the best idea in the world.


* For more in-depth articles by Jim on Business and Economy, check out Opinion-Columns.com