The eventful two weeks that the Indian stock markets have had has meant that not many have carefully looked at the news of a French trader making the largest ever trading loss. Jerome Kerviel, a 31-year old junior trader in the French Bank Societe Generale managed to lose around USD 7.1 billion (Rs 28,000 crore) of his bank's money. Beyond marvelling at the size of the losses briefly, no one in India really bothered much about this news. Soceiete Generale is not a name that means much in India, even though it's a partner in State Bank of India's mutual fund business. Moreover, I think we've all become a little immune to large numbers. I doubt if this Societe Generale's loss would have provoked a larger reaction if it had been double the size.
Over the years, huge trading losses have happened with some regularity in various markets around the world. In the last fifteen years or so, there have been at least ten publically revealed trading losses of more than 1 billion dollars. The most famous has been when Nick Leeson lost 1.4 billion dollars of his employer Barings Bank's money, a loss which sank that 250-year old institution. But there have been much larger losses to. Just last year, a US hedge fund, Amaranth Advisors lost 6.5 billion dollars trading in natural gas futures. In 1998, Long Term Capital Management, a high profile hedge fund lost 4.6 billion dollars and caused a financial crisis. Interestingly, even though in India we generally think of the stocks as the only high-risk market, only two of the top ten losses have anything to do with stocks. Kerviel lost Societe Generale's 7.1 billion dollars in stock index futures (of the Eurostox and the German DAX futures) and Nick Leeson sank Barings Bank trading in futures of the Japanese stock index Nikkei, but that's it. The other eight in the top ten are from markets like copper futures, oil futures, gas futures, interest rate derivatives and currency swaps.
The other interesting thing about these king size losses is that only some of them were frauds. Kerviel and Leeson and some others on the list were rogue traders who were doing things that were not authorised by their employers, although it is being said that Kerviel's bosses turned a blind eye as long as he was making profits. However, LTCM and Amaranth Advisors lost money doing exactly what they were supposed to do. They underestimated the risks they were running but mostly, they were just wrong in the bets they made. However, the most interesting thing about the list of losses is that when I read details of what the traders did, I see exactly the same behaviour pattern that characterises most of the people who are speculating with their own money on our stock markets. They all had huge positions that were leveraged out of all sane proportion. They had all made good gains in easy markets and then lost their heads and started to believe that they were invincible, that they had to be right and any losses they made could be covered up by taking even more risks. In each of these cases, the facilitator has been some variation of a derivative market of the kind that is generally held up as a shining example of 'financial innovation'. While a Kerviel or a Leeson should have been monitored more closely by their bosses, I'm not sure what can be done about ordinary investors who are innovating their way to bankruptcy because of the same kind of behaviour.
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