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Today’s BIS email was an interesting one in the light of recent events. It has a speech by Christian Noyer, the Governor of the Bank of France, regarding Basel II’s implementation in France. Remember while you read it that a certain trader’s activities would have been classified as an operational risk loss.
This passage is interesting in the light of the problems at SocGen:

By 31 December 2007, over 30 on-site inspections will have been conducted in 20 institutions, involving at times up to 100 inspectors at a time. These on-site inspections examined IRB systems for credit risk and advanced operational risk measurement approaches.

As SocGen is one of the largest banks in Europe I am presuming that they were one of the banks visited – I think this a safe assumption. This means that SocGen was assessed for operational risk issues while all of the rogue trading activities was going on – the trading that was risking much more than the capital of the bank.
He goes on to say:

…and 5 institutions (accounting for almost 60% of the total assets in the French banking system) are expected to adopt an advanced operational risk measurement approach. As institutions have the possibility under Basel II of using their IRB approaches to calculate regulatory capital requirements, supervisors must ensure that these approaches are reliable.

I really wonder how reliable the regulators found SocGen’s risk management to be in their supervisory visit? How closely did they look? You would have thought that the trading arm, where most, if not all of these events have historically happened, would have been a primary focus of that review. What did they see?
At the very least, SocGen will probably have to carry a much heavier operational risk capital burden now than they would have originally calculated less than a month ago. I think the BoF will have to have a bit more to say on this in the not too distant future. Who is next in line to resign over this? They may not be at SocGen.

[Update]In the light of the latest revelations – see here it looks like a lot more than a single trader should lose his job. It looks like senior management were turning a blind eye to the trading while it was making a profit and only got concerned once it was making a loss. If so, it would make the criminal charge hard to sustain.

There is a lot more to come from this one…[/Update]

The whole Soc Gen thing would be funny if it were not so serious. The latest information is that a 31 year old trader, apparently acting alone, managed to run up a 50bn euros (USD73bn; GBP37bn; AUD84bn) position without it being noticed. Dear, dear me. This is risk management failure on an almost heroic scale. This is more than the capital of the bank.

Just as well Soc Gen has grown fat over the decades on their home market. The real pity is that it looks like the unwinding of that position has caused losses all around the globe. There will be some very happy counterparties in Paris, though. A few magnums of Veuve Clicquot? More like Grande Dame.

US sub-prime driven turbulence? Probably not. French fraud? Probably yes.

The comments from his lawyer are priceless:

Lawyers for Mr Kerviel, who is being questioned by police, said their client had “committed no dishonest act”.”He did not siphon off a single cent, and did not profit in any way” from the bank’s assets, the lawyers told AFP.

They also accused the bank of trying to “create a smokescreen which would divert public attention from losses that were significantly more substantial than those it accumulated in recent months”.

We have to presume innocence, but I will be fascinated to see how they justify that position. It looks like he had admitted the trading activity, so the only possible defence is the Leeson Defence – which did not work for its originator. At least Kerviel will not end up in Changi Prison if the defence fails.

On question that often arises from situations like the recent, unusual, drop in US interest rates and the stimulus package to support the markets is one of moral hazard. Simply put, the question is whether the tendency of the monetary regulators to respond to widespread market drops with action to push more cash into the system creates moral hazard – a willingness to take more risk in the knowledge that the US Fed (for example) will ride in on a White Charger and help.

My answer is that routine “While Charger” action certainly does create the impression that the “Greenspan Put” is a way out of bad decisions – there is always in the back of the mind the thought that the regulators will act to stop “long-tail” events.

Does this impression actually show through into the real world, though? As the market is really a series of micro events that go to make up a macro picture I would doubt it would have a large impact. To put it another way – will the thought that the Fed may act to bail out the market change the way an individual bond issuer or buyer behaves? If I am considering changing a bond position worth maybe a few million I am really going to consider the possibility of an industry wide bailout if an entire class of assets heads south? Will the thought that the Fed will change rates in the event of a general collapse change the way I trade?

Personally, I doubt it. The individuals actually trading can never really tell whether their position is going to be one of those actually rescued by a general interest rate drop or other action. The only point where this may become a thought is where there is already a widespread drop – but in this circumstance the action would be to point the dealers out of the drop, not into it.

That said, it may affect the risk appetites of the largest of players such as the really big banks, so there is certainly a risk of it. I just think it is overstated by people who look at the macro effects of moral hazard and think that the markets act as some sort of a collective intelligence, rather than looking at it as a series of micro events, which, in reality, it is.


Soc Gen have had a bad quarter, but not a bad year. Unlike several other banks reporting losses this quarter, they are not declaring a loss for the full year – but they do have an additional source of pain – a rogue trader2, losing EUR4.9bn. Apparently this one got away with it as he was formerly in the middle office and had an “…in-depth knowledge of the control procedures…”. Guys – it should not matter how well you know the control procedures, they should be designed to work in any case. I have a feeling this one will run for a while. The point here is that a position should be noticed, no matter what, long before it gets to a value in the billions, never mind a loss in the billions.

My guess is that he did a Nick Leeson – put the positions in as counterparty positions rather than prop (bank) ones. Still the cash to fund the positions should have shown up. As he was forex my guess is that he was betting against the euro – the biggest losing bet around in a liquid currency (update – corrected in comments below).

Like most of these frauds, I would guess the auditors will be both asking a lot of question and be asked a lot of questions. Luckily, they seem to have two audit firms in there – I presume this is French law. That must be fun for the employees having to deal with them.

As a side note – it looks like the BBC has got the wrong end of the stick – their report (as it stands now) says that it was all lost in one trade. This is not correct according to the Soc Gen press release.

They are going to market for EUR 5.5 bn to make up some capital losses. I presume this is to cover for growth in the business and a re-rating of the risk of their trading portfolio.


1. OK – that made you look. The press release from Soc Gen has this all over it. Just shows how ridiculous these restrictions are.
2. (UPDATE) Looks like SocGen has disabled access to the release. I have removed the link. The Economist link lower down the post is much more interesting anyway.

Perhaps I should have called this “reflux” rather than “redux”, as the UK government seems to be determined to keep this one running for a very long time – and painfully for all concerned. The latest step, to attempt to securitize the government’s lending to the Rock, seems guaranteed to keep this whole saga going. If they cannot find a private buyer it will go on even further. Even with a buyer, the government guaranteed bonds will live on for years, keeping open the possibility it may be called on if things get worse.

This should be an object lesson to governments – do not get involved beyond what the law says you must do.

Highly interesting document up on wikileaks regarding the sale of Northern Rock. If true (and the threats from the lawyers seems to imply it is) it confirms what I have said all along – Northern Rock is still a valuable entity and the only problem with it is that it ran out of cash – i.e. it was a liquidity problem that brought it down, not a capital one.

Give it a read for interest’s sake. If you are in any doubt as to the true nature of the Rock’s difficulties, this shows them well.

Thank Amir.

For those interested in how regulatory prudential policy interacts with monetary policy around the world, you could do worse than go to a new paper produced by the Monetary and Economic Department of the BIS.

Introductory paragraphs:

It has long been recognised that that there is a strong complementarity between monetary and prudential policies. A sound financial system is a prerequisite for an effective monetary policy; just as a sound monetary environment is a prerequisite for an effective prudential policy. A weak financial system undermines the efficacy of monetary policy measures and can overburden the monetary authorities; a disorderly monetary environment can easily trigger financial instability and render void the efforts of prudential authorities. Economic history attests to this, as illustrated by the anatomy and consequences of the financial crises that have affected the industrialised and developing world, going back to previous centuries.
So much is agreed. What is more contentious is the view that some fundamental changes in the economic environment over the last quarter of a century may actually have tightened the interdependence between monetary and prudential policies, potentially calling for significant refinements in policy frameworks. In some research at the BIS in recent years we have been exploring this possibility in some detail.

I, personally would disagree with what is “agreed” above – to me, the contrast between “weak” and “sound” is a false one – a “sound” prudential policy can also be a “weak” one, such as using a free banking paradigm and allowing competitive non-state regulators. The “agreement” here is more likely to be amongst regulators and others in the regulatory industry.

That said, within the confines of the current system this is a very useful paper, even if it needs a little bit more proof-reading*. The authors’ access to data and people looks very good and the conclusions they have drawn out of the data and their references look useful.

The real “meat” here, though, is in the tables starting on page 20 – the analysis of the response of regulatory authorities to various financial events over the last 10 to 15 years. The last column in the table could be fuel for weeks of blog posts and discussion. The annex is also useful, being a “first pass” at assessing the impact of the measures taken. Again, for those interested in the area, this stuff is highly contentious, but this analytical framework is a useful one – comparing those countries with took both prudential and monetary approaches to tackling what was viewed as an imbalance to those which only took a prudential measures and looking at the results.

I am not strong enough in statistics to fully evaluate the results, but the methodology looks sound. If you are interested give it a look – and if your stats knowledge is better than mine feel free to give some feedback.

*Last time I checked it was the United States that had an S&L crisis, not the “Untied States”.

Forgive me for a little bit of cynicism regarding today’s announcements from Citi and Merrill Lynch. I have seen all of this so many times it is not funny. Having been in banks when this happens the story internally is that before the CEO leaves or is pushed the emphasis on staff is to minimise losses – “take an optimistic view”. New CEO comes in, the view is to “take the pain” or “look at the position conservatively” or “make a prudent provision”*.

The script usually seems to go like this:

  1. Company does something silly;
  2. CEO, Chairman of the Board and sundry other executives or senior officers leave;
  3. New CEO appointed;
  4. New CEO announces massive losses and uses words like “pain”, “unacceptable”, “crisis” etc.;
  5. Rescue package announced (optional for added effect);
  6. New CEO announces large cuts / restructuring / divisional sales / redundancies;
  7. Next quarter CEO announces big improvements;
  8. Full year report shows big turnaround, losses almost all / all made good;
  9. New CEO is big hero and acclaimed a turnaround expert.

Seems we are at step 5 so far – step 6 will come in a few weeks

My guess is that today’s dip might be a good buying opportunity in advance of step 7.

* Note that I am not alleging any form of illegal or unethical behaviour by anyone at all – it is just the way that the “tone from the top” comes down.

Report in the BBC today saying the British government is about to nationalise Northern Rock. This was probably inevitable after the search for new owners failed. The loss of confidence in the name of the business meant that getting new depositors to replace the old, without a complete change in ownership, was always going to be impossible.

What will happen now looks fairly clear – the government will pass a bill, the doors will shut to new business and current depositors will walk away. Mortgage holders will be encouraged to refinance elsewhere. This will both increase the exposure to the government and reduce what value is left to pay out to shareholders, if any.

Really, it should have been allowed to fail. As my several posts on this situation have made clear, this would have resulted in the business closing, the depositors paid out a reasonable amount at first and then all of it (including interest) over time. Shareholders would then have got a return out of the residual funds – which there would have been. The FSA’s deposit insurance scheme would have been up for some payouts, but they would have recovered it all. The only (minor) losses would have been to shareholders.

Admittedly, this may have caused worries about other institutions – but none was in a position like the Rock and this could have been made clear.

The real panic here was from the regulators and the government, who were blind-sided by something they probably believe they should have spotted.

The blog debate on the practicalities, or otherwise, of “fractional reserve” continues. The more informed debates also make the point, correctly, that it is not just “fractional reserve” in there, but the whole question of maturity (or term) transformation. If you are interested I would like to compile a listing of current blog debates.
These are the few I am aware of – feel free to link to more in comments. Just be aware that if you put more than 2 links into a single comment I will have to rescue it from moderation. Not a problem, it will just take a bit of time.

Those are the three that I am aware of that are currently active. If you know of more, let me know. I know this is not strictly bank regulation, but I enjoy the topic.

Normal service on banking regulation will resume one I have completed a current job at one of my clients.

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