Interesting article this week in the MIT Technology Review (OK, so I don't understand most of it, but I still aspire to be a geek) in the wake of the trading losses announced by Société Générale at the hands of rogue trader Jérôme Kerviel.Last week, the French bank disclosed the $7.2 billion loss. In the wake of the disclosure, Bank of France chairman Christian Noyer declared to a French senate finance committee, "None of the controls within Societe Generale seem to have worked as they should have."
Interviewed in the article, MIT's Andrew Lo, head of the university's Laboratory of Financial Engineering, said that given the fact that all software systems have a human interface, "I would argue that it is impossible to prevent these disasters with 100 percent certainty."
The problem
Lo continues his interview by describing how more and more complexity in the global financial system increases the "ripple effect" of any adverse shock to the system. Says Lo, "Systemic shocks become more likely. Today, we are looking at some significant exposure to relatively rare events."
I've been discussing an issue with fellow BloggingStocks writer, Aaron Katsman, over the past week. Though it's just conjecture, I've postulated that the global sell-off early last week was the direct effect of SocGen unwinding Kerviel's trades. Katsman thinks it's hogwash and that global markets are too big, liquid, and vibrant to allow something like this to cause such an effect.
Lo disagrees. He says boldly, "One natural hypothesis is that the global sell-off that happened early last week was a direct outcome of Societe Generale's unwinding of these rogue trades."
The solution
Lo's suggestion to combat such whiplash in the global markets is to set up the equivalent of the National Transportation Safety Board for capital markets. Lo concludes the interview by saying, "A Capital Markets Safety Board would give investors more insight into the risks of any given investment. Over time, the aggregate information produced by the CMSB would shed additional light on the nature of systemic risks for the entire global financial system.
Pretty interesting solution for investors.
Zack Miller is the Managing Editor of IsraelNewsletter.com and a former equity analyst for a leading multinational hedge fund.
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