PrefBlog

Memorial Day in the US … very little interesting news!

The chatter regarding the SocGen / Kerviel fiasco continues:

“It validates what Jerome has said,” Guillaume Selnet, Kerviel’s defense lawyer, said yesterday in a telephone interview. “The only possible explanation is negligence, individual and systemic negligence.”

The full SocGen report is available via the SocGen Press Releases page. The report itself is illuminating. Essentially, their bookkeeping procedures did not produce exception reporting, or have adequate drill-down capability. Gross incompetence – an accident waiting to happen.

The report, while publicly available, has been encrypted to make extracts hard – I can only imagine they don’t want their various howlers discussed too readily! However, I’ll retype:

Furthermore, the Futures Back Office did not identify the significant frequency of cash complements paid in order to meet deposit requirements as such supervision is not within its mandate. Between January 1 and 18, 2008, in the absence of a sufficient quantity of bonds to cover an IMR requirement undergoing strong growth due to JK’s activities, the Futures Back Office paid a cash complement of over EUR 500 million on five occasions in order to meet deposit requirements, as opposed to one such payment made during 2007 (on March 13, 2007 for a total of EUR 699 million). In the absence of any supervision and of any alert threshold for cash amounts paid as deposits in the procedures in place at that time, Back Office failed to detect the substantial increase in cash payments made under IMR from January 2008 onward. Back Office in fact makes a global cash payment, including by currency and by clearer, other than the deposit paid in cash, margin calls, commissions and interest payments. The controls concern solely any discrepencies between the amounts claimed by the clearer and those calculated by the SG accounting system (GMI/clearer reconciliation). But it is not Back Office’s role to carry out checks on the consistency of the amounts concerned.

Finally, the detailed breakdown of the collateral re-invoicing by GOP, which should have allowed the abnormally high amounts to be identified, was not sent to JK’s direct heirarchal superiors. GOP 2A represented 10% on average of the re-invoicing of the securities deposit financing paid by GEDS to FIMAT Frankfurt since April 2007 (see Table no. 1). This re-invoicing is carried out on a monthly basis by the Securities treasury Middle Office on a pro rata basis in the form of an Excell spreadsheet to the GEDS/TRD manager only (who became GEDS manager on December 18, 2007), i.e. to JK’s L+5, a level which is too high for such data to be analyzed in detail. The DLP and DELTA ONE desk managers (JK’s L+1 and L+2 respectively), who could have identified this significant level of GOP 2A deposit expenditure, directly visible on such re-invoicing statement, were not recipients of this spreadsheet.

In other words, no accountability, no risk management, no brains at all. I’d say the onus is on senior management at this point to show that they should retain their jobs.

Michael J. Orlando, formerly of the Kansas City Fed, has written a piece for VoxEU: Let Form Follow Function: In Defense of Central Bank Independence. Somewhat cursory, but the basic assertion is sound:

Finally, recent events have demonstrated that the Fed may find it necessary to employ new and innovative approaches to target liquidity injections in times of crisis. For example, on December 12 the Fed established a new program to allow discount window borrowers to bid for additional liquidity extended for a fixed period of time. On March 11, the Fed established a program to lend U.S. Treasury securities against a pledge of other, presumably lower quality assets. And on March 16, the Fed initiated another new program to lend directly to primary dealers of government securities. Along with the Fed-arranged marriage between Bear Stearns and JPMorgan Chase, these programs merit continued debate and analysis. However, it is not obvious that the Fed’s ability to respond to this crisis in a timely and effective manner would be enhanced by more immediate legislative or executive oversight.

Willem Buiter disappoints me today with a rather breathtaking “therefore”:

Fundamentally, the key asymmetry is that the authorities are unable or unwilling, whether for good or bad reasons does not matter here, to let large leveraged financial institutions collapse. There is no matching inclination to expropriate or otherwise financially punish or restrain highly profitable financial institutions. This asymmetry has to be corrected. Therefore, any large leveraged financial institution, commercial bank, investment bank, hedge fund, private equity fund, SIV, Conduit or whatever it calls itself, whatever it does and whatever its legal form, will have to be regulated according to the same principles.

Dr. Buiter’s policy aim with this recommendation is, I’m afraid, not particularly clear to me. Additionally, I don’t see a lot of support for his premise that authorities are “unable or unwilling … to let large leveraged financial institutions collapse”. One may quibble over definitions, but I don’t think shareholders of Bear Stears are in 100% agreement with this assertion; neither are the beneficiaries of Carlyle’s leveraged mortgage fund or Amaranth – to name but two.

Protect the core, by all means! But to make all financial institutions as safe as the banks would be contrary to the ultimate public good.

Today’s BCE news (hat tip: Financial Webring Forum) is that the Supreme Court will move quickly on the BCE file:

Canada’s Supreme Court has agreed to speed up the process of deciding whether to hear BCE Inc.’s appeal of a lower court decision that threw the company’s $35-billion planned sale to a group of private-equity funds into doubt.

BCE had requested an expedited process to enable the company to try to stick to a plan to close the deal by June 30.

If leave to appeal is granted, the court said it will hear the case starting on June 17, with each side getting one hour for oral arguments.

Such excitement! There’s not just BCE news, but there’s Barry Critchley has asked a rather important question about the David Berry issue (emphasis added):

The current edition of Toronto Life has a major article on Berry that focuses on his time at Scotia — where he was the firm’s highest-paid employee — his $100-million lawsuit against his former employer and regulatory issues he is facing. Berry, his former associate Mark McQuillen and Scotia all faced allegations brought by Market Regulation Services: the latter two settled while Berry opted for a contested hearing.
…
Berry said the settlement materials are relevant and necessary because RS’s Discipline Notices “explicitly states that proceedings in respect of Scotia’s supervision of Berry and McQuillen were not taken by RS.

There is no information, however, that addresses why Scotia was not held responsible for failing to supervise Berry under [UMIR].”

Berry added that “the agreed facts in the settlement agreement entered into between RS and Scotia do not refer to Scotia’s supervisory obligations, and the agreed sanctions represent a simple disgorgement of financial benefits obtained by Scotia through Berry’s trading.”
…
When RS and Scotia settled, RS’s Maureen Jensen said, “We are pleased that Scotia Capital recognized in this settlement that, even though supervision was not an issue, it would not be appropriate to retain profits generated by the wrongdoing of its employees.” Which raises the question: Did Scotia get a special deal from RS?

It should be noted that it’s not too long ago that the Globe was oohing and ahhing over the fat paycheques handed out to dealers’ compliance staff … and RS was very proud of its role as a training ground. Why is revolving-door regulation permitted?

My last major post on the Berry issue was with respect to the OSC decision. There was some more detail given on May 23. Kerviel … Berry … motivations, methods and results were very different. But the basic issue is the same: does management have any responsibility at all to design a risk management system, use it and take responsibility for it? Or is it just there as an after-the-fact ass-covering and blame-casting device?

The market drifted slightly upwards today on light-ish volume.

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

This entry was posted on Monday, May 26th, 2008 at 9:29 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.