Welcome to European Tribune. It's gone a bit quiet around here these days, but it's still going.

[Updated] Links and thoughts on Société Générale and its traders [with SG's explanation]

by linca Sat Jan 26th, 2008 at 01:12:43 PM EST


Disclaimer : I have worked (not a direct employee, but as a "consultant") for three years and a half at the Société Générale as a computer programmer ; for two years I was working on a program used for risk valuation in the debt financing branch of the SGCIB. Jérôme Kierval, the trader who apparently lost 5 billion euros, was working on the equity branch, DEAI.

Informed partly by my experience there - as a lowly programmer, I had no direct contact with the traders, only superficial understanding of the working of the trading desks -, partly by some links found in various banks, I'll try to make some sense of what happened.


According to this blog post written by someone who knows a DEAI trader, Jérôme Kerviel was an equity futures trader, essentially selling and buying to customers bets on the future value of the European Stoxx 50 index.

His job was to make sure the SG position wasn't getting either short or long : as any good bookmaker, the SG didn't want him to actually bet on the value of the Stoxx 50, and thus Kerviel had to sell roughly as many puts and calls on the index.

What happened was that Kerviel indeed made a bet, that the market would go up. The problem is, he was not allowed to do that by the bank ; so he had to hide it. The way he did it was by creating false bets, with false clients, going the other way ; thus his books appeared balanced.

How could he do it ? as we can see in his resume, he formerly worked in the DEAI middle office - the branch of the bank that is in charge of overlooking the traders, making sure they only do what they were allowed to do. Thus he knew how he was being overseed ; apparently he hadn't taken his vacation time for two years, as vacations prevent hiding one's tracks.

Not only did he work in the middle office, but he worked on the SG referential database - that means part of his job, for two years, had been creating counterparts - clients - for use in the bank's computer system. He knew how to do it.

But - he shouldn't have been able to do it. Supposedly, a basic precept of computer security is that accounts and passwords have to be changed regularly ; that they have to be kept secret, certainly from those who could abuse them. When I worked in the SG, someone doing a job similar to mine, got the boot when it was found his internet access account was used by a whole trading desk. Then, in the beginning of 2007 there had been an information program to make sure we were up to date with the security measures - our passwords were to be unwritten and personal, our desks clean each evening, etc...

Of course, the reality of work in a stressful environment got in the way : we had to give our passwords to the team when going on vacations, for example. I can imagine similar things happening in the Kerviel case : nobody bothering to purge his write-enabled account on the referential database sounds possible. When development has to happen fast, some things are forgotten ; and password management often didn't come in first on the bugfix priority lists.

Many commentators claim that a single trader couldn't possibly lose that much money, and that the 50 billion euros position he must have held is unbelievable. Well, the volume of trades on financial markets is unbelievably high these days ; Kerviel was a market maker, according to his resume, which means SG warranted they'd accept transactions at quoted prices - they made a lot of transactions on his products.

A more intriguing question is why Kerviel did this ; his job didn't include millions in bonuses : he was pay a "measly" 100 000 euros in 2007. This blog post attempts to answer

Our society has glamorized the job of traders ; many young workers in a large bank want to become one. But those that make it realize that they will never get the glamorous jobs in a French bank : those are reserved to people coming from the best "Grandes Ecoles" : Polytechnique, Mines, Centrale Paris. So do the extremely generous compensations that come with these positions : the head trader at DEAI is the best paid wage worker in France. Kerviel wasn't one of them. When he became trader he understood he would only do a pretty routine job, with tight limits on what he could do - and that he'd never really "make money", enough for the instant retirement at 35-40 he may have sought. And he may have become jealous. Maybe he wanted to prove he could make money for the bank. So he did what he wasn't allowed, and started to bet.

When in the middle of January the Stoxx 50 went down a bit too much, it appeared  that the SG was about to inexplicably lose money, and that margin calls were happening when they shouldn't ; after all the SG didn't bet. So all the hiding that Kerviel was doing couldn't go on, and the bank had to sell out of its position. The loss was possibly increased by the fact that it happened on a US bank holiday : the smaller market wasn't able to absorb as easily the massive selling, and what was a billion-and-a-half loss on paper became a five billion euros loss as the markets plummeted.

Thankfully for the SG customers, workers and owners, the bank was large enough to absorb this huge hit. But problems remain : the Société Générale is making huge profits from its retail banking activities ; why should those profits subsidise the risky investment banking activity, and in effect guarantee it?

Will the reputation of the bank - before the scandal, one of the highest in investment banking - hold in face of a clear oversight failure ?

And possibly, is a system where a single man can take such actions that cause risk for a systemic crisis - as may have happened if the SG had indeed gone under - all that stable and viable ?

Update [2008-1-27 14:15:32 by linca]:

The Société Générale has explained what it claims happened. The PDF press release.

It mostly agrees with what I wrote. Except the trader was in arbitrage ; i.e., he wasn't selling bets but profiting of market inefficiencies : if two similar products had different prices despite being supposed to have the same price, he'd make profit on the different and thus make the market more efficient. This implies very large volumes of trading.

SG claim the position unwinding was kept at under 10% of trade volume, i.e. it says it didn't influence the market ; and the market crash started in Asia before the position unwinding began.

Oh, and that first link has really insightful comments. (In French).

Display:
He's got time to write THE book and I hope he gets no more jail time than everyone! above him.

Our knowledge has surpassed our wisdom. -Charu Saxena.
by metavision on Sat Jan 26th, 2008 at 02:40:12 PM EST
I'm not sure he should get less time than those above him. After all, and if what I have written is true (that is, if Kerviel isn't taking the fall for some other loss), he did go out of his way to falsify his accounts, and hide it from his superiors. I've read somewhere that his direct supervisor was replaced in early 2007, which means the new one wasn't really experimented.

The failure is more that of policy ; SG motivates all of the workers supporting traders by dangling in front of them the possibility of becoming a trader. Those new traders then know the bugs of the system they are not supposed to abuse.

And of course the mythology of the trader, the superman of the All-Powerful Market, is problematic in its own ways. The power these guys wield is astounding ; and for them it is often a game.

Un roi sans divertissement est un homme plein de misères

by linca (antonin POINT lucas AROBASE gmail.com) on Sat Jan 26th, 2008 at 03:24:31 PM EST
[ Parent ]
Well, I am surprised that there is no absolute separation between overseer and trader jobs, and that you didn't thematised that explicitely.

*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Sat Jan 26th, 2008 at 03:42:02 PM EST
[ Parent ]
The problem is getting people to do the grunt , non prestigious, repetitive, (relatively) low paying overseer job without the hope of making it to the trading floor. Which is why the separation isn't that tight.

Also, there aren't that many people who know all that well the workings of the financial markets, and the computer tools user by the SG (which are mostly done in-house). Taking somebody from the middle or back offices, or support, is cheaper and faster.

Un roi sans divertissement est un homme plein de misères

by linca (antonin POINT lucas AROBASE gmail.com) on Sat Jan 26th, 2008 at 03:50:47 PM EST
[ Parent ]
No more, no less.  By definition, ´responsibility lies with management´ at every level above him for  policy, security, legal, systems,... that made it possible and the buck should be passed up, not down.

It would be fab if you get him to join ET:  Jerome a prison.  His book title:  The trillions I saved SG in future losses.

Our knowledge has surpassed our wisdom. -Charu Saxena.

by metavision on Sat Jan 26th, 2008 at 04:54:17 PM EST
[ Parent ]
It's interesting because it's a universal problem for capitalism. Very often there are workers, on a standard salary, who hold the future of a large portfolio which is many hundreds of times beyond their salary, in their hands.

In these cases, it becomes very apparent that our system is profoundly iniquitous, as the bosses are rewarded for the work of the line workers. It's not a popular view, but my opinion but such conditions breed a certain kind of crime amongst the workers, because it violates human notions of fairness and decency.

by Metatone (metatone [a|t] gmail (dot) com) on Sat Jan 26th, 2008 at 05:21:44 PM EST
[ Parent ]
many hundreds of times beyond their salary

The estimates on the positions I saw are 50 billion euros. That was five hundred thousand times his salary... (And as a computer programmer, it is demoralising to see those figures passing arounds. Thankfully sometimes one realizes the currency is roubles or yen where eleven figures numbers aren't that huge amounts)

Un roi sans divertissement est un homme plein de misères

by linca (antonin POINT lucas AROBASE gmail.com) on Sat Jan 26th, 2008 at 05:29:33 PM EST
[ Parent ]
Oh indeed, in this case the figures are truly frightening. I was speaking to the generalised case where things are not so horrifically obviously iniquitous.
by Metatone (metatone [a|t] gmail (dot) com) on Sat Jan 26th, 2008 at 05:31:00 PM EST
[ Parent ]
Interesting insight, great diary. Thank linca!
by Metatone (metatone [a|t] gmail (dot) com) on Sat Jan 26th, 2008 at 02:57:18 PM EST
that was going to be my comment precisely,

A pleasure

I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude

by kcurie on Sun Jan 27th, 2008 at 10:32:34 AM EST
[ Parent ]
Superb Diary, linca, with some very interesting implications and insights.

I'm reminded of Barings, and a swing through Japan and Singapore I made just before it all happened. I had a look around SIMEX and could not believe that the SIMEX audit people who went around and looked at members' accounts (including error accounts) had never even met the SIMEX people running the trading floor.

IMHO SIMEX got away scot-free: it could never have happened at IPE, and should never have happened there either.....I sent SIMEX a 3 page fax upon my return to the UK setting out my thoughts (and a couple of recommendations), which I really wish I had kept when I left IPE.

I dunno what Jerome will make of the divide you outline between Officers and Other Ranks.

But it was the same in the UK Civil Service and most other places. In the Bank of England you had the distinction between "Officers" and "Officials", and of course only one of them (I can't remember which)could ever ascend the higher ranks to dine at the "Golden Trough" (the dining arrangements for the top people: mind you the "Silver Trough" was pretty good).

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sat Jan 26th, 2008 at 03:40:16 PM EST
It's not so much a difference between formal rank, as an informal but well known one. If you went to the right schools, you'll be hired at the same level as everyone, but go up the ladders way faster.

I remember a coworker admiring the swift career of the new head boss of the SGCIB, who was only 45. I told him that the guy was an X-Mine, and so that career was pretty normal.

Un roi sans divertissement est un homme plein de misères

by linca (antonin POINT lucas AROBASE gmail.com) on Sat Jan 26th, 2008 at 03:54:11 PM EST
[ Parent ]
European Tribune - Links and thoughts on Société Générale and its traders
Thus he knew how he was being overseed ; apparently he hadn't taken his vacation time for two years, as vacations prevent hiding one's tracks.
I was told once that people in charge of a portfolio are required to take at least one two-week vacation each year because at that length of time they cannot help but ask someone else to manage their books for them.

We have met the enemy, and he is us — Pogo
by Migeru (migeru at eurotrib dot com) on Sat Jan 26th, 2008 at 03:49:56 PM EST
Well, we have a new folk hero in France, Jerome Kerviel. Who want to buy a T-shirt: "He gave the finger to the Grandes Ecoles."

Hey, Grandma Moses started late!
by LEP on Sat Jan 26th, 2008 at 04:27:12 PM EST
If he did do this on his own, it demonstrates extremely dangerous levels of non-robustness in the financial system. It tells me a Dr. Strangelove moment (in which one actor is able to destroy everything) for the financial world is very possible.

you are the media you consume.

by MillMan (millguy at gmail) on Sat Jan 26th, 2008 at 09:31:33 PM EST
Yes. At one point, because of small mistakes, we put down two production databases ; I wonder what even a computer guy with bad intentions and good access to the backups could do.

Un roi sans divertissement est un homme plein de misères
by linca (antonin POINT lucas AROBASE gmail.com) on Sun Jan 27th, 2008 at 03:23:36 AM EST
[ Parent ]
The other question I'd ask is how often are the backups checked to see if they actually work?

Any idiot can face a crisis - it's day to day living that wears you out.
by ceebs (ceebs (at) eurotrib (dot) com) on Sun Jan 27th, 2008 at 06:40:49 AM EST
[ Parent ]
That wasn't my job but I guess they were checked regularly ; the bank  was supposed to survive complete destruction of the headquarters and keep functioning, post 9/11.

Un roi sans divertissement est un homme plein de misères
by linca (antonin POINT lucas AROBASE gmail.com) on Sun Jan 27th, 2008 at 06:48:25 AM EST
[ Parent ]
All trader/client phone conversations are also recorded and archived, are they not?

You can't be me, I'm taken
by Sven Triloqvist on Sun Jan 27th, 2008 at 06:54:02 AM EST
[ Parent ]
I wouldn't know. I know the trading desk didn't have 'net access, so as to avoid inside stuff.

Un roi sans divertissement est un homme plein de misères
by linca (antonin POINT lucas AROBASE gmail.com) on Sun Jan 27th, 2008 at 07:12:51 AM EST
[ Parent ]
I worked in one place where the backups went to servers in another building, the other building was managed remotely, and checking the backups was one of those jobs that just never got done. Recovery exercises were just one of those things that were easiest to put off in the hectic schedules. Untill youfind a job has come to an end and you've got a spare day till the next one starts. At that point one of the team wanders over to the other building and finds that the backup script is actually failing to save the backups onto the server and has been doing that for three months.

Any idiot can face a crisis - it's day to day living that wears you out.
by ceebs (ceebs (at) eurotrib (dot) com) on Sun Jan 27th, 2008 at 07:04:39 AM EST
[ Parent ]
There was a specific service in charge of backup plans, it wasn't an additional task for the usual developers - proper backups are strongly regulated in banking, so I suppose it was properly done.

Un roi sans divertissement est un homme plein de misères
by linca (antonin POINT lucas AROBASE gmail.com) on Sun Jan 27th, 2008 at 07:11:34 AM EST
[ Parent ]
It helps to be in an organisation that recognises that backups are business critical.

Any idiot can face a crisis - it's day to day living that wears you out.
by ceebs (ceebs (at) eurotrib (dot) com) on Sun Jan 27th, 2008 at 07:45:56 AM EST
[ Parent ]
Helps to have no choice about it...

Un roi sans divertissement est un homme plein de misères
by linca (antonin POINT lucas AROBASE gmail.com) on Sun Jan 27th, 2008 at 12:24:59 PM EST
[ Parent ]
Password management is a huge problem at large institutions. Groups of support workers frequently share passwords because it's the most practical approach to doing their jobs--even if against the rules. Most users voluntarily choose extremely weak passwords, so organizations enforce strong password rules--which then encourages users to write them down.

In the good old days, to break into a bank you had to get in the front door, into the safe, and then out again without being thwarted or caught. Now, you can do it all from the comfort of your home office. This problem is bigger than most people realize...

by asdf on Sun Jan 27th, 2008 at 12:56:48 PM EST
My experience in banking, first in Equities Custody then in the Middle Office, has taught me one thing : do watch the bank summaries you receive each month. Password management isn't the only thing that sometimes causes troubles...

Un roi sans divertissement est un homme plein de misères
by linca (antonin POINT lucas AROBASE gmail.com) on Sun Jan 27th, 2008 at 01:42:37 PM EST
[ Parent ]


Display:
Go to: [ European Tribune Homepage : Top of page : Top of comments ]

Top Diaries