How do you lose £3.7 billion? Have you ever lost £3.7 billion down the back of the sofa? Meet Jérôme Kerviel. He lost £3.7 billion of his employer’s money.
Here’s how. Jérôme worked for Société Générale, a French bank. He was what is called a derivatives trader. They are called derivatives because they are securities that are derived from other pieces of paper. There are swaps, options and futures. In the case of futures, you can buy someone’s crop before it’s even been planted. The farmer can go ahead and sow because he knows, whatever the weather, he will get his money anyway. He’s not taking a risk. He’s covered. That’s what they tell us, anyway.
Someone’s taking a risk, of course. Someone is betting on the weather. With a future you can bet whether it will be a good summer for the wine harvest or a bad one. It’s like an accumulator on the dogs out of trap five at Romford Greyhound Stadium. If all the dogs win, you can win a lot of money with a small stake. Derivatives work the other way too. The downside is that you can lose a lot of money very quickly, as Jerome and his bosses now know.
Described as shy and introverted, Jérôme was a nerdy back room boy for Société Générale. He was regarded as a mediocrity so they ‘only’ paid him 100,000 Euros. He was supposed to be covering them against loss. Instead he started setting up phantom accounts and betting huge sums of their money on derivatives. At one point he was betting 50 billion Euros, more than the entire bank was worth. He lost.
Now this news came as a godsend to the proponents of capitalism when Jérôme was rumbled on Thursday 24th January. For the previous Monday January 21st, stock exchanges had taken a tumble all over the world. £77 billion was wiped off share prices in London alone. We declared that the dive came because the economic fundamentals were not sound, that capitalism was sliding into recession [see Panic!]. Now they can say it was all Jérôme’s fault. The reason the markets went down was because Société Générale was getting all Jérôme’s bad trades off their books on the Monday before they broke the news to the rest of us.
Think about it. Is it actually a good argument for capitalism that the whole world can be screwed up because of a solitary rogue trader? Is the system really so precarious that one crook can send world financial markets into freefall?
It also makes this stuff about derivatives and risk reduction sound stupid. Derivatives trading increases risk, as we now see. Betting is now totally out of control. In 2003, there was $49 trillion of real wealth in the world. At the same time there were $85 trillion in derivatives. Obviously this does not eliminate risk – it augments it.
Secondly if a bank can be brought down by a rogue trader, how safe is the financial system that handles our money? Bank employees handle money. Don’t their bosses know this puts temptation in their way? The Security at SocGen is the equivalent of leaving your front door open when you go out of your house. Why should we trust anyone in the financial system with our money?
The story of the rogue trader bringing the whole system down is rot, of course. The markets started to collapse in the east, in Shanghai and Tokyo, while the French were still sleeping soundly. French PM Gillon confirms that “SocGen had nothing to do with the situation on the financial markets.” He would say that though, wouldn’t he?
Though there was hysteria on the markets last week, the panic was soundly based on a deteriorating economic situation. But when you get the real economy approaching recession and financial swindles blowing up, they interact and make each other worse.
The worries are coming thick and fast. Another one in the alphabet soup of financial ‘innovation’ (inventing useless things that blow up in your face) are Collateralised Debt Obligations. That’s now old hat. Now they have CDO- squareds – CDOs that own other CDOs, like mortgages upon mortgages. How did we ever live without them? You don’t really need to know what they are. You should be aware that so far $8 billion has gone missing.
The financial press is also concerned about the monoline insurers in the USA. They’re called monoline because in the past they were only in one line of business, and it was dead safe. They insured local authority projects. Guess what? They’ve diversified. They’ve been playing away. And they’ve lost money. If one of the big ones goes belly up, they could take a bank with them. And the implications for the real economy if public projects can’t be guaranteed could be huge.
Monoline MBIA has an exposure of $30 billion, including $8 billion of CDO-squareds.
As Ruth Sutherlamd comments in the Observer (27th January), “Booms and frauds go together as naturally as strawberries and cream.” Now boom is turning to bust. Jérôme Kerviel has become a cult figure, dubbed the ‘Che Guevara of finance’. There’ll be a film about him. In the last film about a rogue trader, Nick Leeson, his character gets the line, “That’s all the market is, one giant casino.” He’s right. Let’s face it. They’re all rogue traders.
- Stock market latest: more panic by Mick Brooks (January 23, 2008)
- World economy in crisis - The financial panic: where are we now? by Mick Brooks (January 23, 2008)
- Panic! by Michael Roberts (January 22, 2008)