The Cat and Mouse Game of Risk Manager versus Rogue Trader
Every several years, or so it seems, a rogue trader pops up somewhere to cripple an institution with a loss that looks like the GDP of a small country.
This naturally sends trading desk managers, risk managers and the top-of-the-house management into afervent self-examination of their own risk controls. While one would be foolish, from a practical and political standpoint, not to check the locks on one’s own doors and windows after the neighbor’s house was just robbed, the ability to prevent a rogue trader from looting a firm’s capital is redolent of that old saw: there are no locks for thieves (i.e. an aggressively motivated thief will find a way in).
Of course firms need risk controls. Most firms, in fact, actually have quite effective controls, until a highly intelligent but bent trader devotes all of his brainpower to finding a way around them. Trading is an individual skill. Traders are more like ballplayers than businessmen. They carry their ability around in their head and only require a firm to provide them with a screen, phone and – this is the big one – capital.
Similarly, a ballplayer needs a team to provide the infrastructure, yet the actual ability rests mainly with the athlete. The nature of trading breeds a culture of individualism. Traders view themselves as self-contained profit centers. In most cases, this engenders nothing more than the healthy self-motivation and confidence required to successfully trade brutally competitive markets. But occasionally, things go very, very wrong.
The odd thing about Allied Irish Bank’s apparent rogue trader, John Rusnak, is that, based on the scant information available so far, he fits neither of the two most common profiles of rogue traders. Most rogue traders are bred of either ego or lifestyle gone supernova. Joe Jett, who in the early 1990’s was a putative rogue trader of zero coupon government bonds, fits the former. He didn’t live a sybaritic lifestyle, but traded gargantuan size and became, for a period of time, the zero coupon bond market itself.
The other profile is the lifestyle king. He lives the high life – penthouse, country home, wine cellar, stable of cars and a leggy blonde with an icy stare – and needs to finance it with ever-bigger bonuses driven by ever-bigger trading profits. Unfortunately, trading rarely produces a steady stream of uninterrupted profits.
This is where the wheels normally start to leave the tracks for either the egotist or lifestyle king. If one’s entire sense of self is tied to one’s dominance of the markets, then a losing trade is literally tantamount to wiping out one’s existence. If trading profits beget bonuses and bonuses beget lifestyle, then trading profits – for the lifestyle king – have to keep coming. The next step, for both, follows perforce: losses must be made to disappear and profits to appear.
All that follows – fake tickets, buried tickets, altered confirmations, false addresses, cat’s cradle-style forward trades, etc. – is nothing more than the sordid details that are behind every trading scandal. The risk barriers so assiduously erected are hurdled with Olympian skill when all of one’s mental faculties are devoted to creating the illusion of profits. The trader brings his well-honed analytical skills, probability judgment and raw nerve to gaming the system – there are no locks for the motivated thief.
Surprisingly, Allied Irish Bank’s John Rusnak fits neither profile. He didn’t dominate a market – no one had even heard of him before news of his $750 million loss hit and everyone was scratching his or her head as to how he could have lost so much money anonymously. He also appears to have acquired none of the lifestyle accouterments that fit the second common profile.
Patching together the little information that is available, it appears that, like Valjean’s decision to steal the bread, everything just spiraled horribly out of control from the first mistake. In trying to trade out of a loss, he exceeded his trading limit – the threshold to the dark-side was crossed. Once started, whatever the motivation, the pattern is the same: do whatever it takes to hide losses and book fake profits. It appears that Rusnak, bread in hand, just kept going.
Rusnak had the benefit of operating out of a distant branch office (a red flag to risk managers), but is there really any way to prevent someone who is willing to ruin his own life from kicking over the orange traffic cones for a while? Rogue traders are like kamikaze pilots – you really can’t stop them, but you can look for the early warning signs of disproportionately large profits and ticket volumes, exceedingly intricate trading strategies and odd personal behavior and work hours.
In the end though, there will be more rogue traders to come. A trader by nature is a solitary character able to harness his acute powers of observation and risk taking into profitability by outsmarting other traders. When the screw gets turned just a bit too far – by dint of ego, allure of riches or simply one errant step down a very slippery slope – those same skills are brought to bear against the risk controls of an institution. Risk managers everywhere will dissect the post-mortem on Rusnak and, perhaps, some new locks will be put on the firm’s trading-capital supply cabinet. This is what must be done, but make no mistake, some errant trader in the future will figure out how to pick those locks also.
Source: RiskCenter.com |
