This week’s attention grabbing headline wasn’t the economy. It was the tale of a lone trader who manages to clock up a couple of billions in losses before the police was alerted. All of us are thinking: Yet again! Leeson was the first one. Then there was Jerome Kerviel. And now a fresh-faced UBS trader joins the ranks of those elite few who manage to perpetrate massive fraud before they are discovered.
The question we have to ask ourselves is why? It’s not like they are stealing money from the company. They don’t have access to physical cash. They can’t transfer money from their trading accounts to their own accounts.
The only reason anyone would conceal losses is if they were financially compensated for how much money they made for the bank. In there lies the heart of the matter: moral hazard.
In economic theory moral hazard is a situation in which a party insulated from risk behaves differently from how it would behave if it were fully exposed to the risk.
Moral hazard arises because an individual or institution does not take the full consequences and responsibilities of its actions, and therefore has a tendency to act less carefully than it otherwise would, leaving another party to hold some responsibility for the consequences of those actions.
The 3 traders we know about, Leeson, Kerviel and now Adoboli, were all most likely on a performance related pay-package. Yet all 3 of them hardly had anything to lose, except perhaps their jobs. Yet somehow they choose to bet bigger and bigger to get out of the hole, oblivious of the consequences to their surroundings.
Trader Nick Leeson’s saga
Nick Leeson’s saga started when a back office mistake (an assistant executed a clients order as a “buy” rather than a “sell” – an error which could not have cost Barings bank more than perhaps $20,000) escalated into a full blown outright bet on the direction of the Nikkei Index, betting the future of the bank in the process.
Kerviel’s saga hasn’t surfaced completely. Looking at the charts he was long the DAX and EUROSTOX index and he lost big. He must have added and added to that bet; otherwise it is simply impossible to lose the amount he did.
UBS trader’s story has yet to emerge
The UBS trader’s story has yet to emerge. Maybe it had something to do with the Swiss Central bank’s announcement to protect their currency. Time will tell. However, from the court statement he is charged with fraud dating back to 2008. At the time he was just 28.
The underlying theme of all 3 traders is the fact that they could not admit they were wrong. They could not face up to the possibility that they were wrong. The fear of being wrong is something all traders have to keep in check. Now, yet again, our honourable profession has been tarnished. Hopefully no lasting damage has been done.
It is relatively straight forward to keep the fear of being wrong in check, but it takes a daily reminder (at least for me) to keep under control.
Whether you are a retail trader or a trader at an institutional level, you have to be honest and have integrity. The institutional trader has to be honest to himself and his management. We on the retail side have to constantly introspect and be brutally honest with ourselves.
Man will always strive towards progress. It is in our nature. Yet we all have an Achilles, which is our ego. I am not removed from that myself. However, through persistent training I have at least come to a point where I can quickly acknowledge that it is my ego trading, rather than my normal self trading. It wasn’t a magic pill that brought me here or some earth shaking eureka moment. It was simply an observation of my action.
Every day all traders have the potential to make irreversible financial damage to themselves. Yet most of them go home without having done any damage at all. It is a question of training and repetition of a few routines. Like the saying goes: we are what we repeatedly do.
“Everything that has been will be, everything that will be is, everything that will be has been.”