PrefBlog

A trader at Merrill in London has been naughty, apparently overpricing his inventory by something less USD 20-million. It’s bad news for him, it’s bad news for his supervisor and it’s not all that great for Merrill … but it wouldn’t be news if everybody wasn’t so nervous! Unless more cockroaches scuttle out from under that fridge, I’m inclined to accept their official position:

“The firm routinely reviews the marks our traders set,” Merrill spokesman Jezz Farr said today in an e-mailed statement. “Our preliminary review determined that one desk used marks that appear to be outside of our accepted policy. We have suspended a trader and we continue to review this matter.”
…
“This case shows our oversight system works,” Farr said in the statement, referring to the firm’s detection of the suspended trader’s conduct.

As noted by Calculated Risk, US mortgage delinquencies are rising. I haven’t seen anything yet about whether these increases are sufficiently severe and unexpected to affect credit.

I have made some observations on one of the papers referenced in the Bank of Canada Review : Spring 2008 … you can chase it down through that post.

As noted in a Bloomberg story, the FASB has announced that it:

today issued FASB Statement No. 163, Accounting for Financial Guarantee Insurance Contracts. The new standard clarifies how FASB Statement No. 60, Accounting and Reporting by Insurance Enterprises, applies to financial guarantee insurance contracts issued by insurance enterprises, including the recognition and measurement of premium revenue and claim liabilities.
…
Statement 163 requires that an insurance enterprise recognize a claim liability prior to an event of default (insured event) when there is evidence that credit deterioration has occurred in an insured financial obligation. It also requires disclosure about (a) the risk-management activities used by an insurance enterprise to evaluate credit deterioration in its insured financial obligations and (b) the insurance enterprise’s surveillance or watch list.

To my mind, the critical paragraphs in the statement are:

25. Expected net cash outflows (cash outflows, net of potential recoveries, expected to be paid to the holder of the insured financial obligation, excluding reinsurance) are probability-weighted cash flows that reflect the likelihood of all possible outcomes. For purposes of this Statement, the expected net cash outflows shall be developed using the insurance enterprise’s own assumptions about the likelihood of all possible outcomes based on all information available to the insurance enterprise (including relevant market information). Those assumptions shall consider all relevant facts and circumstances and, where applicable, be consistent with the information tracked and monitored through the insurance enterprise’s risk-management activities and used to assist in making operational decisions.
…
29. An insurance enterprise shall disclose information that enables users of its financial statements to understand the factors affecting the present and future recognition and measurement of financial guarantee insurance contracts.

It is interesting to consider this change in terms of the Fitch / MBIA battle reported briefly on PrefBlog on March 24, with much better discussion available from Floyd Norris’ NYT blogs If you don’t like your grade, fire the teacher and Jay Brown Keeps Fighting.

FASB Statement 163 seems like a step in the right direction, but whether there will be enough information made available that investors can rationally check the credit ratings is something I have not – yet – seen discussed.

Vallejo has filed for bankruptcy as indicated on May 7. According to Markit 10-Year MCDX closed at 49bp today, essentially unchanged from its opening levels.

And in quite possibly the most astonishing news to hit the street since the last bulletin that the sun rose in the east this morning, SocGen management winked at Kerviel’s trading positions:

Jerome Kerviel was able to amass 50 billion euros ($78.7 billion) in unauthorized futures positions at Societe Generale SA because of fragmented internal controls, a report commissioned by the bank said today.

Kerviel’s supervisors failed to “react in an appropriate manner to several alert signals” and missed at least 1,071 bogus trades, a special committee of the bank’s board found. Unwinding those positions cost a record 4.9 billion euros, the biggest trading loss in banking history.

His supervisors missed the level of his gains, cash flows, brokerage expenses and overlooked warnings from Eurex AG, Europe’s biggest futures exchange, the report said.
…
Kerviel’s manager “tolerated” bets on the direction of index futures and certain equities that were unjustified by his “assignment and level of seniority,” the document said. As a trader on the bank’s “Delta One” desk, his job was to use large volumes to arbitrage small price differences between equity index futures and forwards.
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In the first three months of 2007, when most of Kerviel’s “massive fraudulent and concealed positions on index futures” were built up, he had no direct supervisor, the report said. His new manager “did not carry out any detailed analysis of the earnings generated by his traders” and received insufficient support from the head of the Delta One desk, the committee found.

Eric Cordelle, who wasn’t identified in the report, was brought in as Kerviel’s direct supervisor in April 2007.

I am unable to determine whether Eric Cordelle went to a good school, or if he’s just another disposable barrow-boy.

The Globe has some more detail:

The internal report, the second published by SocGen into the debacle, said the unidentified assistant had manually entered a large number of fraudulent transactions done by Mr. Kerviel.

It said the assistant registered “several abnormally high intra-monthly provision flows, without having obtained any valid explanations as to their validity.”

It added that the assistant had registered a total of almost 15 per cent of Mr. Kerviel’s fictitious trades.

Thus, they have grounds to pin a big chunk of the blame on a $30,000 p.a. trading assistant … and from the sounds of SocGen’s operation, it wouldn’t surprise me if traders had license to bully the trading clerks. If I remember correctly, that was part of the explanation at RT Capital.

Update, 2008-5-24: Kerviel’s lawyer had a great comment reported in today’s Globe:

“We notice that while protecting the superiors of Jerome Kerviel, the Société Générale has found a new scapegoat – who just happens to be a 23-year-old assistant,” said Guillaume Selnet, a lawyer for Mr. Kerviel.

He noted that the directors’ report was prepared by the bank’s own services and insisted that SocGen’s version of events keeps changing.

“My feeling is that – we are now on the second report – by the third report it’s going to be the fault of the cleaning ladies,” he added.

* end update.

I will say, however, that SocGen’s new-found frankness is refreshing compared with Scotia’s in the David Berry affair. The OSC has released its reasons for the David Berry decision. Of particular interest is the summary of Berry’s “Scotia Defence”, paragraphs 25-31. Those contemplating a career with a bank are urged to remember that:

• All your actions will be recorded in minute detail
• The bank may, or may not, review these actions
• If the bank needs a scapegoat – or wishes to win a contract dispute – it will find something in the records to hang you with

Preferreds had a good solid day, on what passes in these lackadaisical times for average volume.

There were seventeen other index-included $25-pv-equivalent issues trading over 10,000 shares today.

This entry was posted on Friday, May 23rd, 2008 at 7:18 pm and is filed under Market Action. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.