The $2 Billion UBS Incident: 'Rogue Trader' My Ass

http://www.rollingstone.com/politics/blogs/taibblog/the-2-billion-ubs-incident-rogue-trader-my-ass-20110915?print=true

by bootload • 15 years ago

131 68 15 years ago

I'm not sure what the relevance of investment banker's "huge appetite for risk" is.

The current crisis was caused by people making AAA-certified safe bets, most of which were done in order to comply with Basel II and other capitalization requirements [1]. And even ignoring capitalization-driven demand, a long position on housing was considered a safe bet.

If anything, we needed more risk taking and more derivatives - bankers willing to bet against the crowd, and derivatives which give them the ability to take a short position.

[1] If a commercial bank wants exposure to housing, all they needed to do is make some loans. But various bank safety regulations encouraged them to hedge their risks by selling off the loans and purchasing AAA paper in order to hedge against mortgage risks in their local market.

palish5• 15 years ago

The relevance is: "investment banking" may have done more harm than good. (As in, consider their whole existence. What might the world have been like without investment banking?)

phyalow• 15 years ago

No Major Corporations, or capital raising/lending.

lionhearted• 15 years ago

> (As in, consider their whole existence. What might the world have been like without investment banking?)

It's a seen-and-unseen problem. Wages rising for the same activity is actually rare and historically really weird. The chief way people improve in the world is to automate/creative destruction old professions in favor of more modern ones, and through lower costs due to efficiency. Investment banking enables and accelerates both of those processes.

It's a stretch, but not insane to think that, say, streaming video or iPads might not exist without investment banking.

Someone replies, who cares about iPads or streaming video? But how much have, say, TED talks enabled thinkers to make progress on hard important problems?

The causal chains here are long and complex, it's hard to say for sure. But creative destruction and replacement of old industries with new means better professions, and reducing costs is the other chief way to prosperity. You know about the huge blowups because they're noteworthy, you don't consider what industries wouldn't exist without a gradual re-allocating and efficiency, freeing up more people to do higher level work and driving costs down.

It's hard to do mentally, inevitably someone will reply, "LOL, this guy thinks without investment banking there'd be no iPad!! That's all Jobs and Woz dude!!" I don't know. Maybe. But why is South Korea so much nicer to live in than South Vietnam? Why did South Vietnam start to improve rapidly when they liberalized the banking system and started taking foreign investment? Capital allocation really pulls the world forwards, but many of the gains are subtle and hidden while the failures are prominently on display.

yummyfajitas2• 15 years ago

Whether or not you believe I-banking is a good or bad thing, it is utterly tangential to the main point I was making.

The current crisis was caused because too many investment bankers were risk averse in the same way, not because they were risk taking.

RockyMcNuts• 15 years ago

do you think Google would exist, and they would have been able to raise money for a massive server farm, if initial investors didn't know they would be able to IPO it if it was successful?

do you think the market for YC startups would be hot if there was no public stock market for companies to raise the money to buy them?

rayiner3• 15 years ago

Investment banking as an umbrella term is pretty useful. Investment bankers have historically been professionals advising companies on financial issues. If you're Ford and want to construct a new factory, you go to an investment bank which helps you issue corporate bonds to finance the new factory. A factory gets built, which creates jobs and products for the market, and Ford and investors split the surplus from that action, with the former making more revenue and the latter getting interest payment. Investment bankers also handle acquisitions, IPOs, and other generally useful corporate finance, generally non zero-sum transactions. In return, the bankers are paid a fee for their services.

The problem is that these traditional investment bank functions only make up something like 12% of the revenues of a traditional investment bank like Goldman Sachs: http://www.wikinvest.com/stock/Goldman_Sachs_Group_(GS)#Inve...

Most of the rest of the revenue comes from trading and other activities of questionable utility.

Joakal2• 15 years ago

It actually makes sense. If you run the IT department, you have to risk giving almost all the code to developers who can then put it in an email to themselves.

The alternative is draconian restrictions that stifle creativity, freedom and leadership.

Trust, is very important.

ars2• 15 years ago

I don't know why you were downvoted, but it's usually best not to mention it in the post. Most of the time it gets fixed by later moderators. (At least if the story is popular.)

Joakal2• 15 years ago

I'm at 0 now. I've removed that edit for now. Just wondered why it was very negative.

(The edit stated I was at -2 and asked why I was downvoted)

deepGem• 15 years ago

Well my friend, u've just drawn the wrong analogy here. Perhaps you have little or no idea of large scale software development. No developer can take a piece of code with him/her - implications are horrible. Even if they did, the code is probably worthless unless they managed to steal the entire code base. Assuming someone manages to accomplish this, it'll still take time for the damage to occur and by then the theft will be discovered.

What these traders do is, from my understanding, far more risky and the chances of someone discovering their 'wrong trade' before the damage is incurred is probably nil. That's why u always hear that the trade lost so much money. U never hear, the trade was about to lose so much money and someone averted it.

danssig• 15 years ago

Yes exactly. Having worked for several big banks it is simply inconceivable that no one knew what this guy was doing. Which is probably why his immediate boss resigned immediately after the police took him away.

sek• 15 years ago

The same situation with Jerome Kerviel, he did this for a long time and nobody complained as long as he made Money.

morsch• 15 years ago

That's not exactly the point he is making, though:

They’re not "rogue" for the simple reason that making insanely irresponsible decisions with other peoples’ money is exactly the job description of a lot of people on Wall Street. Hell, they don’t call these guys "rogue traders" when they make a billion dollars gambling. [...]

In the financial press you're called a "rogue trader" if you're some overperspired 28 year-old newbie who bypasses internal audits and quality control to make a disastrous trade that could sink the company. But if you're a well-groomed 60 year-old CEO who uses his authority to ignore quality control and internal audits in order to make disastrous trades that could sink the company, you get a bailout, a bonus, and heroic treatment in an Andrew Ross Sorkin book.

matwood2• 15 years ago

immediate boss resigned

The CEO should resign. Either the company lost $2B and is now pinning it on a 'rogue' trader or their security is flat out incompetent. Either way, all of the CxO positions should be tossed out.

The whole things stinks really. $2B is A LOT of money to lose. With that sort of money flying around and the amount of power those involved likely have, it's easy to see them leveraging the criminal system to CYA and stick this to some underling.

maxxxxx• 15 years ago

If the guy had made 2 billion by accident the CEO would get credit for it and take a big bonus home. It again shows how messed up the system is. The big guys have all the upside but pretty much no downside.

0x122• 15 years ago

$2B is a lot of money, indeed. But the trend to hand out large funds to be managed by relatively young people is one that will increase as the margins on the trades decrease.

You need to use a lot of money to work with if you want to do arbitrage on a fraction of a percent for a couple of minutes to make more money than the operation itself costs.

Not all trades are profitable.

Also, losses like these are always a double failure of sorts. The trader is a given, but there is also an oversight problem.

chollida12• 15 years ago

> Either the company lost $2B and is now pinning it on a 'rogue' trader or their security is flat out incompetent. Either way, all of the CxO positions should be tossed out.

That's a good point.

Let me ask a serious question.

What if some rogue google employee some how changed the search index so image searches always returned porn.

Should Larry Page be fired?

Both situations are cases where "security is flat out incompentent"

is this about the lack of accountability or is this strictly about the loss of money?

fleitz• 15 years ago

$2 billion is a 5 person hedge fund that raised $200 million and took it to a prime broker (read: UBS, GS, etc).

$2 billion dollars is a parking ticket: http://www.reuters.com/article/2009/01/11/ubs-idUSLB34005520...

bd_at_rivenhill• 15 years ago

I disagree, these sort of losses are usually caused by failures in risk management systems or procedures. Nick Leeson was permitted to settle his own trades while being head of a trading desk (which is never a good idea), and Jerome Kerviel had previously worked in the middle office at Societe Generale and used his knowledge of their systems and procedures to hide his trades. Kweku Adoboli had previously been a trade support analyst (a middle office position) and UBS is currently undergoing a major restructuring of its risk management systems, so it wouldn't surprise me at all if he were able to circumvent their systems to escape detection. The universe seems to be telling us that middle office people shouldn't be moved to front office positions on a delta one desk.

DanielBMarkham3• 15 years ago

From the title I expected the article to inform me about why this wasn't a rogue trader, that is, some new information about this particular case.

Instead I get a long rant about the evils of investment bankers. Might be a great political point, and it was certainly a nice rant, but it had nothing to do with the title except in the broadest sense.

In short, I felt tricked to read the piece. There was only a sentence or two to directly support the title. The rest was a screed on the generic problem. This is the kind of article where people who are pissed about bankers (and I count myself among them) will read and nod their heads and totally agree with the author -- all the while forgetting that the meat of the article provides much heat, little light.

pardo• 15 years ago

I can find at least 4 paragraphs directly related to the title, explaining why the author considers this is not a case of a "rogue trader" but of a "rogue industry". That's about 25% of the article devoted exactly to what the title says (the rest of the article giving useful background for the author point in this 4 paragraphs).

I wouldn't say that the title is deceiving.

DanielBMarkham3• 15 years ago

Yes but instead of addressing this specific case, the author spends his time ranting and waving his hands around about the industry in general. Hell, I already knew all of that. I clicked on the article because I expected something about this particular case.

If that's not deceiving, then anybody can write an article about just about anything. Just move to the general case, throw in a lot of invective, and dance a bit. You could write stuff like this on an assembly line.

I'll put this a different way: this is an editorial piece. As such, it's a nice one. I liked it. But it's not a news article, which was what I was expecting. It just takes a news article and sticks it on top of some pre-canned outrage.

jsherry• 15 years ago

This paragraph encapsulates it pretty nicely:

"In the financial press you're called a "rogue trader" if you're some overperspired 28 year-old newbie who bypasses internal audits and quality control to make a disastrous trade that could sink the company. But if you're a well-groomed 60 year-old CEO who uses his authority to ignore quality control and internal audits in order to make disastrous trades that could sink the company, you get a bailout, a bonus, and heroic treatment in an Andrew Ross Sorkin book."

ars2• 15 years ago

I guess there is an assumption that CEOs and Junior members need to follow the same rules?

chernevik4• 15 years ago

I'm basically an Ayn Rand cultist, and I think the article delivers. It is now obvious that the CEOs running Lehmans, Bear, and Citibank in 2007 had absolutely no idea of what their assets were or how they were funded. They were as far outside their "risk limits" and "authorized positions" as any of these "rogues". But their limits were phrased with far less clarity and with far more wiggle room. The criminality of these "rogues" is defined by their failure to comply with clear and easily adjudicated policies. No such criminality could be applied to the CEO's deviation from their duties. The difference between the CEO and the rogue trader isn't in their basic behavior but in the standards that apply to them.

That problem cannot be solved by law or policy governing behavior. The standards applied to these CEOs do not admit of the precise specification needed for clear differentiation between error in judgment, bad luck, malfeasance or dereliction of duty. Hofstadter talks about the "computability" problems addressed by Godel and such, trying to determine which problems are and aren't resolvable by computation. Governance at that level is a similar kind of problem.

The implications of this are profound. Since we can't legislate / regulate right behavior, we have to motivate it through incentive alignment. Thirty years ago these banks were partnerships -- if they failed, they wiped out most of the saved capital of their retired partners and senior employees. You can be very sure those folks were both willing and able to apply the qualitative judgments of risk unavailable to a policy driven review.

Those partnerships were converted to publicly held equity because this was less risky for those partners and allowed the companies to achieve larger scale, momentarily conveying cost advantages. But public equity holders don't, and can't, understand these entities as well as those partners did, and therefore cannot discipline management nearly so well. The real long-term costs of that dilution in risk management are now more apparent.

None of this would be any of my business if banking weren't a necessary component of modern money creation and thus inherently intertwined with the government. As such, any citizen has a stake and a voice in the stability of these institutions and their role in the creation of money. The latest regulatory revisions seek to obtain the needed stability by improving the foresight of the regulation, backstopping any failure with an implicit government guarantee on the system. Since the regulation _cannot_ be improved, we are headed for another bailout at some moment to be determined. Meanwhile we are essentially underwriting excess compensation for those managers and traders who can figure out the extraction of cash from the system before the equity again falls to zero.

There are alternatives. Each of these institutions should be a lot smaller, so the system can tolerate the collapse of any several. And they should be generally capitalized by investors who can understand their assets and liabilities, who are in a position to get the confidential information needed to the institution's specific balance sheets, and who _cannot_ hedge or diversify away enough risk to become indifferent to the institution's success. Publicly traded equity fails on all of those conditions.

The consequences of partnership equity are obvious. It rolls back the scale, and with it the momentary cost advantages, enabled by larger, dumber, indifferent public capital. Those large institutions managed with integrity (e.g., JP Morgan) will be f*ed. Capital costs will rise, in part due to induced scale and liquidity inefficiencies, but in part due to the reflection of the real risks of these institutions. But the policy problems of moral hazard and public subsidy of private speculation will be removed. We will be spared the logical contortions required to explain away the obvious immorality and idiocy of many of the people running these institutions. We will avoid the corruption of language and thought that necessarily follows from attempting the impossible task of policing an unspecifiable morality. Most important, we will remove dangerous political corrosion that follows from associating that intellectual corruption with such extraordinary potential for private gain.

tldr; "Rogues" differ from CEOs only in the ability to specify position limit violations. The inability to specify CEO position limits implies that financial stability is unavailable through regulation. Stability thus only available through alignment of management and equity incentives and knowledge. The only equity with proper incentive and knowledge would be partnership equity.

tldr(tldr;) CEOs differ from rogues only in the impossibility of specifying their "position limits", so CEOs can only be managed by equityholders as knowledgeable and focused as they are -- e.g., partners, not public equity holders.

arethuza7• 15 years ago

"I'm basically an Ayn Rand cultist"

I'm sure you don't mean that literally, according to Why People Believe Weird Things she is supposed to have run something that was rather close to a personality cult:

http://www.amazon.com/People-Believe-Weird-Things-Pseudoscie...

NB This is not an ad hominem attack on her ideas, just an observation that according to some accounts she was a rather odd individual.

rayiner3• 15 years ago

There are regulatory changes that can help. I think people underestimate just how much effort and talent banks spend on using regulation to their advantage.

Take for example FDIC insurance, as mentioned in the article. Ostensibly, it's intended to help people with money in their bank accounts. But it also means that banks can be riskier with trades, and count on the government to cover certain losses. The same is true for agency-backed mortgages.

pradocchia• 15 years ago

Those partnerships were converted to publicly held equity because this was less risky for those partners and allowed the companies to achieve larger scale, momentarily conveying cost advantages.

Yes, the partnerships went public to transfer risk away from the partners, to externalize it. It was the only way. How else do you maintain profits when the economy has flattened out?

Yes, it is economic cannibalism, but what's the alternative? They can't change to a steady state model, and they are too strong to just give up and fail. So, they burn the furniture.

You know, I really hope it doesn't get any worse than this. I am afraid they won't stop with just the furniture, that they will continue to burn and burn until there is nothing left, and we have a violent revolution or something. And I wonder whether there is some disruptive technology on the horizon that will change the game--a distributed source of energy perhaps? My crystal ball is very cloudy.

jimbokun• 15 years ago

"That problem cannot be solved by law or policy governing behavior."

Of course it can. Glass Steagall prevented the kind of meltdown we just experienced for decades, until it was repealed under the Clinton administration.

DenisM• 15 years ago

That's the best analysis of the situation I have read anywhere, not just hacker news. If only we could get this message to the msm...

rayiner3• 15 years ago

I think his point is that all traders are "rogue traders" when they're making their bets with money sitting in federally-insured commercial bank accounts. They're just called such when they lose.

teyc• 15 years ago

I'm still very interested in these fraud cases. The main reason being that one person has effectively social engineered/hacked their way past bank internal controls. Imagine if UBS had inadvertently hired a crew of Anonymous, they would be totally sunk.

chopsueyar• 15 years ago

They seem to be doing a dandy of a job without Anonymous.

shapeshed• 15 years ago

I have made a start at replacing the investment banking system with a tiny shell script. https://gist.github.com/1222010

Feel free to fork and improve.

cpeterso• 15 years ago

And if you are looking for some advice when investing in the stock market:

  get_hot_stock_tip() {
    ACTIONS=($"Buy" "Sell");
    ACTION=${ACTIONS[$((RANDOM%2))]};
    STOCK=`</dev/urandom tr -cd A-Z | head -c$((RANDOM%4+1))`;
    echo "$ACTION $STOCK";
  }

  Sell GUF
  Sell LNT
  Buy WILK
  Buy EWM
  Sell RLAO

ddw• 15 years ago

I found this funny: http://www.eschatonblog.com/2011/09/unauthorized_16.html

"I think even I could code the little trading computer with something like "if bet>$1 trillion, deny authorization." Or, ok, these things are complicated, how about if "Probability of loss>$1 trillion is >.00001 then deny authorization."

StrawberryFrog• 15 years ago

The devil is in the details, specifically in working out the probability of loss. The whole point is to know that a bit better than the other guy. See also: putting your trust in AAA rated mortgage-backed securities.

gwern• 15 years ago

That is pretty hilarious. If only things were that easy...

arethuza7• 15 years ago

I worked for a bit on the mid 90's on a distributed real-time risk management tool that was based on simplified VaR calculations.

From what I recall, the calculation of a "risk" value for an individual trade isn't too bad but it gets exciting when you try to do this for a lot of trades across a complex portfolio - especially when you have to factor in other kinds of risk (e.g. forex).

I was the lead software guy and it was fascinating to work with the ex-traders who were providing the financial knowledge. A shame that the product died horribly due to litigation on contractual issues.

Hisoka• 15 years ago

It's not just investment bankers that have an appetite for this. It's a human problem - greed, and short-term thinking. Given the right environment and rules, and most humans would act the same way. The key is to prevent that environment from flourishing. Don't give them so much leverage. If you got $100 million in the bank, don't freaking let them trade $1 billion. Don't let them loan $1 billion. If I ask for $100 million back today, you better give it back TODAY.. not tomorrow.. not next week.. NOW.

The analogy in the internet world is SEO, and gaming the search engines.

iqster• 15 years ago

Q: What do you call a 'Rogue Trader' who makes a 2 billion dollar profit?

A: Managing Director

- Heard this on CNBC just now (attributed to the "Twittersphere")

Symmetry• 15 years ago

As long as we structure the incentive of organizations to get them to take on as much risk as possible (though bailouts on the downside), arbitrary external limits on how much risk they can take on will just result in them finding ways to work around them. Like by giving lots of freedom to ambitious young guys and saying "Don't do anything too risky, though if by some chance you make lots of money we'll give you a big bonus".

The $2 Billion UBS Incident: 'Rogue Trader' My Ass

Related Stories