Societe Generale just won an award for risk management in its derivatives area - Now they have taken a $7 billion dollar hit there. CIBC's Chairman sensed there was a problem with CIBC's exposure to subprime - but it took weeks to tease it out.
Most people are aghast at the scale of the damage done to banks and wonder how the control systems could have been so poor. Was it just greed?
I don't think so. I think we are past a threshold of complexity where bank management can comprehend and control risk.
After more than 20 years in a dealing room - I learned one thing. No matter what controls you have, in the end you have to rely on the people. It is always possible to game the system for a while - especially if you are clever and there are few stupid people who have large books on the desk.
My sense is that the leverage implicit in derivatives and the ability to postpone a reckoning makes it possible for the rogue to have the power of taking down the bank. In a simpler world you could mark to market and see where you were and you could look at the long term history of spreads and get a sense of your position. (Traders do not bet whether markets go up or down only punters do that, they like Casino owners bet on spreads that are more predictable)
As derivatives add layer upon layer, the complexity scales in a non linear fashion. Not only can the rogue hide his shit - but the book itself cannot be comprehended.
For me a lesson for all of this would be for the Fed to pull a brains trust together and examine this issue of complexity - is there a way to pull back to a level where it can be understood and hence controlled?
