In the past week there has been a lot of hullabaloo about a French trader, Jerome Kerviel, who nearly bankrupted France’s second largest bank, Societe Generale, when he lost almost 5 billion Euros trading a range of markets. His final position included: a 30 billion Euro position on the Eurostoxx index, an 18 billion Euro position on the DAX and a 2 billion Euro position on the FTSE. The total value of the positions was some US$73.5 billion, which far exceeded the bank’s market capitalization of around US$52.6 billion. In the past week there has been a lot of hullabaloo about a French trader, Jerome Kerviel, who nearly bankrupted France’s second largest bank, Societe Generale, when he lost almost 5 billion Euros trading a range of markets. His final position included: a 30 billion Euro position on the Eurostoxx index, an 18 billion Euro position on the DAX and a 2 billion Euro position on the FTSE. The total value of the positions was some US$73.5 billion, which far exceeded the bank’s market capitalization of around US$52.6 billion. In order to open these positions Jerome had to security of the bank’s risk management system to allow him to open positions bigger than he was entitled to (i.e. he probably borrowed the password of a colleague who gave him his password while he was on holidays to manage his open positions – a common practice in the industry). Jerome’s motivation for undertaking these trades was the hope he would get a huge bonus.
This loss is a record breaking loss by a rogue trader. Wikipedia has a league table of all time great rouge traders, including:
In 1995, Nick Leeson lost 827 million pounds for Barings Bank trading Nikkei index futures
In 1995, Toshihide Iguchi lost 557 million pounds for Resona Holdings trading US Treasury Bonds
In 1996, Yasuo Hamanka lost 2.6 billion dollars for Sumitomo Corporation trying to corner the copper market
In 2002, John Rusnak lost 350 million pounds for the Allied Irish Banks trading FX options
In 2004, Juke Duffy lost 360 million Australian dollars for the National Australia Bank trading FX options
The common thread with all these traders is they made big bets, hoping they could win big and they tried cover their tracks and exceeded their assigned trading limits by exploiting holes in the institution’s risk management system. For the risk they have taken the reward has been a loss of their job, quite possibly the loss of a large number of other people’s jobs and a 16 month to 8 year stint in the slammer.
Probably the most famous of these traders is Nick Leeson. In 1995, Nick placed a short straddle in the Singapore and Tokyo stock exchanges, betting that the Japanese stock market would not move significantly overnight. However, the Kobe earthquake hit early in the morning on January 17, sending Asian markets into a nose dive (who would of thought – the chances of that are next to nil – just goes to show you that black swans can appear at any time). Leeson attempted to recoup his losses by making a series of increasingly risky new investments, this time betting that the Nikkei Stock Average would make a recovery. But the recovery failed to materialize and he succeeded only in digging a deeper hole. By the end, Nick had lost 827 million pounds. Every one of these trades exceeded the risk limits for his trading. Because Nick had worked in the back and middle office, he knew how the risk management system could be exploited, which in turn allowed him to open the trades and then cover up the mistakes afterwards.
The moral to the story here is about trading well outside of your normal risk management parameters. When you are trading for yourself this is very easy to do: you just open up a big trade or a large number of trades, betting on the direction of the market. Greed and a need to get ahead drives people to do crazy things and sadly the great majority of traders wipe out a great proportion of their trading accounts (the other traders who get lucky and pull this off get promoted and live happily ever after in a job where they are never allowed to trade again). The failed trader then cover up what they have done from their wife / husband by opening even more bad trades, leaving their trading account and quite possibly the families’ life savings in a smoldering heap. Eventually they get found out, and their whole world falls apart and they spend the next 8 years picking up the pieces. The personal consequences of big bets outside your risk management rules are the same, irrespective of whether you are working for a big firm or trading for yourself. Karma is a funny thing.