Lack of Risk Management Led To A $7 Billion Loss

Jerome Kerviel, now there is a name you don't hear every day. Well get used to hearing it because that name will be spoken repeatedly during the next month or so. Mr. Kerviel is the 31 year Frenchman who worked as a trader for Societe General and who reportedly lost $7 billion for the bank on unauthorized trades.

How does this happen? Who is minding the store at SG? How can Societe Generale allow an employee to lose $7 billion? The question is about risk management, and where was it? Losses happen and even at times large losses take place. What is mind boggling is that the scope of this employee's trading activity was unknown. How on earth can the amount that this guy was trading go unnoticed? Where was management? Again I stress - losses happen, yes even $7 billion worth, but to have unauthorized trades occur in such size is startling. What would have happened if the losses continued to go unnoticed and the losses became larger?

Lets suppose for a second the opposite happened. Let's say no one caught these trades but that eventually the trades turned profitable. Actually quite feasible since the world's equity market did rally sharply from Tuesday's bottom. Also it was only after weeks of trading that a compliance officer at the bank found out what was going on. So if a compliance officer had not stumbled onto these trades then what could have happened? Might the trader actually have made tons of money? He reportedly was long equity futures which had been going his way until the start of 2008. But the start of 2008 pretty much turned gains into massive losses as the world equity markets collapsed. But ever since the Fed rate cut the equity markets made up tremendous ground. Makes you wonder had this trader had more time would his trades eventually have turned profitable? Maybe he would have made SG billions instead of losing $7 billion.

Risk management, risk management risk management. I can not stress these words enough. Unless an individual has the skills of a Warren Buffett or a Peter Lynch a trader should not make a habit of averaging down. Actually in almost all cases averaging down should be avoided. A trader that makes a habit out of averaging down on a bad trade will eventually get carried out. Mr. Kerviel was carried out today if only figuratively as he is currently missing.

**********************************************************************************

Update on Saturday. I stand corrected. Mr. Kerviel is not on the run but has been with his lawyer all week.