There's Risk...and Then There's Risk

The Societe Generale story has become almost a parody of banking one would expect to see in a typical Hollywood movie.

Jerome Kerviel, the trader with the inferiority complex, works his way up from the humble back office to a fairly unimportant trading desk. He proceeds to wreak havoc on his employer's financial condition by stealing passwords, dummying up trades, counterparty emails, and ledger information. Using his knowledge of risk management and accounting software, he juggles his books for over two years, completely hoodwinking the bank's management.

For me, one line amidst the several Wall Street Journal pieces on this evolving risk scandal rang absolutely true. It was the one concerning the French trader behaving decidedly un-Frenchly, skipping vacations and working overtime. A lot.

Back in my days at Chase Manhattan, officers were required to take two consecutive weeks of vacation for risk management purposes. We were told that, although our function was not even within distant earshot of any P&L responsibilities, we would adhere to the bank's regulations regarding vacation-taking.

It had been learned long before the arrival of us newly-hired corporate strategists that a two week break from making book entries was almost always sufficient to reveal any one-person fraud.

Funny how this well-known banking practice was simply overridden for Kerviel. One of banking's simplest and most time-honored ways of tripping up fraudulent bookkeeping was short-circuited without a peep.

And, then, we read that Kerviel would simply acknowledge suspect trades as 'mistakes,' make them right immediately. Then double back later that day and re-enter them. How many visits by the risk management or accounting folks would it have taken for SocGen's management to have suspected active and purposeful risk management evasion?

How many 'mistaken' trades per month, for a year, did the average trader experience?

Amidst all the talk of esoteric risks these days- CDOs, credit derivative swaps, and SIVs- here's a bank that got tripped up by the oldest scam of all. A simple fraudulent book-entry scheme that allowed the trader's position to balloon to many times his authorized limit.

It's probably going to take down the head of SocGen, and maybe two or three more senior officers. And it should.

I think it sustains my point from this recent post regarding bank consolidation. In it, I wrote,

"Kessler then writes,

"So who has the strong hand? As always, it's a capital game, whoever accumulates the most will be best positioned for what's next."

I disagree. Capital accumulation certainly matters, but I don't think it's a "most" sort of thing. If anything, Kessler misses the point that having so much- too much, actually- capital is precisely what has gotten many financial firms into trouble. They fail to diligently allocate it, and the result is what we see in recent months. Failed risk controls, sloppy capital allocations and wastes of funding. "

Large banks just seem to invite this sort of fraud and risk management failure. And what is the rumored reaction? That PNB wants to acquire the now-wounded SocGen.

Oy!