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January 29, 2008

Financial Regulator Wanted! No Experience Needed
by Adrian Ash

"We need to stay cool and send positive signals...I repeat: We shouldn't create alarm." - Joaquin Almunia, European commissioner for monetary affairs, interviewed by Der Spiegel, Jan 27th

JEROME KERVIEL, fast-overtaking John Law as France's worst-ever financial mishap, claimed on his most recent resumé to enjoy judo and sailing, as well as running up $7.1 billion in losses for his employers in his spare time.

Something of a loner according to the world's media (only 11 friends on Facebook - can you imagine!), he's also been called a "computer genius" by his colleagues at Société Générale in Paris.

But that genius earned him a mere €100,000 last year - "peanuts in the banking world" as the British press puts it. What gives?

Kerviel studied economics at Nantes and then Lyon (one of France's top 10 universities), before joining SocGen as a back-office drone in 2000. He worked on risk-control and security systems for two years, before graduating to Trading Assistant (a.k.a. middle-office drone) on the European equities desk, plugging numbers into SocGen's stock-market derivative positions.

"He spoke very little, answering questions with nothing more than a yes or a no," whispers a colleague, aghast. Behind the weirdo stare, however, this low-grade bean-counter was in fact a criminal mastermind - or so everyone says - bent on gambling three times SocGen's entire stock-market cap by "hacking through four separate fire-walls" according to French finance minister Christine Lagarde.

Monsieur Kerviel then chose "very specific operations which didn't involve any cash movements...placing transactions which did not require immediate confirmation" from senior management, says Jean-Pierre Mustier, head of corporate & investment banking at SocGen.

Judging by the public statements of SocGen's management, Kerviel also kept a white fluffy cat and hid a fish-tank stocked with piranhas just below the trap-door in his hallway. "The nature of his fictitious and fraudulent operations were constantly evolving," pleads Daniel Bouton, SocGen's CEO, in an interview with Le Figaro.

"And when the control systems detected an anomaly, he managed to convince control officers that it was nothing more than a minor error."

Sacre bleu! This sad loner was able to fool all of the people pretty much all of the time, including the time when SocGen's risk-management team got down to scrutinizing his book. They'd even been alerted by Eurex - the European derivatives exchange - that something was more than a little amiss with Kerviel's positions.

Didn't the 2,600 people apparently working in "risk management" at France's second largest bank bother to dig deeper? Ahhh...but Kerviel was a criminal genius, remember. Everybody says so. Albeit a criminal genius stuck in bean-counting roles for six years who managed to scrape barely half the average stock-trader's salary when he finally got a trading position.

It could have happened anywhere, or so everyone agrees - even if Kerviel did lack the brains and balls to really get ahead in the competitive, cocky world of financial trading.

On the other side of the trade, meantime - and protecting the world's investors and savers from the skew-eyed evil geniuses working Excel spread-sheets at French investment banks - sit the regulators. You might think they're too busy already keep up with today's brightest financial brains. But just wait until the politicians are finished trying to cover their own derrieres.

"We have to put a stop to this financial system which is out of its mind and which has lost sight of its purpose," spat French president Nicholas Sarkozy on a trip to India last weekend.

"The point of a financial system is to lend money for economic activities, which, in turn, generate profits. It is not to go and speculate on different activities which create enormous flows and profits in a few hours."

Oh really? Just what does Monsieur Le President think derivatives are used for today - creating economic value through prudent lending? Jerome Kerviel struggled to make $150,000 a year in a job that regularly pays nearer $300,000 plus year-end bonus. Even when the authorities at Eurex queried his trading, the "risk management professionals" at SocGen fell for his schtick (it seems) and missed the sheer size of the positions he'd built up.

Either that, or they did know what was happening...and the rumors of a €300,000 bonus ($447,000) if Kerviel's high-risk model paid off are more than just chatter.

It's not just the high-octane world of derivatives tom-foolery that's bamboozling government regulators and their elected bosses, however. "The failure of Northern Rock, while primarily a failure of its directors, was also a failure of its regulator," reckons John McFall, the UK member of parliament who's just led an official inquiry into Britain's first banking run in 130 years.

"We propose the creation of a new post of Deputy Governor of the Bank of England and Head of Financial Stability," his report concludes - seemingly unaware that the BoE already has a deputy governor responsible for financial stability.

Sir John Gieve was appointed Deputy Governor in Jan. 2006, with specific responsibility for the Bank's Financial Stability work.

Ah, but "the deputy governor should be someone with senior banking experience," counters Michael Fallon, another member of the Northern Rock inquiry. "You can't have someone like Gieve, a civil servant without any banking experience."

So who would you expect to hire instead? A senior banker looking to lose all his Facebook friends by stamping on their business models in between rounds of golf? Gieve is the perfect man for the job of monitoring financial stability, anyway, because what he does have is bureaucratic experience. In spades.

A career policy-wonk from the age of 24, Gieve really showed his own talents as Permanent Secretary to what used to be called the Home Office. (After it lost three political chiefs in only five years, the Justice Ministry as it's now known underwent something of a re-branding.) It was entirely "unfit for purpose" claimed one of the hot seat's brief incumbents - and running the department day-to-day was Gieve's responsibility.

Indeed, the man now charged with over-seeing the UK's financial stability seemed to have real trouble with his Excel spread-sheets back at the Home Office.

"Accounts contained numerous errors and internal inconsistencies," said the official auditor's report in Jan. 2006. He refused to sign off the Home Office's internal accounts for the last year of Gieve's tenure.

"In particular, amounts relating to cash, Exchequer funding and non-retainable income...were contradictory and did not reconcile between the different places in which they appeared in the accounts," the auditor stated.

"There were also material omissions and misstatements, for example the value of the private prison estate was incorrectly recorded in the accounts."

Sir John is no accountant, however. That's why he nabbed a deputy guv'nor-ship at the Bank of England three weeks before the auditor's report on his Home Office accounts was released. Just the man for the job!

"It is clear that the distinctions between different types of financial institution - banks, securities firms and insurance companies - are becoming increasingly blurred," announced Gordon Brown on taking office as UK finance minister in May 1997. Now enjoying the slings and arrows that go with being prime minister, "there is a strong case for bringing the regulation of banking, securities and insurance under one roof," he concluded back then, axing the Bank of England's supervisory role and giving it to a new 'super regulator' that would become the Financial Services Authority three years later.

Yes, the very same Financial Services Authority that failed in its duty to monitor and regulate Northern Rock.

"Is the creation of a such a regulator feasible," asked The Banker magazine in June 1997. "Will it necessarily be more effective, and should it be attached to the central bank? In a business dependent on trust and confidence why abandon a well respected institution in the hope that a less prestigious one will do better?"

Even the head of the Bank of England, "Steady" Eddie George himself (BA Cambs; career central banker; no private-sector banking experience whatsoever), found it hard to bite his tongue, despite winning independence on setting interest rates within one week of Gordon Brown (PhD Edin; career politician, plus a brief stint as lecturer & journalist; no banking or business experience whatsoever) becoming Chancellor of the Exchequer.

"Former BoE supervisors have expressed concern over whether credibility could be maintained in a single institution which is responsible for both the mis-selling of pensions and systemic risk," The Banker magazine went on.

"And BoE governor, Eddie George, has warned that the new and expanded [regulator] risks becoming over-bureaucratic and too inflexible in taking a one-size-fits-all approach to financial regulation.

"Other have worried over how the BoE staff, and the culture they bring with them, will blend into the new 'super-SIB' structure. Some fear the different purposes of regulation will themselves become blurred within a single organisation."

British readers might find all this...written almost 11 years ago...wearisomely familiar. The looming collapse of Northern Rock's aggressive short-term borrowing model was utterly missed by the Financial Services Authority last summer, even as the global credit crunch bit. It was left to the current BoE governor, Mervyn King (PhD Cambs; career academic; no private-sector banking experience whatsoever) to warn - vaguely - of the risks to stability posed by the UK's record credit binge.

But as Helen Liddell, then economic secretary to the Treasury, put it in May 1997, re-arranging the UK's regulatory structures was just a "management issue" which would be solved.

And government can resolve anything it chooses, right? Most especially the multi-trillion international financial markets...where the world's brightest brains sweat bullets trying to turn a quick buck even quicker.

Adrian Ash
BullionVault.com

Head of research at BullionVault.com, the fastest growing gold bullion service online, Adrian Ash is also City correspondent for The Daily Reckoning in London, and a regular contributor to MoneyWeek magazine.

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