Le grand desastre de la Societe Generale

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– France does not usually collect gold medals when it comes to finance. Oh, sure, it has a staggering public debt. Also, the tax rate is one of the highest among developed countries – Paris bureaucrats absorb 54% of the GNP and there are six levels of local government that pay themselves with local taxes.

But, overall, financial news from France – the world’s sixth-largest economy – is usually rather tepid. That’s why the recent Societe Generale fraud scandal came as such a surprise. With its eye-popping figures, its photogenic, noble perpetrator, and its display of embarrassed elites, it had every ingredient of a great story.

To recap: In late Januaf)’, a large volume of sales in futures trades created a worldwide market slump. A few days later, one Jerome Kerviel, a lowly trader from respected French bank Societe Generale (or SocGen) walked into a police station and fessed up to a multi-billion euro fraud. At $1.47 per euro, that’s real money. Soon, juicy details started to emerge: Kerviel, an unremarkable 31-year-old securities trader, somehow acquired futures contracts for amounts far above his authorized limits. He ended up with positions worth about 50 billion euro – or $70 billion. Discovering the mess, the bank unloaded Kerviel’s stash of futures within three days, creating a worldwide market slump. The bank lost 3 billion euro in this fire sale. Add another 2 billion euro in losses from other activities – conveniently announced at the same time – and Kerviel seemed the culprit of a 5 billion euro loss.

Kerviel’s management was let go, but when Daniel Bouton, the bank’s CEO, presented his resignation to the board, it was rejected. How nice of the board.

The parallel with another trading scandal was obvious. In February 1995, trader Nick Leeson single-handedly brought down another old and respectable institution, Barings Bank. He too cooked the books, taking unauthorized positions that resulted in massive losses. But the parallel stops there. First, Leeson’s losses were a mere 827 million pounds – less than $2 billion, and a fraction of the SocGen losses. Second, the British trader cowardly fled to Kuala Lumpur whereas Kerviel, owing to his mistake like the Gallic man he is, squarely went to the police. Finally, greedy Leeson was trying to get a fat bonus, whereas Kerviel, on salary, only sought to make money for his employer. Take that, perfidious Albion!

Analysts started to wonder. How could one entry-level employee create such havoc? Was he a financial mastermind? Or maybe a super-hacker capable of manipulating trading computers? And, wait a minute, how come France’s tough and complex banking regulations didn’t prevent this?

There are controls and regulations in the French banking system, all right. There are so many, actually, that nobody knows them all. The European Commission – a bunch of non- elected bureaucrats now responsible for more than 800/0 of the laws and regulations in the ED. – emits a continuous flow of new rules, which adds to (and sometimes conflicts with) national laws. Now, add the internal procedure manuals that routinely plague banks. You cannot possibly keep up. You can- not obey the law because you cannot know the law. As a result, the only way to be safe is to ObeyThe Boss. Kerviel did. That’s why he feels he is a scapegoat today. It remains to be seen if upper management was aware of his activities.

As for high tech wizardry, Kerviel simply used. a few old tricks. He used colleagues’ passwords to log transactions under their names: passwords are routinely written down on sticky notes in many brokerages, since rules force employees to change them often. He also created fictitious customer accounts to hold his illicit stash of contracts. He probably edited out any red flag from the unprotected Excel spreadsheets that pass for auditing tools on most trading floors, explaining away inconsistencies by the notorious inaccuracies and errors that are the norm in these slapped-together pieces of work.

Auditing by spreadsheet is a recipe for disaster everywhere and banks are no exception. But the rules are changing so often that creating a real auditing application would be impractical, since it would be obsolete before its deployment anyway.

Inevitably, voices are now clamoring for more extensive, tighter regulations. Never mind that the ones in place are inefficient, badly implemented, and mostly disregarded. Never mind that when a scandal threatens some executive, he passes responsibility down the line and is allowed to keep his highly paid position by his gang of Good Old Boys. Never mind that politicians often extract kickbacks from the organization that they can control. For the statist mind-frame that prevails in Europe, the lines are drawn: profit is a swear word, banks are nests of conniving capitalists pigs, and more laws from a benevolent state are the only thing that can protect the unsuspecting public from these malevolent financiers. Mere facts need not apply.

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