‘Rogue Traders’ provides tales of financial negligence

BY SCOTT E.D. SKYRM

Sixty-six billion dollars. That”™s how much money has been lost by rogue traders over the years. Granted, sometimes there”™s a fine line between a Wall Street trader taking an enormous loss and labeling him as “going rogue,” but if you look at the 45 largest trading losses of all time, at least 40 can be attributed to a rogue trader. In my book “Rogue Traders,” I tell the stories of some of the largest trading losses of all time.

There were very few rogue trading losses before the 1980s. In fact, there was only one, in 1974, that was large enough to show up in the history books. That”™s the $180 million loss by Herstatt Bank in Germany on foreign exchange trading, which led to its collapse. In the 1980s, there was $1.6 billion in losses. In the 1990s, that number shot up to $18.6 billion. And since the beginning of the 2000s, the number has grown to a startling $45.9 billion. There”™s got to be a reason for it.

So what is a rogue trader? I define a rogue trader as someone who”™s taken unauthorized trading positions or risks ”“ someone who”™s manipulated a market, hidden losses, partaken in some kind of illegal activity, someone who arrived at a fork in the road with two possible paths and took the wrong one.

When I first became a junior trader in the early 1990s, and finally got my own trading account, my boss gave me some very interesting advice. He told me the first thing I”™d learn was “what not to do.” He was basically telling me that I was going to make mistakes, and he expected it. He expected I”™d take losses ”“ granted, only for a short period of time. Mistakes were expected like not putting a stop-loss on a trade, letting losses grow larger and making trades that appeared to make easy money up front but had hidden risks in the back end ”“ all the Trading 101 words of wisdom written in all the books that people so often ignore. In one way, “Rogue Traders” is about “what not to do.”

The book offers lessons from the roguesӪ mistakes. It examines what went wrong and what caused $19.5 billion in losses. It includes the stories of seven rogue traders: David Heuwetter, of Drysdale; Howard Rubin, of Merrill Lynch; Joe Jett, of Kidder Peabody; Nick Leeson, of Baring Brothers; Brian Hunter, of Amaranth; Jerome Kerviel, of Soci̩t̩ G̩n̩rale; and Tom Hayes, of the Libor scandal. It looks at the growth and development of the repo market, mortgage-backed securities, securitization, U.S. Treasury securities, futures, natural gas, stock indexes and even Libor.

Philosopher George Santayana wrote a famous statement in 1905 in his book “Reason in Common Sense.” He said, “Those who cannot remember the past are condemned to repeat it.” That quote was answered by Kurt Vonnegut years later: “I”™ve got news for Mr. Santayana: we”™re doomed to repeat the past no matter what. That”™s what it is to be alive.”

But I want to be clear: Just because some people don”™t learn from mistakes, it doesn”™t mean you shouldn”™t.

“Rogue Traders” is about money made and money lost. It”™s about bosses who looked the other way when there were clear signs of trouble. It”™s also about what people do when they can”™t face a setback, a loss or a crisis. Often, it”™s what fairly normal people do when confronted with professional ruin. Is it about greed? Bankers”™ greed? Wall Street greed? There”™s certainly a lot of that, but I”™ll let you decide that one for yourself.

Prior to the 1960s, Wall Street banks were all set up as private partnerships. There was unlimited personal liability and everybody who was taking risk had their money tied up at the firm. The head trader watched everyone on the trading floor ”“ his retirement money was tied up in the firm, too. It was a system that had unlimited downside for all those involved.

In the 1950s and 1960s, these firms began to incorporate. As their size grew, the partners wanted to limit their personal liability. Merrill Lynch incorporated in 1952 and Paine Webber in 1969. It solved the problem of unlimited personal liability, but people still had their money tied up at the company.

But in the 1970s and 1980s, things really began to change when all the firms became public companies. Merrill Lynch went public in 1971, Salomon Brothers in 1978, Bache was sold to Prudential Insurance in 1981, Kidder Peabody was sold to General Electric in 1986 and Morgan Stanley went public in 1986. “The world changed in some fundamental ways, and most of us were not on top of it. We were almost dragged into the modern world,” according to John Gutfreund, the CEO of Salomon Brothers. The partnership structure that had incentivized the employee-owners to take conservative risks was beginning to disappear. Risks were being taken by low-level employees at investment banks with thousands of employees and traders who lost huge amounts of money lost their jobs only to get second, third, and even fourth chances.

The system became even worse in the 1990s. Most of the investment banks were absorbed by global commercial banks. They had global trading operations, which were nearly impossible to manage, and the old, conservative nature of the business was entirely gone

It was a new era, populated by young and aggressive traders who were all eager to make large sums of money. The whole system was upside down: The downside became limited and the upside unlimited. Traders could make millions of dollars in bonus money and if the trader blew up, they merely lost their bonus, or perhaps their job. But they still had the chance to get another trading job after that because now they were known as a big, market moving trader.

These days, there”™s new regulation: The Dodd-Frank Act was passed in 2010, so hopefully going forward, rogue trader losses won”™t happen. The risk management systems at banks are more robust, but on a cynical note, there seems to be a directly opposite correlation between regulation and losses. The markets are more regulated than ever, but still the London Whale rogue trading event occurred at JP Morgan in 2012. So when”™s the next rogue trading event? Perhaps if someone learns from the mistakes of the past, we might figure out how to prevent it.

“Rogue Traders” is New Canaan financial markets and repo adviser Scott E.D. Skyrm”™s second book. In June 2013, he released “The Money Noose ”“ Jon Corzine and the Collapse of MF Global.” Email him at scott.skyrm@yahoo.com. On June 14, he will sign copies of “Rogue Traders” at the Elm Street Bookstore, 35 Elm St., New Canaan, 10 a.m-noon. The event is free.