25 January 2008
Nobody Knows Nuttin' : Latest Proof
The US markets were closed for M.L. King's birthday on Monday, but the rest of the world's exchanges took steep dives. Then when the markets in the US re-opened on Tuesday morning, they started sharply lower, regaining some of the lost ground as the day went on. On Tuesday, again, sharp loss in the morning, this time with a firm rally in the afternoon -- regaining more than had been lost -- ending the day above Friday's close.
What was going on? There was no dearth of explanations. It involved bond insurers, liquidity problems, jobs statistics, reactions to developments in the US presidential campaign. Phases of the moon and the death of Heath Ledger were only rarely invoked as explanations, but were on standby.
Meanwhile, though, in Paris, officials of that country's second largest bank, an institution that has been around since the era when Paris was briefly run by the communards, were desperately trying to close out the positions of a rogue trader who had lost about 5 billion euros of their money.
The timing and the scale both look right for this to be cause and effect. The Société Générale employee, Jerome Kerviel, had been making huge unauthorized and very speculative trades, and had evaded the bank's risk-management controls by hacking its computer system. Its an old story, though it seldom happens on this scale. Trader hopes to cover his initial losses by doubling down. Heck, if I just lost $100 on a coin toss, I should bet $200 next time, shouldn't I? I could win my money back and still book a gain. If I lose again, so my losses are $300, I can always bet $400 on the third try. Lose again, bet $800. Sooner or later, I've got to win.
Well, no. There is no law of probability that guarantees that even a talented hacker can dig himself out of such a [w]hole. The losing streak can continue until your bankroll is gone.
In this case, it continued until he tried something fancier than usual in his hacking, and raised red flags. Bank officials questioned him throughout the day Saturday.
Monday ... well, you know the rest. Extreme volatility on all those non-US markets. The bank made no official statement on the matter until yesterday, Thursday.
Still, the incident proves that markets are hard to fool. You can fool some of the traders some of the time, and your bank bosses for a long time, but world markets figure it out and start to mark prices down accordingly.
This is why nobody knows nuttin. Even the brightest of us is just a single neuron within the brain which is the world financial market as a whole.
Knowledge is warranted belief -- it is the body of belief that we build up because, while living in this world, we've developed good reasons for believing it. What we know, then, is what works -- and it is, necessarily, what has worked for us, each of us individually, as a first approximation. For my other blog, on the struggles for control in the corporate suites, see www.proxypartisans.blogspot.com.