How to Lose $7.2 Billion: A Trader’s Tale

Quite a few interesting details in this article, an excerpt:

Mr. Kerviel arrived at the bank around 7 p.m. on the night of Jan. 19 … At the beginning, he was questioned about a single trade that had been discovered the evening before and aroused concern: a transaction with a German brokerage house that had seemingly lost the bank €1.5 billion ($2.22 billion).

Grilled late into the night at Société Générale’s headquarters, Mr. Kerviel acknowledged that the trade with Deutsche Bank never existed and then revealed far more disturbing news: his books contained genuine trades that exposed the bank to a €50 billion risk.

Mr. Mustier entrusted one of his best traders with the task of unwinding the bets. The result, by the time the information was released to the public on Jan. 24, was a loss of $7.2 billion — the largest single trading hit in banking history.”

Bingo! Minus 4,900,000,000 euros. The trader given the task of exiting that monster with minimal damage has my utmost sympathy — from one bald man to another: Mes condoléances.

Inner Life of Jerome Kerviel, Accidental Rogue, by Michael Lewis

“Jerome once thought of himself as having a way with the ladies but sex is the furthest thing from his mind. He’s ceasing to be French. He’s becoming American.

Now come these weird, false, fleeting sensations of total freedom. His ordinary mind cannot fully accept the reality of his situation and so it works overtime to generate fantasies. He fantasizes about dying before anyone finds out. He fantasizes that terrorists blow up Societe Generale before anyone finds out.

He walks home one night and there is something about the durability and grandeur of Paris. It gets him thinking. He is long $60 BILLION in equities. That’s more than the market value of the entire freaking bank. And no one knows! Maybe no one will ever know! Maybe he can just keep losing billions, in private.”

I can tell by certain word choices and phrasing that Michael Lewis reads my site regularly, but unlike me, he writes well and gets paid for it. :)

Here are the daily and weekly charts for the Euro Stoxx 50 futures (front month) from the beautiful volume-at-price perspective. The SocGen traders turned a $2 billion loss into a $7 billion loss by hitting the market so hard, mainly selling the Euro Stoxx 50, but they really had no choice — they had to get out as quickly and quietly as possible, every trader who has ever found himself “accidentally” stuck on the wrong side understands this in his bones.

“The Dow Jones EURO STOXX 50 (Price) Index is a capitalization-weighted index of 50 European blue-chip stocks from those countries participating in the EMU. The equities use free float shares in the index calculation. The index was developed with a base value of 1000 as of December 31, 1991. This index uses float shares.”

The Euro Stoxx 50 futures are by far the most actively traded equity index futures in Europe. The FTSE and the CAC are the next most active, but don’t really compare. Interestingly, the Swiss market futures are more active than the DAX, I believe. (Update: I’m wrong about this… see the comments section.)

Click to enlarge (Euro Stoxx 50, Daily)

Click to enlarge (Euro Stoxx 50, Weekly)

Kerviel Felt Out of His League

“… if clawing your way up from the mailroom wins you a badge of honor in the U.S., not so within in the rigid class system that defines the upper ranks of French finance. Mr. Kerviel’s effort to impress his colleagues now appears to be a motivating factor behind his disastrous trading spree.

‘I cannot believe that my superiors did not realize the amount I was risking,’ Kerviel said in the interrogation. ‘It is impossible to generate such profit with small positions. That’s what leads me to say that while I was [in the black], my supervisors closed their eyes on the methods I was using and the volumes I was trading.’”

I call bullshit, Jerome. If you’ve got other SocGen traders killing themselves after being so harshly reprimanded for losing a lousy €9 million in unauthorized trades (”He took his bag, left Société Générale and jumped off a bridge” [I loved that line, lol]), there’s no way management would look the other way when you’re making multi-billion euro one-way bets.

Wall Street firms have a mix of PSHs (”poor, smart, hungry”) and RDLs (”rich, dumb, lazy”). The latter (about half of new hires) tend to be somebody’s nephew/niece, or very good looking, or both.

Back in the early 1990s, I talked with a top headhunter in Hong Kong about working for a bank as a trader, and she said, “Forget about it, they only hire pretty girls, and you’re neither pretty nor a girl.”

Funniest thing I’ve read (so far) this morning (emphasis mine):

“… a French lawyer acting for 100 small shareholders said he had sued Société Générale over the way it had unwound Kerviel’s fraudulent share deals last week, Reuters reported.

The lawyer, Frederik-Karel Canoy, said the bank should have informed markets about its pending losses before embarking on a selling spree from Jan. 21 through Jan. 23 to unwind the €50 billion of risk exposure built up by Kerviel.”

Yep, they should have shouted from the rooftops, hey! we’re stuck long $73 billion in the Eurostoxx, DAX, and FTSE; we’re already sitting on $2 billion in losses; do you guys wanna buy some from us? :)

Details on the exposure from this W$J article (emphasis mine):

“As of Jan. 18 — the day Mr. Kerviel’s ruse went astray — Société Générale had €18 billion of exposure to the DAX, €30 billion exposure to the DJ Euro Stoxx 50 and €2 billion to the FTSE 100 Index in London, according to Mr. Mustier. All of these exposures were established this year in a short period of time, he said.”

Presumably after Jerome received his insulting €1500 bonus.

Here’s a look at the Eurostoxx 50 futures, which apparently made up the biggest part of Monsieur Kerviel’s $73 billion position, during the three days of unwinding. This 30-minute candlevolume chart is good for showing blasts of volume. See those three massive down bars on Monday, the 21st? I’m guessing they’re probably the handiwork of the bald and perspiring young men at SocGen trying to cut Kerviel’s already massive losses that terrible morning. There’s no graceful way to exit $73 billion of anything quickly.

Click to enlarge

I read the statement from SocGen, “Explanatory note about the exceptional fraud,” closely and with interest. It’s not badly written, but reads at times like it was directly translated from French. I recommend that SocGen hire a native English proofreader tout suite, assuming they can still afford one.

“The unwinding of the fraudulent position

The equivalent nominal amount of the fraudulent position uncovered on Sunday January 20th was approximately 50 billion euros.

The priority was to unwind the fraudulent position as quickly as practicable, given the risk generated by its size.

The unwinding could only start on Monday, January 21st and in a measured fashion so as [to] keep volume levels under 10% [ed. They mean keeping SocGen’s share of trading volume under 10% of total trading volume], in order to respect the market’s integrity.

Conditions in the market were very unfavourable. In the afternoon of Friday January 18th, there had been a sharp downturn in the European markets. In the night of January 20th to January 21st, there was a significant drop in the Asian markets (Hang Seng -5.4%) before the European markets opened.

The position was unwound over three days in a controlled fashion, thus ensuring that Societe Generale did not exceed around 8% of volumes traded on the relevant futures indices (EUROSTOXX, the DAX and the FTSE).

The position was finally fully closed or hedged on the evening of January 23rd. Overall, movements in the market triggered by the sharp fall in the Asian markets during the night of January 20th to 21st resulted in a final total loss of 4.9 billion euros.”

It’s good that they’re trying to explain things clearly, but I’m not so sure about the “unwound in a controlled fashion” bit. The market had to smell something wrong to plunge like it did, and I’m not sure how the SocGen traders kept from tipping their hand on Monday morning. I’ll post the intraday charts of the EuroStoxx 50 and DAX futures when I get a chance.

Interesting details from the IHT article, emphasis mine:

“… a review of Kerviel’s trading records showed that he first began creating the fictitious trades in late 2006 and early 2007, but that these transactions were relatively small. The fake trading increased in frequency, and in size, during the course of the year, he said, but the largest fictitious trades - involving futures contracts on the Dow Jones Euro Stoxx 50, the DAX in Germany and the FTSE index in Britain - were entered in early January.

Mustier said that that volume [around 8% during the unwinding from Jan. 21 through 23] compared with Société Générale’s normal share of daily trading volume in those futures of 2 percent to 4 percent, though in the cash market, the bank’s trading frequently represented up to 10 percent of the daily volume.”

So if they were doing 7-8% of the volume in the Eurostoxx 50 and DAX on Monday and they normally did 2-4%, people would notice and take advantage, particularly if SocGen were just sellers — it would be nightmare to try to mask your intentions when you’ve got that much to sell, and sell quickly. I’m sure that the bald young traders at SocGen grew a little balder that day.

One Trader’s Loss at SocGen: $7.2 Billion

“Mr. Kerviel cost the bank $7.2 billion by allegedly making huge unauthorized trades that he hid for months … The losses are forcing Société Générale to seek $8.05 billion in fresh capital from shareholders … He was a low-level trader whose job was to make bets on how large European indexes would trade … His expertise was trading baskets of stocks such as the Euro Stoxx 50 [Expertise, de quoi?].

In the middle of last year he began placing huge unauthorized bets that European markets would continue to rise. At first, Mr. Kerviel fared well and he was winning toward the end of the year [Mais bien entendu]. People close to the bank said the combined positions were worth about $73 billion. [Yowza!]

Though Société Générale says it first learned of problems on his trading desk last Friday [Jan. 18] and uncovered what it termed ‘massive fraudulent directional positions’ last Saturday, it waited six days to go public with news of the losses. That allowed the bank to unwind its positions and avoid even greater losses.

Mr. Kerviel joined Société Générale’s investment banking unit in the summer of 2000 after graduating with an advanced degree in trading [Did he graduate with honors?] from the University of Lyon, in central France.

Last Saturday, Société Générale executives called Mr. Kerviel in for questioning…. The interrogation took a good part of the day because Mr. Kerviel had convinced himself that he had discovered a new way to trade equity securities [I LOVE IT! Une façon nouvelle, pour sûr :)]. For a while, he went in circles while justifying the trading strategy. Finally, on Saturday night, he broke down and admitted to the trades.”

Sad. We’ve all been there but precious few of us, OK absolutely no one ever, had $73 billion on the line.

Click to enlarge (Euro Stoxx 50 Index, Daily, One Year)

Societe Generale Reports EU4.9 Billion Trading Loss (Bloomberg)

“‘It’s not possible that our covering operations contributed to the market’s fall,’ said Philippe Collas, the head of asset management at the bank.”

Did he say that with a straight face?

Here’s a look at the 10-minute chart of the S&P futures over the last couple days *including* the after-hours trading sessions. You have to look at both the night and day (paging fellow Cole Porter fans) sessions to get a complete picture in many futures markets, including the S&Ps.

Click to enlarge (S&P 500 Index future)

I thought it would be useful to look at the very short-term (three minute) intraday charts of the US Dollar Index, 10-year Treasury Note future, S&P 500 future, and the Gold future, given the Fed’s emergency action:

“The Federal Open Market Committee has decided to lower its target for the federal funds rate 75 basis points to 3-1/2 percent.

The Committee took this action in view of a weakening of the economic outlook and increasing downside risks to growth. While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households. Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets.”

(Aside: I’m not thrilled with a lot of their language: “in view of a weakening of the economic outlook” … of a, of the — bureaucrats love prepositional phrases; “incoming information,” sounds lame; do contractions deepen? do markets soften? They need someone who can write clear, concise English. Greenspan did so much damage with his intentionally convoluted Greenspeak — maybe his true legacy?)

Click to enlarge (US Dollar Index)

The dollar was already trending lower into the Fed cut, but weakened quite a bit more on the news which makes sense.

Click to enlarge (10-year Treasury Note future)

The T-Note dropped initially on the news but then stabilized, holding onto its gains.

Click to enlarge (S&P 500 Index future)

The S&P popped on the news, traded lower for a brutal stop grab (those pit guys are the nastiest in the world) below the “news bar” low, then traded back up and formed a stable range.

Click to enlarge (Gold future)

Gold also popped (predictably) on the news and went back up to the Lucky 888 range.

A few comments from Billionaire Gross:

“It’s a sad testament to think the Fed has to cut interest rates eight days in front of a meeting to salvage the equity markets … The U.S. economy is in a rather sad state of affairs in that it depends on housing and stock prices to keep going … We need a fed funds level at 2.5 percent to 3 percent. The sooner the better … You would have to think the Treasury rally is almost over. It’s a safety-only type of vehicle. It certainly doesn’t provide an attractive return.'’