John Gapper’s new e-book, How To Be a Rogue Trader, is really good. Gapper’s been covering such things ever since he wrote a 1997 book about Nick Leeson which itself has just been reissued in Kindle form. And you might be surprised how many rogue-trading scandals there have been between then and now. Leeson was roughly contemporaneous with Joseph Jett, at Kidder Peabody; since then we’ve had Toshihide Iguchi at Daiwa, Yasuo Hamanaka at Sumitomo, John Rusnak at AIB, a team (!) of four rogue traderes at National Australia Bank, Jerome Kerviel at SocGen, and of course Kweku Adoboli at UBS.
Gapper’s book looks at the common pathologies here, and finds quite a few. The first is a trait common not only to rogue traders, but rather to all animals — it’s been seen in birds quite vividly. It’s the entirely rational decision which you see in any movie where somebody utters the line “it’s the only chance we’ve got” — no matter how improbable your chances of success, if the alternative is failure, then you take the gamble.
Some people are more likely to take those risks than others, of course — and those people are exactly the ones who end up getting hired on trading desks. As Gapper recalls, Christopher Heath, the former CEO of Barings, would ask potential recruits if they were “hungry” — much as Ace Greenberg and Jimmy Cayne did at Bear Stearns. And “hungry” is exactly the state that you need to put birds in before they start taking stupid risks.
Investment banks don’t just hire the kind of people who are more likely to go rogue, they also encourage exactly the kind of trading that rogue traders excel in. Risk-management operations are designed to reduce risk, rather than detect fraud. And rogue traders, if you believe their numbers, tend to be running extremely low levels of risk.
There’s an almost infinite number of strategies, on Wall Street, which work until they don’t. Many involve shorting volatility in one form or another, maybe by selling out-of-the-money options. That brings in lots of cash, and you can do it for a long time until you blow up. More desperate strategies involve doubling down in an attempt to make up bad bets — a strategy which Andrew Weisman has demonstrated is likely to work for more than seven years of outperformance until the inevitable conflagration. Or you can simply mark your illiquid assets to “market” rates which get further and further away from reality. If a rogue trader does this, says Gapper, he “appears to be doing everything right”.
And he’s also likely to be supported, at least implicitly, by the most senior executives at the bank. “There has never been a case of a rogue trader carrying on his fraud for months or years without the executives in charge having noticed at least some signs of trouble, and often having been bluntly advised to investigate,” writes Gapper. “They often react by ignoring what they see, and telling the whistleblowers to shut up.”
Of course we have no data on how many times executives are asked to investigate something suspicious and they say yes. But this kind of gut denial that anything could be amiss is far too common in executive ranks, especially in banks where the first job of every executive is always to manage risk.
Gapper does find one thing which the executives, as opposed to the rogue traders themselves, have in common: they, too, have excessive amounts of hunger. The banks worst hit by rogue trading, Gapper writes, are not generally found in Wall Street’s bulge bracket. Instead,
they are striving to get there… they are outsiders that are eager to make their mark and are willing to take short cuts. They tend to be retail and commercial banks seeking to transform themselves into investment banks. They have a case of what became known before the 2008 crisis as “Goldman envy”.
Just as rogue traders want to be successful traders, rogue banks want to be Goldman. These kind of blow-ups, in other words, are a natural byproduct of precisely the ambition which is so highly valued on Wall Street. And as a result, they’ll never go away.