Only The Reckless Need Apply

The Independent  –  19 Sept 2011

I accidentally became a stockbroker in 1996. Two days into my bizarre new career I realised that I had somehow chanced upon a cash cow that was crying out to be milked by a cocky, risk-taking buffoon like myself. I just needed to learn the rules of the game, understand when those rules could be broken, and sit back and watch my bank balance grow exponentially.

When I looked around my bank’s hectic trading floor during that first week it also quickly became apparent that the big swinging dicks were nearly all brash, confident mavericks who had decided in their crib that defeat was not an option. Just like a ghetto kid who sees the local gangsters driving flash motors with stunners in the passenger seat, I knew immediately how I would have to behave if I was to thrive on the mean streets of EC2 … and it wasn’t by learning the minutiae of accountancy or attending investment seminars.

The simple fact is that investment banks both attract and reward macho, hyper-competitive gamblers whose arrogance is only rivalled by their ruthlessness. These are, of course, the very character traits that lead to rogue trading. Combine these lovely features with a willingness to win at any cost, and a conviction that the normal rules don’t apply, and you can soon see how characters like Nick Leeson and Jerome Kerviel decided that doubling up on punts that had gone belly up and hiding the previous losses was the “right thing to do”.

I suspect that when the details of the case against the trader Kweku Adoboli, who is alleged to have lost UBS £1.5bn, we’ll discover if he was subjected to similar pressures.

But crimes like these don’t just happen because of the flawed personalities of certain traders. The investment banking system gives these characters the motivation and the opportunity to take these huge unauthorised punts.

First of all, the asymmetrical nature of the bonus system incentivises reckless gambling because bankers receive a portion of any bets that come good but don’t lose any of their own cash when they fail. Combine this wonderful reality with the fact that you are betting with someone else’s money – and the fact that your senior colleagues repeatedly tell you that the party is coming to an end soon – and the incentive is there to put all your chips on red and to hell with the consequences.

Sure, you may lose your job if you screw up, but if you’re already down £10m or so that’s a racing certainty anyway so you’ve got nothing to lose.

Second, the system is clearly open to abuse by a clever fellow who knows how the back office works. Every banker’s job entails assessing risk and reward and Leeson et al clearly decided that their chances of being caught before they’d made back the money they’d initially lost were sufficiently small to warrant another illegal roll of the dice. That assumption is a clear indictment of their banks’ internal risk controls, which were supposed to have been improved after the financial crisis.

Finally, the vast sums that these rogue traders lose are only possible because of the existence of complex derivatives that allow traders to win or lose massive multiples of the stakes they gamble. It is these “financial weapons of mass destruction”, as legendary investor Warren Buffett called them, that got us into so much trouble three years ago, and their continued existence and the lack of controls over them should send a shiver through everyone.

Investment banks attract “potential rogue traders”, encourage their risk-taking, and fail to curb their excesses. We should not be surprised of the outcome if we put lions in a cage with lambs.

Thoughts ?

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