The Weird World Of Economics

The Seven Billion Dollar Gambler

PARIS — A French bank announced Thursday that it had lost $7.2 billion, not because of complex subprime loans, but the old-fashioned way — because a 31-year-old rogue trader made bad bets on stocks and then, in trying to cover up those losses, dug himself deeper into a hole.

Société Générale, one of France’s largest and most respected banks, said an unassuming midlevel employee who made about 100,000 euros ($147,000) a year — identified by others as Jérôme Kerviel — managed to evade multiple layers of computer controls and audits for as long as a year, stacking up 4.9 billion euros in losses for the bank.

Unlike many of his high-level trading colleagues, Mr. Kerviel graduated not from one of France’s elite universities, but from a business college in Lyon, and worked up the ranks. It was from his perch in the department that deals with auditing the bank’s trading that Mr. Kerviel developed what bank officials described as an “intimate and perverse” knowledge that he used to cover up unauthorized trades.

The bank uncovered his scheme last weekend. It was selling off its positions during Monday’s market turmoil in Europe that led, in part, to the Federal Reserve’s history-making rate cut of three-quarters of a percentage point.

The fraud appeared to be the largest in history by a rogue trader. Mr. Kerviel made no money personally, but apparently hid the trades by making fake orders to balance each of the genuine orders he placed. One unanswered question that authorities will investigate is why it took so long for the bank to uncover the fraud.

The bank maintained Mr. Kerviel acted alone, but experts wonder how that could be possible, given the checks and balances at financial institutions.

Christian Noyer, governor of the Bank of France, the nation’s central bank, said that the losses had put Société Générale in “a very dangerous situation,” but that the bank’s plan to seek 5.5 billion euros ($8 billion) in fresh capital from shareholders would return it to financial health.

Société Générale said that the trader was no longer working for the bank and that four other people — including the head of its global equity and derivatives trading division, Luc François — had been dismissed. As of late Thursday, the bank had not filed any criminal complaint, said Isabelle Montagne, a spokeswoman for the Paris prosecutor’s office.

Mr. Kerviel’s whereabouts were unknown, with the bank saying he was missing. But a woman identifying herself as his lawyer told French television Thursday night that “he is not on the run” and that Mr. Kerviel was willing to speak to authorities.

In bankerly understatement, Société Générale’s chairman, Daniel Bouton, wrote in a letter to clients Thursday that “Société Générale has been victim of a serious internal fraud committed by an imprudent employee.”

The fraud, carried out over the course of a year, harked back to other huge frauds traders managed to inflict on their employers. In 1995, Nick Leeson, a Singapore-based trader, incurred the equivalent of $1.4 billion in losses over $27 billion in bad bets on Japanese markets. (Similarly, Mr. Kerviel bet on European stock indexes.)

In the end, Mr. Leeson brought down the venerable British bank Barings. After spending four years in prison and writing a book, he is on the lecture circuit.

Mr. Leeson — who like Mr. Kerviel had detailed understanding of back-office operations — was found to have acted alone. But Barings was criticized for poor controls and oversight.

While Société Générale will survive — in contrast to Barings, which was broken up and sold — the loss is an embarrassment to a venerable French institution. It was founded in 1864 under Napoleon III, and today has 120,000 employees and 22.5 million customers worldwide.

The Kerviel scandal was not the only problem the bank revealed on Thursday. It also said that it would write off 2.05 billion euros ($3 billion) of United States exposure in the fourth quarter, including 1.1 billion euros related to the housing market and 550 million euros related to United States bond insurance companies. It said it was setting aside an additional 400 million euros in provisions against the risk that losses in those two areas would grow.

Société Générale officials said that Mr. Kerviel confessed and that the bank had begun legal proceedings. They said they did not know his motives, and, in a news conference some French news organizations called “surreal,” questioned his sanity, saying he had “family problems.” The officials did not offer evidence to support their assertions.

Société Générale said it had no indication that the trader — who joined the company in 2000 and worked for several years in the risk-management office before being moved to the Delta One trading desk in Paris — “had taken massive fraudulent directional positions in 2007 and 2008 far beyond his limited authority.”

The bank said that the trader — who Mr. Noyer, the central bank governor, said “breached five levels of controls” and was “a computer genius” — continued the fraud until this past weekend. That is when auditors in the risk-management office detected fictitious trades involving European stock index futures.

When the fraud was unveiled, Mr. Bouton said, it was “imperative that the enormous position that he had built, and hidden, be closed out as rapidly as possible.”

The timing could hardly have been worse. Société Générale was forced to begin unwinding the trades on Monday “under conditions of extreme market volatility,” Mr. Bouton said.

Bank officials insisted that the volume of their sales on Monday was not large enough to have a major influence on markets.

The scandal brought more scrutiny to European banks, which have been criticized for their lack of transparency, and particularly to Société Générale.

“It is quite surprising that positions of that magnitude would not have been monitored much more carefully in this era of intense focus on risk management,” said Mary L. Schapiro, chief of the Financial Industry Regulatory Authority, an American regulator. She was in Davos, Switzerland, for the World Economic Forum.

SocGen, as it is widely known, has been criticized for a reluctance to be more forthcoming about its subprime exposure, but the bank was generally well regarded in the financial world.

This month Risk Magazine, a British publication, named SocGen “equity derivatives house of the year,” praising its ability to manage its risks.

The French prime minister, François Fillon, also attending the World Economic Forum, told reporters, “Société Générale had confronted a very significant fraud,” but he insisted “the scandal has nothing to do with the situation in the financial markets.”

He added: “The Bank of France has no worries about the solvency of this financial establishment. The French government is following the situation very, very closely.”

Mr. Bouton, Société Générale’s chairman, wrote in his letter to clients that “control procedures have been revised and reinforced to avoid any recurrence of further, similar risk.”

The bombshell for the bank comes as mounting losses from subprime-related investments have raised questions about risk management at institutions.

Howard W. Lutnick, chief executive of Cantor Fitzgerald, said that such a huge fraud by one trader indicated a bigger weakness in the bank’s systems.

“One person could engineer it — but how could one person finance it?” Mr. Lutnick said on the sidelines of the World Economic Forum. “The question for the risk management department is, How was this kind of fraud financed? Where did that money come from?”

Howard Davies, former chairman of the Financial Services Authority of Britain and now director of the London School of Economics, said the bank’s explanation of events seemed incomplete. “I don’t think we’ve had the full story,” he said, arguing that one person, however well informed on the bank’s control procedures, should not be able to hide a trade of this scale.

“It’s a lot of money,” he said. “Normally you have a compliance mechanism,” which involves trades like these being run by more than one person, to avoid a situation where it is “only one pair of eyes.”

C. Ricardo Esteves, executive director of Banco Hipotecario of Argentina, was more blunt: “It is not credible. One person responsible for this? I just don’t believe it.”

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