French Finance Minister Christine Lagarde said Monday that some internal controls at Societe Generale failed or were ignored before the banking giant announced massive losses attributed to a single trader.
Here is one version of the story. It’s gotten plenty of news coverage. It’s gotten relatively little pundit coverage. It neither fits the pro-market narrative of one side, nor the "blame it on the Bush administration and deregulation and bad U.S. corporate governance" narrative of the other. By noting the story, and pondering its broader implications ("your favorite hobby horse matters less than you think"), I would like to do my small amount to counteract the silence of the pundits. By the way, I owe this concept to Daniel Klein.
The story may not fit either narrative that you describe but there are other narratives out there. Here’s one. Capitalism, free markets and free trade have enabled unprecedented improvements in human welfare. As a means of organizing an economy, demand economies have demonstrated themselves to be abject failures. Most people accept this yet most associate the benefits of capitalism with the creation of, stuff. Stuff can be lots of things: cars, trucks, software, haircuts, poems, etc. People also recognize that there can be more abstract things that have real value, like insurance. As the complexity of financial instruments and transactions has expanded over the years, they’ve always been justified as an integral part of the capitalist system. They grease the wheels of the capitalist machine. To disparage them is to disparage the free market itself (consider the rhetoric around the recent proposed tax increase on hedge fund managers).
Yet increasingly, things haven’t felt quite right. Blockbuster success is an inevitable aspect of a vigorous free market. People don’t begrudge Bill Gates for his billions. He created something (and I say this as someone who largely loathes his software). But there are now whole classes of people who earn staggeringly large amounts for very nebulous activities. This is true of the managerial class (CEO pay anyone? where no failure goes unrewarded) and the financial class. The breathless reports of the Wall Street bonuses boggle minds. And the supposed critical incentive element of the bonuses seem rather dubious when a headline like “Banks reduce bonuses only slightly” appears in yesterday’s Washington Post, at the cusp of what looks like the greatest financial debacle in a generation.
This narrative is one in which the SocGen fiasco fits. The notion that Jerome Kerviel accomplished his destruction single handedly, like Nick Leeson before him, seems dubious. Instead, this feels like a symptom of a systemic rot. The LTCM incident, and the way in which it was handled, was another window into the rot. Our economy has evolved into a staggeringly complex entity. This is good. Simple economies are simple because they are dirt poor (literally, recall the Haitian dirt cake story). Yet it feels like this complexity is being exploited by a privileged few who are looting the system; and looting it to a degree that rises well above background noise. Look at Wasserstein’s bonus at Lazard, and its size relative to their profits. This looting is defended with idealized paeans to the free market, which all right thinking people support. I’m in the 95th income percentile and all this shocks me. I can’t fathom how someone with a median income can view this. It feels like an obscene fraud perpetrated by parasites.
There’s a narrative for you.
It isn’t just bloggers that largely ignore – it is the entire US media. CNN covers the primaries for endless hours each day but hardly spent any time covering the SG debacle. The primaries are interesting to be sure, but not in my book a minor story by comparison.
There are so may sub-plots here you’d think for sure this MUST make for a great media story: there’s personal drama (Jerome now has broad support with many people who note that, unlike Nick Leeson, he did not make money for himself in this); intrigue (rumors that SG tried to hide other losses through this episode); speculation about the future of a huge bank (the likely prospect of SG being broken up into 3 divisions – each taken over by another French bank, BNP Paribas, Credit Agricole + someone else); volumes of analytical stories about corporate governance, financial instruments, regulation, etc. etc.
For all these stories… so little coverage??? I don’t get it. At all.
He didn’t exactly steal money, borrowing without permission really is the right euphemism here. And he ‘borrowed’ 50 billion euros. That’s a lot more than hunter-gatherers had, in case you hadn’t noticed. The mere fact that this is possible is already mind-boggling.
I tend to agree with much of what ramster says. I do think the points about CEO compensation, a topic much discussed here, should be seriously considered by those who see no problem in that area. The same applies to Wall Street bonuses. Indeed, even if some of those bonuses are reasonable in the context of the firms’ profits, it’s worth asking whether those profits are a reasonable return on the firms’ activities or reflect other factors.
As for Kerviel, I suspect, as I do concerning the “rogue traders” who preceded him, that the rogueishness was a little broader than we are told. It is hard to believe that there weren’t at least a few people at SG who wilfully looked the other way as all this was going on. Let’s remember, too, that rogue traders do not necessarily produce catastrophes. I’ll bet more than one has been successful, with his activities remaining unpublicized except for glowing reports about th eprofitability of the trading dept.
I don’t understand it, but I think the number is too big to be anything but an accident. After you turn over all the rocks, there will be some ugly surprises. This is based simply on intuition. The guy was too low on the food chain, and the idea that he could be just a scapegoat doesn’t make sense. This is based on thinking that ‘you couldn’t make this stuff up.’ Any sort of conspiracy would have blown up by now.
The questions that I have is why, since they knew about it over the weekend, their crack derivatives department couldn’t have used their knowledge of the situation to unwind things at a lower cost.
As far as real risk, I really don’t understand how the trillions in notional value of CDS’s are going to work out, since it is enormous and unregulated and we now see just how flawed risk management can be.
Dave has a narrative too. It’s that JK was just a thief. As it happens, that’ll be SocGen’s narrative too. And it was Barrings before. As far as LTCM, it’s too obscure (outside of finance news geek circles) to merit comment. John Merriwether of LTCM fame is not pumping gas or asking “would you like fries with that” as seems his due given that his abject professional failure nearly precipitated a financial crisis.
These are all just data points. Fleeting glimpses of the reality that hides behind a fog of rhetoric. Why aren’t there stories about this? Because the larger subject of economics, finance and markets is incomprehensible to most people. I think I have a pretty good lay persons level of knowledge in this area and still I just don’t feel equipped to grasp the complexity or everything from Bretton Woods to CDOs to SWFs to whatever. Everyone has a vague general understanding that these things are all connected and related to how the economy functions, but after that, it just gets to complex. Amidst this complexity, you hear stories of a single young trader losing billions, while a few thousand people at Goldman make billions in boonuses. Apparently one is fraudulent, rogue activity while the other is perfectly normal yet it all looks the same from the outside. And it feels rotten. All these people do is dip their bucket into the money stream as it flows by and pull out their share. They don’t actually contribute anything, yet they get paid vastly more than anyone else.
Perhaps Parisian arrogance had some role. But of course we are successful. We studied at Ecole together.
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