The banking system is built on trust. If all the people who have money in a bank came for their money at the same time, which is referred to as a “run,” such a bank would have to close its doors. Banks make money by lending out the money you deposit, and then collecting interest on the loan repayments. If a bank has $200 million in deposits, it will routinely have all that money out in loans. All the money is never in their vaults.
In the international banking and financial system, the game becomes more complex and it becomes more dangerous. The most dangerous game is currency speculation, such as the derivatives game on which Hon. Ralph Fonseca lost $12 million of Belize’s money. A currency trader can bet that a specific currency will rise or sink in value. If the currency behaves as the trader is betting, then he or his bank makes a lot of money. If the specific currency behaves otherwise, then he or his bank “takes a bath,” as it is said. Belize took a bath because trader Ralph guessed wrong.
The Financial Times reported on Friday, January 25, 2008, that a single rogue trader was “being blamed for the biggest fraud in investment banking history after Société Générale, one of the pillars of French finance, revealed his actions had cost it 4.9 billion euros (US$7.2 billion) and forced it into an emergency 5.5 billion euros cash call on shareholders.” At one point, Jérôme Kerviel, a junior trader working on SocGen’s European equities derivatives desk, had the bank exposed to a staggering 50 billion euros in losses. SocGen’s market capitalization is 34 billion euros, much less than the losses the bank was facing.
According to David Gauthier–Villars in the Wall Street Journal of Saturday/Sunday, January 26-27, 2008, Kerviel circumvented SocGen’s high-priced and complex security system to make trades over the past several months. Kerviel was making huge bets that European stock indexes, such as the CAC in Paris and the DAX in Frankfurt, would rise. But the markets began working against him earlier this year, and Kerviel began racking up huge losses. He covered up those losses by recording fictitious trades that went in the opposite direction.
In 1995 the trader Nick Leeson brought down Barings Bank by hiding an 827 million pounds trading position in Singapore. Leeson explained his actions, according to John Gapper in Friday’s Financial Times, as a misguided attempt to hide losses by junior traders who worked with him that spiraled out of control. More likely, wrote Gapper, Mr. Leeson was trying to build a reputation as a star trader on the Simex derivatives exchange and he ended up taking excessive risks to look smarter than he actually was.
Peter Thai Larsen wrote in the same issue of the Financial Times, “The last thing the world’s banks needed right now was a rogue trading scandal. In the past six months, they have been buffeted by large trading losses triggered by the subprime mortgage crisis in the US, and market turmoil has raised fundamental questions about their business model.”
In fact, the international financial institutions are so powerful they can actually create a crisis where there is none. On pages 264 and 265 in THE SHOCK DOCTRINE, Naomi Klein wrote of how the so-called Asian Tigers were one minute being held up as paragons of economic fitness and vitality, and the next minute traders were attacking their currencies in 1997, creating what The Economist called “a destruction of savings on a scale more usually associated with a full-scale war.”
Wrote Miss Klein, “It turned out that the countries were victims of pure panic, made lethal by the speed and volatility of globalized markets. What began as a rumor – that Thailand did not have enough dollars to back up its currency – triggered a stampede by the electronic herd. Banks called in their loans, and the real estate market, which had been growing so quickly that it had become a bubble, promptly popped. Construction ground to a halt on half-built malls, skyscrapers and resorts; motionless construction cranes loomed over Bangkok’s crowded skyline. In a slower era of capitalism, the crisis might have stopped there, but because mutual fund brokers had marketed the Asian Tigers as part of a single investment package, when one Tiger went down, they all did: after Thailand, panic spread and money fled from Indonesia, Malaysia, the Philippines and even South Korea, the eleventh largest economy in the world and a star in the globalization firmament.”
We close this editorial with John Gapper’s description of the “rogue trader.” “It is common for traders to make losses on positions and then attempt to trade out of them rather than confessing immediately to their bosses. But the thing that marks out the rogue trader is that he carries on with his deception long after most people would have given up, apparently impervious to the damage he is causing.
“What starts off in a minor way, with a small trading position or a few losses, grows to astonishing proportions. The rogue trader ends up spending as much time concealing his trades as working to extricate himself.”
Do you still believe that the G-7 were wrong to do what they did on August 12, 2004?