The stunning disclosure of a $7.1 billion loss due to the activities of a lone trader at Societe Generale sent shivers throughout the financial community. It certainly caused the sharp sell off in European and US equities Monday and Tuesday.There is speculation that it was this collapse in global equity values that prompted the US Fed to cut interest rates, even before the next Fed meeting scheduled for 29th and 30th of January. Incidentally SocGen is known worldwide as a leader in the derivative market and is reputed to have one of the best risk management systems in the world.
The person responsible for the loss is stated to be Jerome Kerviel, a 31 year old junior trader at the bank. But most people are not buying this story. They are asking how a junior trader could build up positions worth almost $73 billion without anyone asking questions about it.The positions were greater than the market capitalization of the bank, which is about $52 billion. The bank's explanation that he used the accounts and passwords of colleagues without their knowledge has few takers. Where did the margin money for these huge trades come from? Surely the bank's management knew about it. Adding to the mystery is the bank's statement that ' the trader did not enrich himself from the fraudulent trades.' The news generated buzz at the World Economic Forum at Davos, where the explanation put out by the bank was greeted with some skepticism. The French Prime Minister Francois Fillon remarked:' It is difficult to imagine how one person acting alone could, in a relatively short period of time, cause such considerable losses.'
The fraud was discovered on January 18th but the news was witheld from the public. This has caused considerable outrage amongst investors in SocGen shares, and they want to know the reason behind it, especially since rumors were already flying around the market that SocGen was about to announce a big hit.
To be fair to Kerviel his positions had caused losses of only about $2.6 billion. The rest were caused by SocGen's hasty reaction of squaring up the positions on Monday morning, instead of spreading out such action over a period of time. Maybe a sell off could have been avoided if they had acted more prudently. Curiously the bank is accounting for these losses in the financial year 2007 although most of the positions were built after January 8th this year. The bank has also reported a $2.99 billion subprime related loss, and plans to raise $8.2 billion in fresh capital. The police has picked up Kerviel for questioning and the bank will carry out its own investigation also. Most of the answers will have to wait till these are completed.