IT Could Have Caught $2 Billion Rogue Trader

superapecommando writes "With the benefit of hindsight, IT experts are claiming that technical countermeasures at Swiss bank UBS could have stopped rogue trader Kweku Adoboli running up a $2 billion loss." If American Express and Visa can mine transaction data and put a stop order on credit cards when you unexpectedly buy gas out of state, it seems like there could be patterns to watch for when the amounts are in the billions, too.

Comments

Sure...

[Anonymous Coward]

... but said IT is the department that get's downsized on every occation; it only costs money and add's no value, rrrrrrrrrrrrrrright?

perhaps, perhaps not

[Trepidity]

A problem is that it's difficult to design a system to automatically determine "risky" or "rogue" or "non-normal" behavior in investment banking, because taking crazy bets is what they do, and interpreting their official policies loosely is a big part of that. Sometimes it turns out massively well, in which case bonuses all around; other times very badly, in which case start looking for ways to label the guy "rogue" and fire him. But it's de facto, if not officially, part of "normal" operation of an investment bank; it just sometimes turns out badly.

Re:perhaps, perhaps not

[adamchou]

Sure, they make plenty of trades that are risky in the sense that there is a high probability for loss. However, they shouldn't be making those kinds of trades when the potential loss is in the billions. That's an absurd amount of money to be using in high risk trades.

Re:perhaps, perhaps not

[Anonymous Coward]

I think people do relish the opportunity to endulge in schadenfreude where banks are concerned though. People latch on to a phrase like "casino banking" and gleefully apply to everyone in the industry with the intent that we should shut it all down. By the same logic:

A police officer took a bribe, we should shut down the police.
Well, there was teacher who was a paedophile once. We should shut down schools too.
Look at that corrupt politcian, shut down the government while you're at it.
The guy at Blockbuster charged me for bringing a DVD back 5 minutes late. Shut down them too!

Re:perhaps, perhaps not

[Dutchmaan]

So it's glorify the gains and criminalize the losses!!! Where have I heard something like that before.. hmm...

Re:perhaps, perhaps not

[dnaumov]

There is no "problem". Any investment bank that is not actually retarded has realtime systems that monitor overall risk of the entire bank it's, any given branch and any given desk.

Re:perhaps, perhaps not

[dnaumov]

And to expand a little further: there is nothing crazy or stupid about making trades sized in the billions. It's not even that uncommon either. Quite a few companies are doing arbitrage trading with trades in the hundredss of millions on a regular basis, where the profit on whatever they are trading is miniscule, but the massive volume makes up for it. The obvious thing is that you are supposed to be hedged. Doing trades in the billions unhedged? Yeah that is absurd. What's even more absurd is that the alarm did not go off the second the trader's and the bank's risk exposure went bananas.

Re:perhaps, perhaps not

[Anonymous Coward]

"Any investment bank that is not actually retarded has realtime systems that monitor overall risk of the entire bank it's, any given branch and any given desk."

That's why I make the risky trades with my cellphone on the crapper, just like this guy, no monitor there.

Re:perhaps, perhaps not

[Pinky's Brain]

We shouldn't shut it down, but we should disallow them to use government guaranteed deposits for it. Deposit banks should not be allowed to use their depositor money for leveraged investments or derivatives.

Re:perhaps, perhaps not

[Pinky's Brain]

Steamrollers can't be hedged ... if you are getting much better returns than treasuries in an efficient market with no inside information you're running much bigger risks, period.

Re:perhaps, perhaps not

[DarkIye]

Wouldn't that make people far too accountable?

Re:perhaps, perhaps not

[khallow]

It's all relative. That depends on how much they're trading and the tolerance for loss of the people who have the money. If I have a trillion dollars and a high tolerance for loss (and trading with that in mind), then two billion dollar in losses would just be a slightly below average day.

Re:perhaps, perhaps not

[NatasRevol]

Wall Street's belief is that there is an efficient market, when there clearly isn't.

I bought a Sept 17, $27.50 put on RIMM on Thursday at $75. I sold it on Friday for $425. If I was riskier I could have put $7500 out and made $42,500. In 18 hours.

No inside information, I just believed that RIMM was going to go down - like a lot of other people - yet them market was not efficient enough to see this drastic change.

Re:perhaps, perhaps not

[jrminter]

Wish I had mod points... You got that exactly right. Here in the US, the politicians could not resist the clamor to repeal the Glass–Steagall Act of 1933 that made that distinction between commercial and investment banks. Set us on the road to the mess we have now...

Re:perhaps, perhaps not

[kurt555gs]

It is time to bring back both the Glass–Steagall Act of 1933 and the Smoot - Hawley Trade and Tariff act. Unless you really want Des Moines Iowa to look just like the slums of Brazil.

Re:perhaps, perhaps not

[Trepidity]

I don't think Wall Street really believes in efficient markets. A large part of what investment banks do (on the "prop trading" side) is attempting to exploit market inefficiencies via various kinds of arbitrage plays.

Re:perhaps, perhaps not

[JamesP]

There is no "problem". Any investment bank that is not actually retarded has realtime systems that monitor overall risk of the entire bank it's, any given branch and any given desk.

Yes, they would probably have that, if IT wasn't so retarded and took ages to 'test' the solution. Of course, the crap they install in the computers is approved right away.

Re:perhaps, perhaps not

[TarPitt]

And the culture in these organizations celebrate risk-taking, and handsomely reward those who take huge risks, and will do anything to resist restricting those "heroes".

No organization like this is going to restrict their "heroes" and money-makers with automated software that tries to second guess trading patterns.

I'm saying this as someone who was asked to leave the HR VP's office of one of these organizations for suggesting that compliance with security policies be part of annual performance review. Quoting from memory, "There is no way we are going to penalize our star salespeople for not following a password policy"

BTW, our security assessment found that bad passwords were a huge problem, to the point where a few minutes of guessing gave us some very powerful access.

Re:perhaps, perhaps not

[alexander_686]

First, the guy is accused of fraud, which implies that maybe he was not complying with the firm's risk monitoring system. (No proof of that yet.)

Second, it's not as easy as you think.He was on the derivatives desk, which can be tricky but can be handled. He was a UBS, which is in multiple markets, which is another curve ball. American options need to be handled one way, European options a slightly different way. It can be hard to sum all of these positions.

Which is why I don't like the summary. For credit cards you have millions of people buy basically the same things. It is easy to see patterns. In investments you have dozens to scores of strategies that change yearly. CMO bonds one year, Swaps the next, Indian equities the next. From a DB viewpoint it is a nightmare. Each position having it own little quirk meaning you have to modify the Security Master table with new fields being populated by wildly different data sources.

It's a Red Queen's race, each firm trying to reach the next level - and you don't build the IT system to last because you know there is going to be another overhaul in 2 years.

Re:perhaps, perhaps not

[ThatsMyNick]

A large part of what investment banks do (on the "prop trading" side) is attempting to exploit market inefficiencies via various kinds of arbitrage plays.

Thereby, making it efficient?

Re:perhaps, perhaps not

[CharlyFoxtrot]

I think people do relish the opportunity to endulge in schadenfreude where banks are concerned though. People latch on to a phrase like "casino banking" and gleefully apply to everyone in the industry with the intent that we should shut it all down. By the same logic:

A police officer took a bribe, we should shut down the police.
Well, there was teacher who was a paedophile once. We should shut down schools too.
Look at that corrupt politcian, shut down the government while you're at it.
The guy at Blockbuster charged me for bringing a DVD back 5 minutes late. Shut down them too!

The difference with the banks is that in the banks it is a structural problem with the behavior being so deeply ingrained in the culture it's difficult to see how it could be changed. Especially since they have the power to avoid outside pressure to reform.

You do have cases where the police have a structural corruption problem too, or where the government is corrupt to the point where it no longer functions. Just look at many third world nations. And yes, when that happens people need to intervene.

Re:perhaps, perhaps not

[SerpentMage]

I have worked on order books for investment banks. The problem here was that he hedged himself with fake trades. A system cannot detect that. What they can detect is if the hedge is not legal. And to catch an amount like saying, "oh look he has a 20 billion trade let's stop it" does not work. Since banks literally have trillions on their books, with trillions as hedges.

The problem is that he short circuited the order books and some IT code did not balance the books properly.

Re:perhaps, perhaps not

[CharlyFoxtrot]

That's the theory and yet all these major banks keep coming out with these rogue traders and that's only the losses big enough that the general public hears about them. Let's face out out on the terrain no-one is holding these guys accountable. IT may set up the system, Risk Management may generate the reports and they'll be either modified to say what management wants to say or just plain ignored because like all gamblers these guys think they have a system which lets them keep on winning even as they are betting their house (or in this case our houses.)

Re:perhaps, perhaps not

[jonbryce]

And it is worth noting that European and American options don't refer to the market they are available on, you can get both types on both markets. European options can only be exercised on the expiry date, whereas American options can be exercised at any time.

Re:perhaps, perhaps not

[Anonymous Coward]

In IB, the software are made in such a way that traders can do what ever they want without anyone seeing it.
And the "oh so" systems to track the risk? you mean the systems that everyone in the bank can access and update ? The ones monitored by outsourced team that will apply any update sql statements?

IB security and system tracking is just laughable.

Re:perhaps, perhaps not

[Anonymous Coward]

Good job on the trade, but your understanding of "efficient" is wrong and your assumption that Wall Street believes in efficient markets is wrong.

Efficient means that for any investment strategy with similar risks, your expected returns are the same. That's expected returns, not returns on one lucky trade. Maybe you made 5x returns on your trade, but if you repeat that strategy 5x, you lose the other 4.

Wall Street and hedge funds don't believe in market efficiency. They're actually the guys who are making the market efficient.. markets aren't efficient by themselves, they need people taking (smart) risks and providing liquidity.

Re:perhaps, perhaps not

[Serious Callers Only]

The elephant in the room here is that they often have no idea how much loss they could potentially suffer, particularly in a turbulent market - some of these products like etfs and cds are so abstract and so opaque no-one really knows what they represent or what risk is involved. Sometimes the complexity is created deliberately in order to dupe buyers - as with mortgages bundled into so-called AAA tranches. All the risk models are based on a normal efficient market AND the risk models were designed by the banks, not by some independent authority. The pressure is *always* there to take bigger risks or disguise risks or push the risk off on some other sucker, and when risky moves go well it is massively rewarded. Hedging risks is expensive and no doubt he felt the pressure not to do so, and may not even have been able to say how much risk he was taking.

Re:perhaps, perhaps not

[Serious Callers Only]

In the case of a police officer taking a bribe - we'd expect police to be properly regulated, not shut down.

Why are the banks so resistant to regulation? No one is suggesting shutting them down but they should see far stricter regulation.

Re:perhaps, perhaps not

[khallow]

Smoot Hawley was a disastrous law that helped kick off the Great Depression and the Second World War, but sure, maybe we'd be luckier this time. As to Glass-Steagall, I might consider it, if they fixed deposit insurance by including a deductible. As it is, there's no incentive for people to put their money in anything other than the highest interest bank that happens to meet their other needs.

Unless you really want Des Moines Iowa to look just like the slums of Brazil.

Smoot Hawley and the resulting tariff war would go a long way towards making that happen.

Re:perhaps, perhaps not

[Anonymous Coward]

All traders' positions and profit/loss are reported and reviewed daily. There's a whole department whose job it is to do that, and its the first thing his immediate managers and the overall trading managers want to know every day. Adoboli must have had some way of concealing or misreporting his positions.

Leeson was in charge of the people who did the reporting - something that would not be allowed today. Kerviel had access to the reporting systems through the fact he had previously worked in that area. Again, that is something that auditors would be checking for these days, but there are unconfirmed suggestions that something of the kind might have occurred this time.

One possibility (and this is just speculation) is that there is "security by obscurity" around some of these middle-office / back-office systems, so that, even without official access, someone who knew how they worked could manipulate them.

They've charged him with false accounting -- to make that stick they'll have to show that he was deceiving the controllers about his activities in some way.

Trading data flows change frequently; it might be that for some class of trades the reporting systems were not completely in place. In that case someone very senior would have had to sign off on accepting the risks of trading without them. That would be a very bad pair of shoes to be in now.

The computer is always guilty

[PolygamousRanchKid]

When a financial boo boo occurs, and IT is involved, it's IT's fault.

When a financial boo boo occurs, and IT is not involved, it's IT's fault.

Computers have a tough time defending themselves, so it is easy to pin the blame on them.

Maybe Watson, IBM's Jeopardy champ, could handle this:

"What . . . is a 'Scapegoat'?"

Re:The computer is always guilty

[dintech]

Have you every heard the phrase "the customer is always right"? I'm not saying that they are and clearly not in this case however in banking, as in a lot of environments where you have only a small group of users, this is often how things play out.

If you're independent and not part of the same company, you can always invite blame-oriented clients to take their business elsewhere. If you tried that in a large company, the only person going somewhere else would be you.

Agreed it sucks, but at least UBS IT bonuses will be good the following year when they implement new controls.

Re:The computer is always guilty

[prefec2]

We have a saying (which loosely translates to): When the boor can't swim, then it is the swimsuit's fault.

Re:The computer is always guilty

[Anonymous Coward]

In other news, the fired IT guys scrap the idea of seismology and geology as their fall back career.

Re:The computer is always guilty

[Anonymous Coward]

Yep, and IT are the service providers to the true bankers.

Suck it, bitches.

Re:The computer is always guilty

[Anonymous Coward]

Sorry, but computers are such a big part of today's world, and in my experience, IT is so incompetent, usually the blame truly does lie with IT. So, what is a scapegoat? A: irrelevant. IT really IS at fault.

lack of liability

[azalin]

In my humble opinion the attitude in the finance sector has to change away from gambling and back to investing.
Btw. How comes those people only get bonuses and not fines to?

Re:lack of liability

[prefec2]

Because that would be fair. The whole thing is to privatize profits and let the public pay the bills. And by the way there is too much money on the market to really invest all that money and get something in return. But it is not only the financial market. You can found companies and relay responsibility for bad business decision to the banks, stakeholders etc. To make things right, the size of organizations in the financial and business area have to be limited.

Re:lack of liability

[Anonymous Coward]

Bad traders don't stay traders for long (and don't keep clients for long either). In general they do at least as well as the market, their bonus reflects how much better than the market. Even when you get the occasional epic cock up (maybe causing a financial crisis) there will still be well paying clients for the companies who survive, so money continues to flow in, as do the bonuses.

Also, a large portion of this bonus money goes straight into the government purse. People like to forget that for some reason. I think I remember seeing a few years ago that (total) taxes from the financial sector in the UK pay for nearly the entire education budget.

Re:lack of liability

[rednip]

Also, a large portion of this bonus money goes straight into the government purse.

Nope, at least in the U.S., unearned income is taxed at a 15% thanks to the Bush tax cuts. Also, 'unearned income' includes the trader's bonus money.

Re:lack of liability

[Pinky's Brain]

It's empty money, it's far easier for money to stop flowing (which it will very soon, a new crisis is inevitable) than it is for trade of necessities to do so. A national economy build on the profits of a finance sector is far out on a limb.

Re:lack of liability

[khallow]

15% is considerable even if you think the percentage should be higher.

Re:lack of liability

[satuon]

There is always risk when investing that the enterprise might fail. You don't know the future, so you can't have investing without some degree of gambling. Risk have to be taken in real life too, not just in the casino.

Re:lack of liability

[Xugumad]

> Btw. How comes those people only get bonuses and not fines to?

The bigger question should be about level of bonus. An institutional trader is generally accepted to be taking less personal risk, than an individual trader, and that's fine, but should be paid in proportion to the risk relative to the risk taken on by their employer. As it stands, there's a trend towards "I made $BIGNUM for my employer so should get a sizable fraction of that as a bonus" without anyone going "Okay, but what was your employer's risk, not to mention overheads, in enabling you to make that profit?"

(And yes, you do get individual traders, even individual algorithmic/high-frequency traders, although typically it's considered loosely on par with hand grenade juggling in terms of personal risk)

Re:lack of liability

[CharlyFoxtrot]

I think I remember seeing a few years ago that (total) taxes from the financial sector in the UK pay for nearly the entire education budget.

Considering financial services now make up 10% of UK GDP the taxes on it should be paying for more than just the education budget. Sounds like they are undertaxed compared with other industries.

Re:lack of liability

[GlobalEcho]

Actually, in this case, Adoboli will go probably to jail and the compensation of bonus-eligible UBS employees will be reduced by a sizeable amount. That's basically like a fine, whether or not you think they make too much money in the first place.

Re:lack of liability

[GlobalEcho]

Actually, you are incorrect. You are probably thinking of partners in private equity. Trader bonuses (and all others' cash bonuses) are taxed as ordinary income...I know this firsthand.

The tax dodge for private equity is that they don't get money, but rather stock whose appreciation is taxed at capital gains rates. Its typically stock they are not allowed to sell and turn into cash, and is therefore regarded as an "investment". They are taxed at ordinary (35%+$state) rates on the initial grant of, say, $1MM in stock but the subsequent 20% per year gains (if they happen) are taxed at the 15% capital gains rate.

Re:lack of liability

[Anonymous Coward]

At my bank that is called claw-back. Bonuses are awarded and paid over a three year schedule. Screw up enough, and they'll take back some unpaid bonus. This applies at the individual, team and group level.

This policy was put into place in 2009, and to the best of my knowledge it has not been used.

Re:lack of liability

[HornWumpus]

Depends on the unearned income.

Some is not taxed at all (social security) unless you have other income.

Some is taxed as regular earnings (gambling winnings including short term cap gains).

To get the long term cap gain you have to at least look like an investor not a speculator. You need to hold the asset for at least a year IIRC.

Calling a bonus 'unearned income' is a gross generalization. Social security disability: that is unearned income.

Re:lack of liability

[Anonymous Coward]

Perfectly said. All the conservative freaks around the world who love to whine and shout "socialism!" only seem to do it when whatever is being proposed might result in actual humans benefiting from something. Somehow the only time you hear from them when regular people with regular jobs are made to pay for the excesses of corporations is when doing so might possibly result in those same people NOT losing their jobs. Witness all the screaming about the auto company bailout but relatively little about all the credit the Fed has been extending to banks and to large corporations, which are taking that money NOT and hiring workers except in India and China. Privatize profits, socialize losses. Capitalism at its finest.

Re:lack of liability

[blackicye]

I think I remember seeing a few years ago that (total) taxes from the financial sector in the UK pay for nearly the entire education budget.

As opposed to the bank bailouts paying for how many years of the entire education budget?

Re:lack of liability

[sjames]

Sure, there is always risk. Investment is when you attempt to limit that risk by studying the company involve. What are it's liabilities, it's assets. What does it DO and what is the general outlook for that line of business.

Of course, you won't be doing that sort of research on a stock you'll hold somewhere between 3 milliseconds and 1 day. At that point, you're more card counter than investor.

Re:lack of liability

[rednip]

Social security is not 'unearned income', people pay taxes throughout their lives to fund it. Sure the feds sold a lot of T-bills to the system to finance the Bush tax cuts (and Reagan's for that matter), but it's hardly 'unearned'. Many in the GOP say that in order to 'preserve' SS we need to raise the retirement age, but I've been paying into the system since I was 16 years old and those payments were based on a 65 yo retirement age. I have no idea why the boomers in the GOP think that forcing my generation to put off retirement so that they might be able to keep the Bush tax cuts, is a fair proposition. This is why Al Gore was talking about putting SS funds 'in a lock box', which sadly reactionaries made into a running gag.

Unearned income is dividends from stock companies and capital gains, why you try to call SS unearned is a narrative you should explain. Sure the first seniors who benefited didn't pay into it, but that was like 70 years ago (they also didn't see the same sort of benefits). SS disability is a slightly different beast, as even an 18 yo with MS could collect, but I'd rather not have them in the streets, maybe you would, but you should be honest about the affect on society.

The simple fact is that there is a wide difference between the top tax rates of 'earned' and 'unearned' income' (the latter taxed at less than half the former) has created bubbles in housing, stocks and art as investors chase 'tax advantages'. If we level them all out, the top rate would be less than 30% even if we balance the budget on it, including money to pay back the debt the GOP (with some help from the dems) ran on the national credit card.

Re:lack of liability

[imthesponge]

"I've been paying into the system since I was 16 years old and those payments were based on a 65 yo retirement age."

And a life expectancy of 70.

Re:lack of liability

[Anonymous Coward]

Much of the improvement in life expectancy over the last 100 years has been the reduction of infant mortality.

Re:lack of liability

[HornWumpus]

Social security disability is generally a scam run by the lazy to avoid getting a job in the first place. It IS unearned income plain and simple. Most Social Security Disability recipients and ALL their legal advocates are shamelessly steeling from the truly disabled.

It is a separate program from Social Security retirement and is paid from the general fund.

You think?

[igreaterthanu]

Any entrance level programmer could make a system that alerts a superior of the performance of one of these people.

Say an alert when the losses are over $100,000 then over $1mil, $10mil, $100mil, etc. or maybe after 50 losses in a row.

It says a lot about this bank that this wasn't caught earlier. An alert should have been triggered far before the losses got to the 2bn mark.

Re:You think?

[Anonymous Coward]

NO computer in the world could of predicted the swiss pegging themselves to the Euro and no trader would of considered that risk as it was unthinkable.

from the perps Facebook page on September 6 simply read “need a miracle”, the same day the swiss pegged.

http://www.zerohedge.com/news/ubs-rogue-trader-had-been-reduced-watching-fox-news-guidance

Re:You think?

[Anonymous Coward]

They were just waiting for his losing streak to break. Just like any other gamblers - except these guys get bailed out.

Re:You think?

[tqft]

The problem isn't detecting the loss after the event the problem is predicting 23 sigma moves.

http://www.zerohedge.com/contributed/ubs-and-big-trade
The trade was profitable until the SNB capped the CHF , capping the trade and trader in the process. At least that is a reasonable working hypothesis. Everything was fine until a week ago. What happened then? The Swiss National Bank announced a cap of their currency vs the Euro.

Why did he have such a large position ? That Risk & Management MUST have known about. And were OK with while it was a winner. When it became a loss, the trader was shafted.

Re:You think?

[Anonymous Coward]

Not that simple. Imagine that you see the losses of 100k, but are now almost powerless to stop the mirror losses of another 100k... which triggers losses in related stocks/options/futures. Getting an alert won't help. I am sure the alert type of system that you are thinking of exists in a far more sophisticated fashion, but in the end they are human decisions.

Understand that these are complex transactions (they are called Delta One) and where a computer can make a best choice, it has already done so a million times over. Its putting together high risk orders where you hedge the high losses so that your probability of landing in the high return area goes up. A computer can give you the options, but it can't make the decision because it doesn't see the difference mathematically between a high risk or medium risk transaction... the return for both is statistically the same.

As others have guessed, he probably landed on the wrong side of an option chain. Where it should have been "No", he clicked "Yes" and in transactions where losses are infinite and gains limited, that could be a big mistake. If anything the alert system probably told him the expected progression and the available avenues. If he was successful, he probably _limited_ the losses to 2 Billion. If he was not, his losses could have originally been a billion.

Re:You think?

[Slashdot Assistant]

if (weeklyLosses >= allowanceForTheWeek)
{
cancelAllowanceForTrader("Kweku Adoboli")
awardYourselfBonus()
/*Bank management report occasional feelings of shame and a "hollow" sensation. Please review awardYourselfBonus to ensure it's compensating sufficiently for these feelings.*/
}

Re:You think?

[julesh]

The problem isn't detecting the loss after the event the problem is predicting 23 sigma moves. [...] Why did he have such a large position ? That Risk & Management MUST have known about.

A few things occur: if it really was a 23 sigma move (I haven't been watching the markets lately, so didn't know what was going on), then the fault really is neither the trader's nor particularly the management of the bank's, but rather the entire industry's. We're talking about an international system of de-facto standard risk management that assumes the worst net losses these traders will sustain is around 5 * sigma. If he'd lost what the models predict he was risking, which is to say about $400 million, I doubt anyone would have made this much fuss. He may have been fired (or perhaps he just wouldn't be getting his bonus this year), but we wouldn't have heard about it. They simply need to start thinking more about the non-trivial risk of unexpected large scale movements (which are not readily accounted for by the standard statistical approaches that are commonly used) and the effects they can have.

Re:You think?

[Anonymous Coward]

This algorithm would not have helped. It was not a cumulative loss that was build over time but it was a loss generated by a single transaction. The guy had gambled on the swiss frank going down against some other currency but the swiss frank went up and he lost this gigantic bet. Probably he had shorted on the swiss frank and by the day that he had to pay back the swiss franks that he had borrowed and sold, the 2 billion loss materialized in one single go.

Re:You think?

[Anonymous Coward]

if it really was a 23 sigma move

It can only have been a "23 sigma" event if the model by which such statistics are established was utterly irrelevant.

This is the systemic problem with banking... the "risk control" is quite sophisticated - but it takes a narrow view of what constitutes risk... and, hence, no-one should be surprised when real-world risks are spectacularly under estimated. A cynic might argue that the whole subject of risk management is an elaborate illusion to give the impression that risks are being taken seriously. The reality is that where risks can't be argued to be marginalised by elaborate argument - they're outright ignored... and the complexity of the systems is relied upon to prevent scrutiny.

Writing software gives something of a unique perspective on risks... software engineers aim to "prove" the software they write - and bugs are declared whenever any sequence of events is established that would, theoretically, lead to an unacceptable outcome. It's considered "too cowboy" to argue that a bug doesn't exist because the client hasn't get generated that sequence of events in the live system. Conversely, this is exactly how risk management works for financial risks - and it is this deceit that has provided the illusion of large profits and the bonuses that accompanied them.

Re:You think?

[Anonymous Coward]

When I saw your nick I thought it was Slashdot Assassin. That would have been a much better name.

Re:You think?

[NoOneInParticular]

You do realize that a 23 sigma event implies the belief in a risk model where an event like this will happen once every 10^112 years?!! You also do realize that the entire financial sector is using these risk models, and are therefore still assuming that 23 sigma events will only happen once every googol lifetimes of the universe? A hedge like this, that will only fail once every googol universes as predicted by economics (and is thus a safe bet on the surface), tends to fail every few years.

Sigma measurements of risk is intellectual fraud, on a scale that is costing us billions.

Re:You think?

[Anonymous Coward]

The guy's a scape goat. A perfect one at that. He's black and from some obscure African nation.
He's got next to no chance of sympathy.

Plus, consider this.
UBS stated after the GFC that they were returning to traditional banking. They didn't fire anyone. Nor did anyone leave.
Investment banking is a completely different skillset to boring transactional banking. This guy, and everyone else in his team would be clueless for the most part about traditional banking.
It's like a casino telling their staff that they're no longer card dealers, but checkout clerks - because by the way, we're selling groceries now.

It doesn't happen. People don't stay if they've been commanded to do a far lesser job.

So, that means he was doing the job he was paid for. Which means he had implicit authorisation to do what he did, which means he's not a rogue trader, but a patsy.

Some sites speculate that he held a large position in CHF/EUR right when the SNB decided to devalue the frank. A 9% loss in 45 seconds. Impossible to predict, impossible to stop-loss out of, and impossible to do anything about. No IT system can detect this until it's too late. The big issue if this rumour is true, is who gives their traders 200,000 to play with?
(100:1 leverage = 200k down, 20,000,000,000. 20bn - 9% in 45 seconds = near enough to $2bn loss.)

If this is all true, this poor man was an unlucky spectator to the true definition of sovereign risk.

Re:You think?

[Anonymous Coward]

The "statistical" models used aren't a fraud, they're just stupid. They're based on the Central Limit Theorem, which contains the conditions "if sigma inf" and "as n approaches inf". In financial markets, sigma is very high (believed by many to be infinite) and the size of n at which the theorem becomes reasonable is therefore absurdly high.

Most of the guys who studied statistics and financial markets with me passed without ever getting that bit.

Sorry, I haven't used my account in a while so I'm posting AC.

Re:You think?

[Anonymous Coward]

If sigma is less than inf. Slashdot ate the symbol.

Re:You think?

[GlobalEcho]

People who think the financial sector is using only these multivariate normal risk models (if I correctly interpret what you mean by "sigma models") are incredibly naive. Many of them have read and believed the books by N. Taleb, which I find tragicomic.

You may have noticed that thousands of extremely smart mathematicians and physicists have been hired by the financial sector over the last decades. Do you really think all those clever people somehow missed something so blindingly obvious?

As I've said elsewhere, it is unlikely this whole situation arises from an unusual market event combined with normal operations at UBS. Far more likely, Adoboli was able to hack the risk system into assuming the EUR/CHF exchange rate was constant. This is known as operational risk and is not very amenable to quantification.

Re:You think?

[GlobalEcho]

bugs are declared whenever any sequence of events is established that would, theoretically, lead to an unacceptable outcome. It's considered "too cowboy" to argue that a bug doesn't exist because the client hasn't get generated that sequence of events in the live system. Conversely, this is exactly how risk management works for financial risks.

That is a very interesting perspective. In this particular case, though, it is likely Adoboli bypassed risk systems, booked fake trades a la Nick Leeson, or set parameters to hide the risks. In this case the proper analogy is something closer to making systems robust to, say, SQL injection attacks, which of course we know not all programmers do even when they should.

Re:You think?

[NoOneInParticular]

I'm arguing against people equating risk with sigma, and in particular those who say that there's a problem predicting 23 sigma moves, as if that's saying something about the likelihood of the event occuring. I'm also arguing against the financial sector who is still using sigma (and beta, and the entire apparatus of mutlivariate statistics) as something that can be used in practice. You are arguing that the financial sector has moved on, but have they? Are they truly beyond the Gaussian assumption, have they really moved away from Value at Risk models, is Black-Scholes truly abandoned, are standard risk-of-ruin calculations abandoned, or are they still trying to fix Gaussian models with martingale and jump dynamics as they were doing last time I looked into it. What has replaced the entire apparatus that wreaked havoc 5 years ago? I still see bailouts on the horizon, banks very highly leveraged, and a sector that has reasoned away risk using the same flawed arguments that have been en vogue for the past 40-50 years.

You are seriously arguing that this has changed? I've worked at hedge funds, I am working in risk management, the assumption of normality is the only game in town. And yes, I am arguing that all those extremely smart mathematicians and physicists are missing the obvious, simply because they are doing what they were hired for: to create models. Stating that we don't have the mathematics to do the job will not land you a position as a quant. They'll hire someone that will try the best they can: steer a car by rearview mirror, driving in the ravine at the next haircut. All we do is drive a little less fast.

I guess that on the trade floor there might be a few that get it and are using algorithms that do assume that they can lose everything at any time and for instance only trade in options, but at the macro level, capital requirements are still stated in risk weighted assets. Options are still being sold. Individuals and banks are still going naked (leveraged) long. Risk is still assumed to be log-normal. Textbooks are still printed stating this as a fact (not as an assumption). Have you seen a shift in teaching economics, away from multivariate stats? No, as nothing has changed.

Re:You think?

[teknomad]

A 23-sigma event can become a 1-sigma event simply by changing the probability distribution your models use. The problem isn't really the math...sigma measurements of risk *DO* work, it isn't intellectual fraud. The problem is that the banking industry's decision-makers are willfully misusing the math because they do not want to accept what the proper models tell them. It is extremely, extremely, enticing to keep using a Gaussian distribution in your big snazzy exotic barrier option valuator rather than the more accurate t distribution because the Gaussian keeps telling you you're making money but the t says hey, you're deep in the grey there, pal, and you're gonna get bit if you keep making this bet!

The math works (most of the time) if you use it correctly. What we need is to get back to a point where massive failures really can be blamed on pure chance or a bona fide failure of the math, instead of willful ignorance in the face of unbearable temptation.

[Just to be clear...I am NOT defending UBS in any way, shape, or form...but I'm also not condemning them. What happened is endemic to the banking industry as a whole, not UBS specifically.]

Re:You think?

[superwiz]

that's all fine and good. but he's charged with false record keeping. so the value of your weeklyLosses variable will be wrong.

Re:You think?

[superwiz]

he got wiped out by the peg of swiss frank to euro. it's a 1 time political event. there is no realistic way to quantify political risk.

Re:You think?

[NoOneInParticular]

So please tell me, what is the financial sector using these days, if not risk models that are ultimately dependent on a (log-) normal assumption? What fundamental shift has happened that threw away 50 years of economic theory forming? What has replaced it? And as for smart people missing the bleeding obvious: Mandelbrot showed empirically that they were completely wrong more than 40 years ago. This was highly publicized, accepted as correct, and the smart people ignored this because Gaussian fairy land is a very convenient mathematical framework to publish in. I would be very surprised if the quants these days work on fundamentally different assumptions from the academics.

Re:You think?

[NoOneInParticular]

Yes, you get it. There's no way to quantify this 1 time event, nor is there a way to quantify all these other 1 time events that happen all the time. There is no meaningful difference between a so-called 23 sigma event, and a 5 sigma event. The math fails in the tails, and assuming that you're safe against one time events is what is causing most of the mayem in the financial world.

Re:You think?

[HornWumpus]

I worked in risk management in electric power trading till I got sick of the weasels in suits.

VAR etc are a lens you use to look at an issue. You don't have to use Black-Scholes to generate your greeks. Aggregating greeks * expected deviation is not a forecast of expected gain/loss. It is an _approximation_ of your portfolios sensitivity to the underlying value (depending on which greek you are adding up).

In power trading we had all sorts of other risks. Scheduling (where the power could actually not be delivered due to real world system constraints or line outage). Plant Outage (power plant falls over). Counter party bankruptcy (where your counter party is bankrupt but you are required to continue keeping their lights on, for which you get to be a low priority creditor in court). Load forecast inaccuracy (basically weather, but complicated by the fact it bit everybody on the same day). Each of these issues is typically handled in the power contract, but the legalities are so ugly there is simply no way to wrap them into VAR.

Operational risk is a bitch to forecast or model. We did it with (mid level detail) operational numeric models of parts of the grid and/or power pools. (Maintaining this data set was a job for a team of about 15 people just for N. America and western Europe.) So (for example) managers can know that shutting down plant A will result in x increase in system operation cost based on grid models while at the same time knowing the plant is essentially a 'spark spread option' (an option to buy fuel and sell power with an exchange rate based on plant efficiency). When the difference between cost based models and option based models is large they know they are dealing with interesting system behavior and tread carefully.

At that everybody involved knows its just a rough chop at the answer and judgement is key to keeping the lights on (which is the top priority per FERC, and you had better not piss off FERC).

All are ways we would 'squint at' the problem. None of them are the sum total of risk. But between them traders and operators have a clue. If they choose to ignore the clues (or bet the company, cough, PG&E, cough) then it's on them.

Re:You think?

[NoOneInParticular]

The intellectual fraud lies in the empirics: the statement that second moment statistics can be reliably estimated based on data. Yes, today your models say that the event that is about to occur is so unlikely that you don't even have to consider it. It is 23 sigmas! Tomorrow, using exactly the same method, your model will tell you that your 23 sigma event is a 5 sigma event. The mathematics is just the mathematics -- what is wrong is the statement that the Gaussian (or even the t-distribution) is a good model of reality. That the Central Limit Theorem holds, and that second order moments are 'finite' (i.e., stable).

To really see where the fraud is, do the following experiment. For fun: download Nasdaq data from 1971 to now. You can get it from Yahoo finance. Load it in a spreadsheet (I'll take excel as an example). Next to the adjusted close column, add a column of log returns [log(x_t) - log(x_t-1)] of these adjusted close prices. Now we are going to look at the (common) assumption that the log returns are normally distributed. So let's try to estimate the standard deviation of the log returns. Go to the end of the spreadsheet, and in the one but last row next to the column of log returns type something like this: =STDEV(H10247:$H$10248). Now apply this to the entire column. This will give you a running standard deviation of the log returns of the entire nasdaq from beginning to end. You get 10247 standard deviations, each a different estimate of the 'historical risk' in the Nasdaq. If you plot this series, you will see jumps, you will see 1987, you see 2002, you see 2008, you see the current crisis. Zoom in to the last few months. You still see jumps. Think about this. You are seeing jumps in a standard deviation calculation where 99.99% of the data is shared between the two computations!

From this data, some people argue that, of course, events change the risk profile, but that is nonsense: the risk profile is assumed to be predicted by the standard deviation, not the other way around. The standard deviation is the risk. By definition. How can an event, if described correctly by this standard deviation, then change the standard deviation? This is magical thinking, not scientific. What you see in a graph like this are a long series of falsifications of the normality assumption -- the assumptions that second order moments are stable in the market. We're talking about 10,000 observations, and a single data point changes the risk profile. Constantly. With 10,000 measurements, the t-distribution is equal to the normal distribution. You will see this for any series. Long series of falsifications of the normality assumption. This is well known, but ignored. That's the intellectual fraud.

Re:You think?

[mbkennel]

Neither academics or practicing quants actually use thin-tail Gaussian models for practical pricing.

Re:You think?

[NoOneInParticular]

Who solved the problem that the parameters for fat-tailed models cannot be estimated from data?

Re:You think?

[superwiz]

well, probability of a 1 time event is technically 0. all the risk management is based on ask what's the worst case scenario in case of an event like similar to events which have already happened. this makes impossible to even price a 1 time historical event of switzerland giving up control over its sovereign currency. if you can't price it, you can't hedge it.

Re:You think?

[RogerWilco]

I'm assuming this sigma you're talking about is supposed to be the standard deviation from some mean?

Does this mean that simple Gaussian statistics are being used to evaluate things that probably aren't? (I'm no expert on financial market statistics, but it doesn't look Gaussian to me at all).

Re:You think?

[RogerWilco]

I worked in risk management in electric power trading till I got sick of the weasels in suits.

Heheheh, I did Electricity forecasting here in Europe. We seemed to have the same weasels, I got sick of them as well.

Your story is soo familiar.

I now am building the largest telescope in the world, much more rewarding work. :-)

Re:You think?

[RogerWilco]

I'm no expert on financial markets, but to me the whole things just doesn't look Gaussian. But even then, the events in the tail outside a few sigma should still happen every now and then.

But I don't believe the whole problem is Gaussian to begin with.

Re:You think?

[tqft]

Yes - This happens a lot. Try to explain non-Gaussian stats to management. In some places (like major banks) it should be possible. There are some other good comments in this thread about the conceptual failure in using these types of statistics at all - tl;dr - modelling political risk with statistics doesn't work because such things are outside the paradigm. There is some good descriptive stuff by someone who worked in electricity trading about how stats fail.

And the EUR/CHF trade hyptohesis appears to be wrong
More detail: http://www.abc.net.au/news/2011-09-19/ubs-raises-trade-losses/2905262?section=business
""The loss resulted from unauthorised speculative trading in various S&P 500, DAX, and EuroStoxx index futures over the last three months," UBS said in a brief statement."

Re:You think?

[GlobalEcho]

To begin with, the financial sector has more or less always used scenario analysis which is of course distribution independent. The obvious flaw, of being only as good as the selection of chosen scenarios, is in evidence with the 2008 credit crisis. Nevertheless, the scenarios involved are based on human experience and intuition and as such are obviously independent of probabilistic models. In general, the financial sector does a better job of scenario testing than any other sector.

Even today you will of course find many risk computations done with multivariate gaussian models. The results are very useful for day-to-day management and even Mandelbrot would concede that on most days they are a darn good approximation. The exceptional days, the tail events, are where the gaussian models are nigh useless. Everyone knows that, and that's why the scenarios, position limits, and so on are put in place.

To make a car analogy, pretending the financial sector relies solely on multivariate gaussian models for controlling tail risk is like pretending that motorists control their vehicles with gas pedal and steering wheel only, eschewing the brakes. To expand the analogy to fat-tailed models mentioned elsewhere, I would say the fat-tailed models are like upgrading to a sport suspension. Nice, but you had still better keep the brakes installed.

You mention that you would

be very surprised if the quants these days work on fundamentally different assumptions from the academics

As it turns out, the quants tend to use the more simplistic stuff by far. A lot of the academic work ignores real-world problems, such as model calibration, parameter uncertainty, or computational efficiency.

Now, securities pricing models are a different kettle of fish from risk models. But since the topic was broached, mbkennel notes that

Neither academics or practicing quants actually use thin-tail Gaussian models for practical pricing.

This quite true, the models used are, in effect fat-tailed. You wonder

Who solved the problem that the parameters for fat-tailed models cannot be estimated from data?

For pricing, we have the luxury of inferring model parameters from market prices. The models used are typically not running with fat-tailed stochastic processes, but in practice the pricing and trading is fat-tailed because the parameters are allowed to vary in theoretically inaccessible ways that express fat-tailed outcomes. Implied volatility is the most famous example of this. If you work through the mathematics of what is really happening, you will find that the market outcomes are the same as if everyone was using a fat-tailed model to begin with.

Again, this latter bit is about pricing. The closest analogy for risk models would be using empirical return distributions, which is certainly done a lot but outside the scope of this discussion.

Control is what they want to avoid

[Anonymous Coward]

There are a lot possible technical and political measures to avoid risky behavior on the financial market. However, the capital companies, traders, brokers etc. work in a world with secrets. If you know them or you know the right one you can make a fortune. So secrecy is important and taking risks is important. And if you start to monitor them and block such behavior, the game would be over. That would be good for all of us, but bad for the financial crowd.
 

a rogue trader?

[FudRucker]

is that the term they use now for a scapegoat to use as an excuse for lax banking & investing policies?

100% accountability? I'm not that's what they want

[SebZero]

I think that such a rigid system would prove to be a double-edged sword and would ultimately not be adopted in some institutions. It requires precise tracking of what each trader "bets" vs their losses and the application of rules to stop them from losing too much. This is data that can find its way into the outside world in the case of scandals such as this and I'm not sure investment banks would want a perfectly documented account of losses becoming public. They play a game of high-stakes risk on a daily basis, under the respectable cover of expensive premises and thick financial service books.

A friend of mine who is in what most of us would call an extremely well-paying profession told me about a highschool friend of hers who worked as a trader in London and retired at the ripe old age of 42 to live in an amazing appartment with waterfront views in central London. I was grumbling about banker-types making phenomenal money and being nowhere near as intelligent as doctors/lawyers/engineers, to which she replied, "Of course they're not the brightest, they're certainly not dumb, but they're wired different to you or I - they're risk-takers. What they do with large sums of money on a daily basis, is gambling in a casino where 'the house always wins' isn't always the case. Normal people put in their position would not take the risks they take for fear of losing"

You can potentially win big, lose or stay the same - but some of these institutions trade retirement funds or government health funds. Governments tend to have inquiries if things go wrong and not having an exacty record of how a system broke down allows the bank face while they use the trader as the scapegoat for everything that went wrong.

no kidding.....

[Anonymous Coward]

The amount of leverage the trader was incurring in relation to his "funds" (whatever he had) must have been staggering....

I can't imagine how you would miss that. All financial alarms should have been going off much before that.

So maybe the trader actively evaded counter measures.

Re:no kidding.....

[Pinky's Brain]

Everyone is over-leveraged at the moment except for the few ultra-rich who are pure creditors, it's the only way to keep up paper profits up while consumption and production are tanking ... of course there will be a reckoning unless the economy catches up, which it won't. The banks are all set up to fall in the near future ... the ultra-rich will mop up the collateral (they'll still lose a lot of money, but they'll end up owning a lot more m2 of land).

But that's the business model

[Anonymous Coward]

Gamble, gamble and gamble more.

Rogue trader = bad apple = bullsh*t.

Re:But that's the business model

[JustOK]

don't go bashing Apple for this!

No on can catch them when it matters

[RobinEggs]

I remember a highly compelling thought experiment published in the New York Times editorial page, back when the economy was first going south - a though experiment which, the authors later revealed, was more real-world practice than experiment.

The way big risks and 'trendy' trades often work is this: if a certain method of investing your pool looks good and other traders in the firm are making big money on it, you have two choices. You can go against the prevailing wisdom, but should you lose then you're the idiot who lost $10 million and you're fired. You can also go with the trend, in which case either you all win together or the entire company (or entire economy) goes down in flames and you're no worse off - in reputation or employment - than anybody else.

My point for bringing this up is that it's not about random idiots going nuts; even if that happens it's just one idiot or one company that dies, and at least they're all the 'rogue' idiots are effectively sociopathic, conflicting entities. The real damage comes when every trader agrees on things; sooner or later it's all coming down, and the rest of us go down with them.

So frankly I think it's *great* news that this guy lost $2 billion; at least it means UBS isn't so locked-down that individual traders can't take risks. Better they learn from giving traders too much freedom than we all learn from them being given or being taught too little.

Re:No on can catch them when it matters

[tukang]

The fact that the guy lost $2 billion is not good in any way for UBS. You seem to be arguing that it's a good thing that this guy bet on a different direction but the direction is irrelevant, it's the magnitude that's astonishing. Traders are not allowed to put so much capital on the line, the fact that he was able to invest so much capital almost certainly means that fraud was involved. Kerviel, Leeson and others all forged papers or electronic records to perpetrate their fraud. The usual formula is they start with a bet, lose their capital, hide the losses, and double their bet. Rinse and repeat.

All banks have systems in place that are supposed to prevent this from happening. The fact that this guy was able to circumvent those systems shows that UBS does not have a good risk management system in place.

Re:No on can catch them when it matters

[Anonymous Coward]

There are many many transaction types, and chains where the upside is 10% and the down is infinity.

Re:No on can catch them when it matters

[garyebickford]

It was not good for UBS, but IMHO it was good for the system. This is an example of moral hazard in action - that principle that was violated by at least some of the US bank bailouts.

As for the size of the loss, forex trading tends to be very highly leveraged, so it's possible to have a hypothetical risk of 100 or more times the amount of a transaction - but with a very low probability of that risk occurring. The risk is not a single number but a probability density function (like a gaussian) with a very long tail (where the 'black swans' live). I presume that the bank's risk analysis system was not correctly recognizing the potential risk and requiring the appropriate hedge .

I certainly don't know the specifics of this incident, but black swan events are very difficult to quantify and it's a delicate balance between being overprotective (leaving money on the table) and being underprotective (leaving the bank vulnerable). A very small difference in the 'number' chosen can make a huge difference in the result. And to make things worse, that assumes that one has thought of and correctly judged the impact fanout of all the possible relevant risk factors - should an asteroid impact, or a large earthquake under London be included in the computation?

Re:No on can catch them when it matters

[teknomad]

At a fundamental level, a bank is nothing more than an engine of greed. I don't mean that in a derogatory sense: I mean that a bank is a simulation of the human emotion of greed. As such, it has the capacity for both great good and great evil. Left to its own devices, a bank will naturally seek to absorb all available value in an economy for its shareholders -- that's what I mean by "a bank is an engine of greed". Because of that, banks critically depend on regulations to tailor and guide their behavior to optimize their positive effect on society (banks are really good at another human trait: following rules). A bank's natural tendency will always be to push against the regulations that society places around it, so the balance between regulation and greed is where society needs to focus to measure whether a bank is doing good, or needs more regulation,...or needs to be disbanded.

Traders have a nasty job...they have to ride that thin line between regulation and greedy actions. If they step too far one way, they're "rogue" and need to be put down like a rabid dog...if they step too far the other way, they're wimpy and ineffective and need to be fired. The problem with riding that thin path is that it has lots of hidden potholes and stumbling blocks that can easily pitch the trader to one side or the other. So a big part of a trader's skill is to recognize when they've stumbled from the path, how far they can stray, when to stray, and how to get back on the path.

If I think about a few of the past rogue traders (Nick Leeson, the LTCM crew, Kerviel), the one thing they all had in common was that they started out with their hearts in the right place: they all strayed outside the thin path between regulated investment and unregulated greed in order to benefit their firms but they were unable to adjust their course in time before things got out of control. HOW they got there is what should really concern us, because it points us to the types of new regulations that may help tighten up the line and smooth out the path so this happens less often with less impact. In a sense, then, I agree: UBS's rogue trader is an indication of evolution, not a singular damning event.

What happens next will determine whether we as a society learned anything from UBS's failure, or whether we are content to keep evolving along this same line.

Re:No on can catch them when it matters

[TapeCutter]

where the 'black swans' live

Same place as me? - All swans are black around here.

Re:No on can catch them when it matters

[garyebickford]

haha- cool! :D

I've worked there...

[Anonymous Coward]

I worked at UBS/Warburg in '97 on the trading floor and back-office systems for equity derivatives, and I know that they do a nightly global risk assessment, so they know that if the company as a whole is out on a limb or if their positions balance each other within the limits they're required to keep. $2 billion is probably about as far as he could go into the hole in a single trading day.

/. states the obvious

[Anonymous Coward]

Of course IT could have caught the rogue trader. That is why IT is not this heavily involved on this level of the trade business.

why even let them exist

[Spy Handler]

the world was doing just fine without these "investment banks" gambling with billions of your money while dreaming up drivel like "mortgage-backed security derivatives"

I'd shut them all down and put the CEO and CFO and the rest of the O's, all of them, in prison.

Re:why even let them exist

[garyebickford]

When handled correctly, "mortgage-backed security derivatives" are economically equivalent to the title insurance required when you buy a house.

Your statement about C-level executives is exactly equivalent to someone saying "Those kids who listen to rap are all a bunch of murderers, cop-killers and junkie-thieves. We should put them all in prison." It's a facile, self-serving, 'classist' and ignorant statement.

Just as almost any demographic group, the vast, vast majority of C-levels are good hard-working folks who are really trying to do the best for their company, their investors, their customers and the public. You hear about the bad'uns, but they are a tiny minority - from my own experience I would argue a smaller percentage than in most other demographics. Folks who can't be trusted tend not to get promoted.

I've worked with a number of such folks at all levels from startups with five people to Fortune 500 companies. Most of them got where they because they worked well with others, maybe had some charisma, tended to make the best decisions given insufficient information (often it's not make the right decision, it's making a decision and making it become the right one by making a success of it), and the ability to instill confidence and optimism in the work force.

But just like auto drivers - the ones who drove home today without incident don't make the news - CEOs that just run good companies well are rarely in the news. The 1% or less who make the news are not typical.

Re:why even let them exist

[poofmeisterp]

What line of work are you in? I need to get there.

Re:why even let them exist

[superwiz]

umm... they gamble with billions of THEIR money. not YOUR money. you suffer when they lose because they can't lend you THEIR money anymore.

Re:why even let them exist

[teknomad]

Obviously, you aren't aware of the history of investment and investment banking. It is unlikely America would exist without the practice of investment banking -- it certainly would not have been discovered by Europeans in the manner it was, nor would it have evolved as the world's commercial powerhouse for the last three centuries. You owe investment banking a great deal more than you realize.

Re:why even let them exist

[garyebickford]

Oddly enough, these days I"m a computer geek writing web-based data mining systems.

In the past I've been VP of R&D for a bleeding edge startup, project scientist in the Robotics Institute at CMU. After CMU, I was control systems manager for a nuclear maintenance robotics company, and product manager for a pretty cool document management software product for the NeXT computer. I once spent the entire afternoon watching Steve Jobs tear apart our user interface and tell us how it ought to be done - and rightly so. :) The head of our company and inventor of the product wasn't very happy, even though Steve told us that if it wasn't good, he wouldn't have spent the time.

A number of years later I was a senior sysadmin building the first serious web server farm for a competitor to Halliburton. this would eventually replace over 100 separate web server projects around the company, running on every imaginable architecture. To get approval I had to get the C-level execs for several divisions AND the very serious global networks division to agree on the system proposal and get it built.

Funny - looking back on all that, I've done some interesting stuff. At the time it was just what I did.

I've long had some pretty strong interest in the implications of considering economics as a 'complex adaptive system' (look it up, it's an interesting area of study). Systems Science FTW!

Re:why even let them exist

[poofmeisterp]

Sweet, bro. I'm in AI so CAS is something I use constantly. Nice to meet ya!

Re:why even let them exist

[dalias]

Your equating of sweeping generalizations about executives with sweeping racist generalizations is a bad analogy and it's offensive. There is no context of systemic oppression whereby executives are denied opportunities and even their basic rights based on sweeping generalizations about their bad behavior; rather they're privileged BECAUSE OF their bad behavior.

Re:why even let them exist

[garyebickford]

I wish I was. I thought my present job was going to involve some interesting machine learning but it's much more mundane. I'm starting to feel stale. I _really_ want to be stretching my brain around neural networks and such. I was teaching myself Erlang for a while (it has a really nice approach to dynamic clustering, although it ain't the fastest out there) but I've kinda slacked off on that. I haven't decided what to do about it.

Re:why even let them exist

[garyebickford]

Funny thing, I said nothing about race. I spoke of a voluntary behavior (listening to rap music) that is not at all restricted to any race. I could have used baseball playing, beer drinking, catfish noodling or any of a thousand other activities, many of which are commonly subject to generalizations and stereotyping. I used rap by chance, and it happened to trigger in you the kind of assumptions that I was pointing to. So, thanks! :) I suggest that you try to get to know some people who actually run companies (small or large), and find out what they are really like, what are their needs, hopes and fears. You might be surprised.

Re:why even let them exist

[Anonymous Coward]

Err no... The gamble with our money. That would be the tax payers who bailed out these fuckers.

Re:why even let them exist

[superwiz]

the taxpayer money was repaid with interest. and they didn't gamble with it. they were loaned that money. if you don't like the fact that your government lends money to big banks (and i don't), then take the issue with the government.

Re:why even let them exist

[dalias]

You spoke of a racist stereotype, compared it to a generalization about executives, and implied that these types of generalizations are morally equivalent. They are not. You then act like you some how "caught me" for picking up on the implied racist stereotype in your original post, as if there's something wrong or "racist" about identifying and calling out racism. This is all textbook behavior. I suggest you google "racism 101", "white privilege", "derailing for dummies", etc. For what it's worth, I do know people who run businesses, some respectable, some not. Even the ones who are not are still nothing like the scum that are big banking executives.

Re:why even let them exist

[poofmeisterp]

And where do you come up with said analogy, dalias?

Is there something that YOU associate a generalized statement about rap with in YOUR head?

Shut up before you get YOURSELF 'dissed'. Oh, wait. Only racial minorities use the term 'dissed'.
/snark

Re:why even let them exist

[dalias]

If you want to make a stand against racism - and by racism I mean systemic racism, the power plus prejudice sense - the first thing you need to realize is that modern racism consists of "code words". It's not about people throwing around the N word - nowadays most people are smart enough to realize if they do that in public they're not going to be very successful staying in power. So instead you have code words. "Kids who listen to rap" is a code word for black youth used when you want to make generalizations about black youth while maintaining plausible deniability. The intended usage is that the person who hears you use the code word will agree with your racist assumptions, and you'll affirm one another's membership in the "club". Assuming you're white (given your comments, the chances are at least 95%...), the responsible behavior when you hear people using racist code words is to call them out on it and let them know that you have no interest in being part of their club, and that you're offended that they assume racist behavior is okay with you just because you're white.

Re:why even let them exist

[Anonymous Coward]

Or make as many jokes and comments about myself and my race, which is crackerjack, and LET IT GO. If you want equality, let there be equality.

If you want to end categorization and stereotyping of people and ideas, end the Human species because it's completely "normal" on all levels. It gets unfair and bad when you use it to your advantage. I don't see that happening here.

Re:why even let them exist

[poofmeisterp]

I responded from a non-logged-in device. Sorry about that. Anonymous was me.

Blame the bank administration

[msobkow]

The blame should be placed squarely on the shoulder's of the bank administrators. There is absolutely NO EXCUSE for not noticing a 2 BILLION DOLLAR LOSS.

It's not the computers.

It's not the traders.

It's not the system.

It's the BANKS ADMINISTRATION.

And it's high time that those lazy incompetent greedy bastards were held RESPONSIBLE for their incompetence instead of getting "bonuses."

Re:Blame the bank administration

[MartinSchou]

And it's high time that those lazy incompetent greedy bastards were held RESPONSIBLE for their incompetence

They will. Oh, how they will! This year they'll only get 95% of the bonuses they got last year. That'll teach them!

Re:Blame the bank administration

[Hatta]

I would bet you anything that this "rogue trader" was tacitly, if not explicitly, encouraged in his behavior. As long as he kept getting lucky, everyone profits. As soon as his lucky streak ends, he's a rogue trader.

Re:Blame the bank administration

[poofmeisterp]

And it's high time that those lazy incompetent greedy bastards were held RESPONSIBLE for their incompetence

They will. Oh, how they will! This year they'll only get 95% of the bonuses they got last year. That'll teach them!

You forgot to factor in dollar value adjustment. The bonuses will be 200% of last year's.

Fault? The people under "them" that did the math on the bonus/dollar ratio. Fault equalized. Innocent. :> /snark

Re:Blame the bank administration

[Anonymous Coward]

Remember this is UBS we're talking about. 95% of zero bonus is still zero.

(If you weren't aware, UBS is generally considered to be a giant fuck-up at the moment. They've been losing tons of top bankers and money. This rogue trader isn't helping their reputation.)

Re:Blame the bank administration

[Anonymous Coward]

Is that before or after they work out how big a bonus to pay the board for creating this mess?

Re:The computer is...NO DISASSEMBLE!!!

[Anonymous Coward]

It's a machine, Schroeder. It doesn't get pissed off, it doesn't get happy, it doesn't get sad, it doesn't laugh at your jokes...

IT JUST RUNS PROGRAMS.

Re:The computer is...NO DISASSEMBLE!!!

[JustOK]

the programs run it

a hedge worth having

[epine]

The obvious thing is that you are supposed to be hedged.

You need to imbibe some Argumentative Theory, followed by a Black Swan shooter.

There's a mathematical definition of hedge, and there's the social theory of hedge. The later means "but I think I can get away with it, so it's OK". The mathematical version depends on having correct variance models. If you don't, no hedge exists. Taleb 101.

Society would benefit from hedging itself against the tendency of bankers to hedge themselves deep into the grey zone.

Seriously, bankers talking about risk is a lot like Tom Cruise interviewed after filming Days of Thunder appearing to say--very fervently--that the idea from the movie that you can't control circumstance at 200 mph is full of baloney and that he really got mad filming those scenes where other characters throw this in his face. He races his own cars and believes in control over destiny, which is common among people who take insane risks.

Even if you have LTCM wonks dictating algorithms to be coded by nuclear power engineers and run in NSA bunkers, you can't escape precipice risk. But you can shepherd all the risk with your border collie safeguard systems into the universal millisecond of doom.

So in the lingo, an unhedged risk is the one where only one bank has egg on its face, and a hedged risk is where every fucking bank has egg on its face, and greater society picks up the tab.

Re:a hedge worth having

[WoOS]

So in the lingo, an unhedged risk is the one where only one bank has egg on its face, and a hedged risk is where every fucking bank has egg on its face, and greater society picks up the tab.

This is the general problem with short-term speculation. It is a (near) zero-sum game (the near due to possible arbitrage gains from providing liquidity for long-term trades). Yet for years banks have posted record gains out of it. That money had to come from somewhere. It came out of the coffers of the financial institutes which had to be saved by governments in the last financial crisis.

And had UBS lost not only 2 but say 20 billions, it would too have to be saved (again) by the Swiss government. Yet the 20 billions would have turned up on several people's bonus/dividend slip.

Re:a hedge worth having

[quarterbuck]

Disclaimer: I don't work for UBS or a bank.
I don't think there is a need to read too much into the word "hedged"
The guy seems to have worked on ETF/delta one desk. The desks job is to sell clients securities and replicate the returns using equivalent assets . For eg: if an insurance company wanted a product that tracks the inflation of Eurozone, UBS would (presumably) sell them a swap or a debt instrument which would pay the weighted average of inflation across Eurozone. They would then "hedge" this risk by buying European inflation protected bonds. As long as they keep the $$ amounts balanced and adjust for currency movements , they are hedged. If German inflation increases, UBS has to pay the insurance company a higher amount for the month, but the higher payouts on the German inflation protected bonds balance this out. UBS's profit would be the fees they charge the insurance company for providing this service. UBS can also make additional profit by buying Italian bonds (which pay higher interest rates) instead of German bonds -- but this involves "risk". The risk here is that Italy goes bankrupt while Germany does not.
It is the job of the trader to ensure that (s)he stays within the risk limits prescribed and the risk department should monitor any excessive risk taking . ie. if the trader sold someone a bond pegged to South African risk, risk department should ensure that the trader did not hedge it with bonds involving Somalia.
The OP was surprised that the speculation seems to suggest that it was not a case of bad hedging, but the fact that a bunch of hedges were not in place at all!! It should be a case of simple accounting to see that there is an instrument on UBS's books which has a notional value of a few billion dollars which has no equivalent hedge.
In the case of Nick Leeson (Barings Bank), he used an "error account" - a pseudo account in the bank to hide his losses. In case of Societe Generale (Kerviel) he hacked into the system to hide his trades. It is yet unclear how this guy hid his trades.

Re:a hedge worth having

[Anonymous Coward]

Sorry to shoot down your high altitude ego balloon, but this is a fucking delta one desk where the hedges are fucking obvious. There aren't "black swans" on this desk, there's no "variance model", there's hardly any math here. Even Taleb doesn't pick on delta one products. Whatever you're talking about makes no sense here (and not much for vol products either, I would say--clearly you've not worked at a trading desk before). This guy put on trades somehow that their systems didn't know about, that's all there is to it.

there was an old lady who swallowed a fly

[epine]

In my coda, the question is whether this parable applies to the lone guy at the trading desk, or to the evolution of computerized trading safety nets which ensure that no one fails until we all fail, Dr Strangelove style.

You be the judge. No hedge achieves measure zero.

"IT" could have caught?

[Anonymous Coward]

You know, when someone talks about computers, computer programs, network cables or the like as IT, I get the feeling that they are clueless about the stuff. Pretty much the same bunch that talks about the screen as the computer or holds a "computer driving licence".

It's embarrassing when Slashdot sinks so low that it sounds copied from a newspaper.

It's also too broad - just as silly as:
Science could have caught...
More money could have caught...
Police work could have caught...

Re:"IT" could have caught?

[poofmeisterp]

Yeah, you're right, Mr. Anonymous.

I have "caught" a lot of things in the past and my opinion has been 90%+ ignored (and yes, the suggestions and findings are documented, not just crybaby complaints). It starts to become a form of target practice after a while. What's the term, "low hanging fruit?"

Out of 100 problems, only 2-5 are addressed. The rest is "not important enough" or "not worth the money" to address. Until there's a disaster, of course. Then it's IT's fault for not having a system in place to prevent "these issues".

Ah, now I know why I saw the word "scapegoat" above.

Kweku Adoboli

[Anonymous Coward]

When I receive a mail from someone with a name like Kweku Adoboli I don't need to read it to know it is a scam.
Maybe the UBS bank should be similarly cautious.

Coming soon to a investment firm near you

[kuhnto]

Music while on hold...

"Hello this is the IT department, what can I do for you today?"

"I need help FAST! I am trying to take advantage of the Facebook IPO, but my transaction is not going through the purchasing software!"

"I'm sorry to hear that, let me take a look on my end... OH, Ah, Oh, I see that your purchase amount is above the IT department's trading policy limit, so the order can not go through"

"THIS IS NOT ITS JOB TO DETERMINE THIS!! THIS NEEDS TO GO THROUGH IMMEDIATELY! TIME IS OF THE ESSENCE!!"

"According to policy C-1474, all transactions above $5000 will need to be put through IT's weekly security and trading meeting."
v "WHEN'S THAT!"

"Thursday."

"WHAT THE F***"!"

"Sorry for your frustration. I have started a problem ticket in the system... the ticket number is four, Seven, Three, Two, DEE as in Delta..."

Click

Don't believe what the official report is

[roman_mir]

The original report is most likely nonsense.

I don't believe that this was just what is reported.

Only if you want to catch them all the time

[tchdab1]

Putting in place restrictions to prevent illegal trades will also catch those who are making money at it.
Funny how we only hear stories about illegal trades that result in huge losses - people are never prosecuted for successful illegal - excuse me, "unauthorized" - trading.

Re:Only if you want to catch them all the time

[superwiz]

it's not illegal. the trades were not authorized by the bank itself (ie, the owner of the capital the trader was spending). the crimes that he is charged with do not stem from illegality of trading. he is charged with false record keeping.

Controls are not just IT

[sjbe]

If American Express and Visa can mine transaction data and put a stop order on credit cards when you unexpectedly buy gas out of state, it seems like there could be patterns to watch for when the amounts are in the billions, too.

Apples to oranges in a lot of cases. Credit card transactions have huge volume, are fairly similar, and its relatively easy to see if someone is making a purchase that is unusual for them. There is a lot of data to compare against. Investment bankers sometimes do routine trades but they also invest in all sorts of complicated ways that aren't routine and that really can't be evaluated for statistical anomalies. Not to say they shouldn't use IT to track what they are doing but it is not nearly as easy as the glib summary makes it sound. There are lots of very effective controls used in the financial world that aren't based in IT.

That said, the real responsibility falls to management and especially to the risk management folks at the bank. It may not have been an IT problem but there still should have been controls in place to ensure this sort of thing doesn't happen.

Not Likely

[Anonymous Coward]

I know that in the US, UBS has outsourced most of their IT operations. In fact, a LOT of UBS IT jobs were offshored in the past 10 year. I know sysadmins, DBAs, and a large percentage of programming jobs were sent to india. I recently interviewed some IT people from UBS. They were applying for technical jobs, they seemed to have devolved into project managers. It led me to believe that UBS management had gotten rid of any technical people in the USA order to save a few bucks, and probably viewed technology as non-strategic.

I can't imagine that someone working for a third party IT company halfway around the planet from where the actual business is done is going to care that much, have any initiative/power to implement new technology, or even be that familiar with what the business actually does.

Re:Not Likely

[HornWumpus]

I worked for a consulting company that wrote power trading and risk management software. The sun never set on this companies software. It ran from Amsterdam to Adelaide, and likely was on the trading desk and operations floor at your power company.

While I was there we went from 8 people to 250 because we cared more then the EDS division we took the majority of our customers from. Sense then it has been acquired and wrecked by a larger consulting company.

That said I have never seen anybody more incompetent in computers then the Brahmen type Indians we hired. They think they are above actual work.

Gupta's from lower castes are generally smart and good workers.

note to citibank fraud detection

[doug141]

Buying gas out of state is not cause to decline a card when there's a big charge from U-Haul on the same account. In fact, that's probably the worst time to decide to start declining your customer's charges.

Risk control failure

[alexmin]

IT will not catch anyone. They do not have neither authority nor knowledge of applicable risk limits. Authority to control traders risks are granted to "risk managers" (duh!) This loss is an abject failure of a risk manager that was assigned to monitor the trades. Unless the trader cooked the books to hide what he was doing as in SocGen case of last year the risk manager deserves to be thrown out of his job with black mark and put in jail for long time.

Re:Risk control failure

[superwiz]

He's been charged with false record keeping. So it does look like he cooked the books.

Complex Financial Products-

[Anonymous Coward]

UBS hasn't told us what kind of trades this guy had on--It is very very unlikely that he was making equity trades retail investors and slashdot is familiar with. There is a lot of speculation based on the timing and the bank that he had a complex Vega(volatility) trade on the CHF/EUR cross that literally went to 0 when a policy decision pegged the currency.

Internal controls to prevent the Leeson style rogue trading are already in place. Controls for complex financial products also exist, but are orders of magnitude more difficult to implement. If the speculation is correct, identifying it algorithmically would require the IT department to have a much much deeper understanding of the products than they traders. If an individual in IT had such a sophisticated understanding of these products, he would be working as a trader not in controls.

Why didn't they catch....

[Anonymous Coward]

.... the fact that they were gambling with the world's economy in 2008?

Really... what a great setup... if we loose OUR money, we all go ballistic.... but if we loose YOUR money.... too bad, so sad.

How to price complex issues

[Anonymous Coward]

It may seem like this is a rudimentary problem, and it is when you are trading things that have a known and agreed upon price (exchange-traded issues primarily), but when you start trading some of the more exotic stuff like derivatives, this is when the problems occur. The price that you mark-to-market at is pretty much just made up. Becomes pretty challenging to do risk management when the price that something is worth cannot be easily determined.

IT is busy with employee Blackberries and iPads

[Anonymous Coward]

Yeah, sure, I wish I had the resources to look into this "rogue trader detection program" idea of yours but my staff is busy handling complaints from the office staff that they can't get their Blackberries and iPads working with the corporate firewalls and VPN so they could update their Facebook status and stay up to date on celebrity Tweets.

Remember when you cut my budget and I had to toss out half my staff because you consider us a "cost center" and not a "profit center"? ONE TRADER costs you A BILLION DOLLARS and you had to cut MY budget of all places.

Follow the bonus

[sgt scrub]

Wake me when the IT department finds out which affiliate of the bank profited from the "rogue trader". This is becoming standard procedure. The "losses" get woosh'd to another branch, one guy takes the blame, a department gets threatened to be axed, and somebody on the executive rollodex gets a big_ass_bonus.

this is what outsourcing get's you people so far a

[Joe_Dragon]

this is what outsourcing get's you people so far away from the what the company does or have so many levels of contractors / sub contractors that you get people who have no idea about stuff that are big for that company / site VS the standard IT outsourcing / contracting plan.

IT has (almost) nothing to do with this incident

[Anonymous Coward]

It pains me to see dozens of responses, many of which contain complete drivel.

It is clear that few of you have see the inside of a bank or any other large financial institution, much less being qualified to bitch about things you don't have a clue about.

From the news reports regarding this incident, and my limited knowledge of trade processes and IT, I would surmise the following.

The trader was able to hide his illicit activities since 2008, as:

1. His trades were booked on disparate trade entry systems, of which many are only synced after business hours to the accounting/central system for overnight processing. This is how accounting breaks occur, and it is no simple matter to reconcile them. Talk to you friendly neighborhood finance reporting guy (no, not the accountants, i mean the reporting specialists) to get a clue.

      Many products do not even have an updated price available as a data feed (you pick the phone and dial the counter party when you want an updated price).

    You can only monitor trades which have been entered on to the system. Do you know that some species of trades can be booked and settled overnight and are only entered on to the system the next morning?

    How the hell do you calculate exposure on these things, geniuses? You're gonna check on the trade blotters which the scheming trader will not update accurately?

    How do you know when you have breached the daily trading limits on a real-time basis, when today's executed trades don't appear on to the database until tomorrow?

2. The internal and external auditors were sleeping on the job. Someone from one of the Big 3 firms fucked up here, no doubt. And no surprise too, most audits are worth shit.

3. The risk managers are mostly harmless -- they are not traders and haven't got a clue on the actual trade processes, hence all their fancy risk monitoring is worth shit.

        You need in-depth know-how on the intangible processes (trade entries, accounting entries) and the tangible processes (who reconciles the broker confirmation faxed from Antartica at 3am against the trade blotters from the previous afternoon? And how quickly and accurately can they do it?) to even begin to manage trading risk.

The aforementioned are deep underlying causes which will require a complete overhaul of the way trades are done worldwide.

Remember, you can only properly monitor what you can properly measure.

IT folks, get over yourselves -- you have no idea what a nest of worms banking is. Stop thinking the world revolves around you.

Conjectures

[Anonymous Coward]

We don't really know what happened to caused the problem; for all we know he was supposed to hedge the bank's CHF liability and didn't fully do so thinking that the franc wouldn't move 10% in an afternoon.

The amount of money isn't really that large for the bank that size anyway.

Until we find out some real details I am going to amuse myself by reading the comments of a bunch of people who have neither worked on a trading desk nor with risk management systems all of whom assume they know what happened and have a solution.

Yes

[Kupfernigk]

I'm sorry, but all the smart mathematicians and physicists in the world can only derive better models and better algorithms. What the financial sector seems to have failed to do is to employ enough psychologists. Taleb isn't wrong; he has pointed out that the models cannot account for random political events, for psychological forcing, or natural disasters. The probability of these cannot be reliably assessed.

On the other hand, psychology has a lot to say about the arrogance of psychopaths who assume that everybody else is less clever than they are, and how this is usually the factor that leads to their downfall.

Re:Yes

[mbkennel]

"I'm sorry, but all the smart mathematicians and physicists in the world can only derive better models and better algorithms. What the financial sector seems to have failed to do is to employ enough psychologists. Taleb isn't wrong; he has pointed out that the models cannot account for random political events, for psychological forcing, or natural disasters. The probability of these cannot be reliably assessed."

So, can psychologists assess the probability of these events better than mathemeticians and physicists working with Bayesian extreme value Pareto tail estimators?

Re:Yes

[Anonymous Coward]

"I'm sorry, but all the smart mathematicians and physicists in the world can only derive better models and better algorithms. What the financial sector seems to have failed to do is to employ enough psychologists. Taleb isn't wrong; he has pointed out that the models cannot account for random political events, for psychological forcing, or natural disasters. The probability of these cannot be reliably assessed."

So, can psychologists assess the probability of these events better than mathemeticians and physicists working with Bayesian extreme value Pareto tail estimators?

I think you may have missed the point of the parent poster. He's not implying that psychologists can assess probabilities better than mathematicians and physicists, but that they can help people become aware of their biases and overconfidence in their own abilities.

The fact is, given a high stochastic environment like the financial markets, small probabilities with high payoffs cannot be computed from historical data and therefore cannot be forecast with any known degree of accuracy. People tell me there are tools like Extreme Value Theory for handling these things (which, btw, I find to be extremely non-rigorous), but they miss the fundamental point: it is not a mathematical modeling problem, but an epistemological one. In these kinds of domains, nothing in historical data can tell you anything about what is going to happen.

I am a mathematical modeller (Ph.D. in applied mathematics), though not in finance. After years of being in this game, I started realizing that predictions from mathematical models usually work very well in certain "regular" domains (physics being one of them), and fail completely in others (usually economics and other high complex and stochastic environments).

I would be wary of trusting even very smart mathematicians and physicists -- their expertise is often domain-specific.

Re:Yes

[GlobalEcho]

Taleb is correct when

he has pointed out that the models cannot account for random political events, for psychological forcing, or natural disasters. The probability of these cannot be reliably assessed.

However that is not exactly news, and financial firms were worrying about, and limiting, such risks long before the whole business became very mathematical. The true and good things in Taleb's books are not novel, and whatever is novel in them is not of high quality.

It is also untrue that

smart mathematicians and physicists in the world can only derive better models and better algorithms

Much as you would prefer to demonize them, for example with the psycopath label, they are humans and capable of quite wonderful things outside the domain of modeling. Being good at mathematics does not preclude being a good entrepreneur, businessman, or artist. Among physicists and mathematicians you will find many better at taking unquantifiable risks, such as political turmoil, into account than you are.

Re:Yes

[GlobalEcho]

it is not a mathematical modeling problem, but an epistemological one

Quite. I cringed when the grandparent brought heavy-tailed models into the discussion. Financial firms are well aware of this, and fight the epistemological problem as best they can using position limits and scenario analysis. Generally, they are more rigorous and systematic about that than businesses operating in other sectors.

The credit disaster of 2008 shows that, even using position limits and scenario analysis, absolutely idiotic things can happen. For me, though, the lesson was not that financial companies were doing too poor a job of perceiving, understanding and controlling risk. They do as good a job as anybody, i.e. not very good, and they always will as history has shown at least since the 1600s. Rather the lesson is firms should not be allowed to get so large, especially if they are to be associated with banks, and that banks themselves must be instantly and easily separable from riskier groups.

it's not quite that easy

[superwiz]

credit cards only have to find dubious transactions in a sea of transactions where all transactions are independent. the fact that you buy a sweater does not reduce the price you pay for your car. The risks in financial transactions are generally very much hedged. So the fact that you have bought item A may, in fact, have reduce the risks involved in buying item B.

Re:IT has (almost) nothing to do with this inciden

[PPH]

Disclaimer: I have never worked in the financial business, so my knowledge of its IT systems is all third hand.

I have done a significant amount of work in various engineering fields, including applications development to support configuration control and work flow management systems. Some of this work was in areas requiring strict compliance with regulatory agencies rules (FAA, for example).

In the final analysis, most of the failures of IT systems and the resistance to mitigate those failures are cultural within an organization or industry. Build a system that monitors work products and people will figure out a way to game it. Discover those loopholes and attempt to close them and you'll face stiff resistance. There is nothing like the rage of a manager who has figured out a way to 'meet schedule' for the past 20 years that is now faced with having that bug patched. Actually, there is one thing worse: going back through 20 years of transaction records to expose the trickery.

In your industry, traders poke numbers into various reports in the hope that the market will never move against their position. In mine, engineers bury the analysis that reveals which failures could lead to a wing falling off *.

*Example: Taking the printout from an automated FMEA (Failure Mode and Effects Analysis) and hand copying it into a thousand page document (try OCRing that chicken scratch) for submittal to the FAA.

Why the rush to blame and fix?

[DutchSter]

Seriously ... the fraud was discovered Wednesday with arrests following overnight and the suspect made his first court appearance yesterday. Even the prosecutor has said that he doesn't even know if the suspect profited from his actions.

Almost no confirmed details have been released and yet every Tom Dick and Harry in cyberspace knows exactly what happened and has a simple fix whether it be regulatory, managerial, coding changes or a combination of all three.

To trot out the usual car analogies ... this is kind of like the news reporting that there was a serious car crash on the freeway an hour ago, three cars caught fire and five people are dead. Then in the next segment they have a panel of experts who talk about how better brakes, traction control and a closer fire station could have prevented the tragedy.

Anybody who claims to know what could have prevented the incident at such an early stage is overgeneralizing, talking out their ass ... or both.

This fraud has been going on for the better part of three years. We barely know what controls have been circumvented at this point and we sure don't know how they were bypassed. Why can't we wait for the investigators to figure out what happened first before we start trying to prevent the next one?

only losing trades are rogue.

[Anonymous Coward]

i have never seen a story about a rogue trader MAKING any amount of money. that's because only losing trades are rogue. this isn't a systems, accounting, or technology problem. it's a cultural one.

if you make money you can do whatever you want. if you lose you'll get fired. if you lose enough, you'll get arrested.

frequency of transaction matters too

[Anonymous Coward]

where transaction are in the millions (e. g. visa) it easier to mine data meaningfully compared to less frequent events (hundreds or thousands trades for a bank)

Well...

[Anonymous Coward]

I like cows. They go moo. That's so hot.

Why that would cost money?

[Billly Gates]

I.T. doesn't make money. Bankers do!

Cut the cost centers! ... and give the savings to the shareholders.

Re:100% accountability? I'm not that's what they w

[Anonymous Coward]

Well, clearly you don't actually know anything about trading desks, because basically what you're saying is all false. If you can say anything about the trading desk, it's that EVERYTHING is logged. Every trader's PNL is tracked, the risks are calculated every day (much more than that actually), every trade is recorded. Even phone calls, which are normally illegal to record under US law, are recorded on trading desks since verbal contracts may be made. If anything fishy happens the SEC will review all those logs. In all likelihood the issue at hand is that somebody found a way to make unlogged trades--hence the "fraud" accusations.

You can potentially win big, lose or stay the same - but some of these institutions trade retirement funds or government health funds.

You are confusing trading desks with asset management. Disabuse yourself, and seek out some factual information before you defecate on /. anymore.

Don't be so naive.

[mbkennel]

You've just rediscovered stochastic volatility. A few people got the Nobel prize for work they did decades earlier.

Yes, the assumption of strict normality and constant variance has been falsified a long time ago. Nobody pricing even vanilla options will use these. It's obvious from the implied volatility smile (which wouldn't exist in the classical case).

Re:Don't be so naive.

[NoOneInParticular]

Of course, when real money is on the line, people do tend to look at the data. Of course, volatility smiles are there. And yet. Nobel prizes are awarded for techniques that fail any type of empirical scrutiny. Black-Scholes and Markowitz. People talk about sigmas, betas, correlations, and greeks as if they are measurable quantities, while (some) professionals know that they're not. Students are still taught that this is a good first approximation (all models are wrong, some are useful). All this to teach the hidden assumption that you can use past price to tell anything about an instrument. When people become professionals, they might learn the ugly truth (after they've been bitten a couple of times). If they become individual investors, they're screwed, as they were taught a lie.

The situation is much like a society that is teaching astronomy by first starting with a flat earth assumption, and explain bodily movements by gods in chariots. Only when you are going to work in practice, or become a post-grad, we will tell the nasty details of a round earth, orbiting the sun. This society never got to figure out relativity.

Do you realize how many people have been taught the basics of pricing through normal assumptions, and were thereby taught something that is going to bankrupt you if you apply it? Is that sound? And are you really sure that the professional market is aware of how little is in those models? I'm sure a few know exactly what they are doing, but I've met lots of representatives of the bulk: they truly believe that fundamentally, second-order statistics are sound, but just need a bit of tuning to be used.

The point I'm trying to make here is that a sector that has so little fundamentals as the financial sector, should be very careful about how they quantify, teach, and communicate risks and events. Even to themselves. This is a sector that fools itself very easily. So of course, nobody blindly trusts Black-Scholes models, but they still run them to get a feel. And when the market does something wild, they lose a lot of money. Option traders still use them for computing the delta, to compute their risk-neutral exposure. They still go broke because of this. Nobody blindly trusts the beta of a company, but it still gets communicated in reports. In general, nobody really trusts all these multvariate statistics, but they still form a basis that people use as a guideline. It is just a pity that this guideline is thoroughly underestimating the risk people actually run.

An anecdote. Actual bank, circa 2005. They were doing a risk computation, so they applied VaR. They had to, Basel-II requirements. (my numbers are going to be off, it's too late here, I'm not going to compute them) They knew their computations led to unacceptable risk if you plug in the true numbers (as VaR invariably does), so instead of computing the value at risk at the 99.9% probability range, as was required, they computed it at the 99.9999999% range. Technically, they were trying to manage risk from a 12 sigma risk level. They were fully aware that they were running a risk much higher than this 12 sigma level, yet their instruments didn't allow them to put in the right numbers. When I watched them I had the feeling they were steering an airplane with a random altimeter, which they were constantly compensating for. Of course, they never looked out of the window.

I honestly don't know what the industry is exactly doing these days, as I said goodbye to hedge-funds around 2006. I however honestly doubt that a fundamental shift has occurred, and that the intellectual fraud of model-driven risk management has been abandoned. I do know that gross exposures are (finally) getting some attention as an indicator of risk, but I also see that the sigma myth is still alive and kicking.

// TODO: uncomment

[Anonymous Coward]

// TODO: uncomment when tested or losses exceed $1B
// if (DetectRogueTransaction(tradingContext)) return;

In this case, why not?

[mbkennel]

The Swiss National Bank had previously been complaining about the value of the franc and had, within the year, previously intervened to raise EUR/CHF, but the intervention didn't stick then. This time they promised a much more forceful and permanent intervention and for some reason the market believed them this time instead of trading against them like previous times.

So the fact that the CHF would be subject to national bank intervention was hardly an unpredictable 'black swan'---it was an ordinary grey pigeon crapping on somebody's portfolio.

This guy just cheated (probably doing what his bosses wanted him to do) to take on directional bets when he was nominally not supposed to.

Re:In this case, why not?

[superwiz]

not sure how much oversight he had. he was at a director level. and he is charged with false record keeping. so it's pretty certain that he stayed under the radar of risk management.

Eh you believe that crap

[Sheik Yerbouti]

Hehe I am not sure I buy their line. I think they lost two billion with casino style banking and this chump gets to take the fall for it. It's a fine line between fraud and oh crap we lost a bunch of money AGAIN gambling with pensioners money. What are we going to tell the press?

Prove the fraud in court and then I might believe the line they are selling.

Ten to one this guy does not do time because he was probably doing his job. What do you think investment banks do? I mean it's been proven they are all just a bunch of gamblers. Except they gamble with your 401k.

Tech measures could have caught "Rogue Trader"?

[microphage]

"With the benefit of hindsight, IT experts are claiming that technical countermeasures at Swiss bank UBS could have stopped rogue trader Kweku Adoboli running up a $2 billion loss", timothy

Yet another "Rogue Trader" thrown to the wolves. The fact is, apart from the huge amount; such trades are commonplace and as long as money is being made, management turn a blind eye. When one such `trade' goes south, then it's time to blame the `rogue Trader'. While Kweku made the trade, there had to be someone else upstairs signing off on the trade and who would have noticed a dip of $2 billion in the balance. I understand that nowadays there are electronic devices that can display your bank balance on a television screen, any time and anywhere on the planet. If I can make a prediction, Kweku will be incarcerated until he cops a plea, and then let out for time served, as long as he don't implicate anyone upstairs.

UBS is technology retarded!

[Anonymous Coward]

IT would not be allowed to do anything, they cannot retain developers, they have been laying them off. The technical capabilities of this firm is a joke. Outsourcing has and leadership from above with no vision. Technology can do wonderful things but not when run by the idiots running this firm, cough Trogni. This is comming from in insider, seriously messed up place, developers cannot sneeze without big brother but 2 billion in losses is just another day in the office.

back office

[RogerWilco]

I understand that both this guy and the guy who lost a couple billion at some French bank a few years ago had come up though the back-office, so would know what limits would set of the alarm bells and would fly just below the radar.

I think the real problem is too much risk taking because in general if you do well, you get a fat bonus (all the way up the management chain), and if you fail most of the hurt is on the customers, shareholders or taxpayers. Usually the worst thing that can happen is that you get fired.

It's like gambling at the casino, but every time you loose, people give you new money.

IT to catch rogue traders

[Transaction7]

Deja vu all over again. The big banks and other financial institutions involved in this kind of gambling all knew v3ery well that another such actually or allegedly rogue trader had done this at another big bank based in Britain and the Far East, among other times this has happened. The very idea that they let one lone trader expose them to this kind of losses without a senior execjutgive, without the trader's motive to take risks with the company's and its depositors' money, closely supervising this activity, is incredible in every sense of the word. If the top dogs didn't know, especially over this time frame, it was because they didn't want to know. As another posted, even credit card companies have computer programs to alert them to unusual activity in real time. Of course American Express and others let someone else run up bills on my cards that they never would have let me run, greatly exceeding not only my highest balance but my reported annual income. What kind of accounting do these big outfits use that they wouldn't hvae a running live record of their major positions? There is another looming question here. When you start having trading activity of such huge volume that it materially affects the value of currencies, here reportedly affected the value of the Swiss franc, why didn't one or more of the affected governments, as well as the bank, check on this? I have had one nagging question for some time. All of the big banks and financial outfits are deeply into the zero-sum trading game because they all appear to find it so profitable. The idea that banks would make loans, based upon character, capacity, capital, and collateral, to real businesses, has largely gone by the wayside in favor of such zero sum gambling. The reported news is all about big profits, big bonuses for traders, etc. Why don't we seem, and I repeat seem, to hear about the necessary corresponding losses except in this kind of context in which somebody, always an allegedly brilliant trader (gambler) working for the company, racks up a staggering, huge loss for the institution, and is always branded a rogue, a crook, etc.