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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 $2 billion loss." If American Express and Visa can mine transaction data and put a stop order on credit cards when you unexpectedly buy gas out of state, it seems like there could be patterns to watch for when the amounts are in the billions, too.
A problem is that it's difficult to design a system to automatically determine "risky" or "rogue" or "non-normal" behavior in investment banking, because taking crazy bets is what they do, and interpreting their official policies loosely is a big part of that. Sometimes it turns out massively well, in which case bonuses all around; other times very badly, in which case start looking for ways to label the guy "rogue" and fire him. But it's de facto, if not officially, part of "normal" operation of an investment bank; it just sometimes turns out badly.
10 PRINT CHR$(205.5+RND(1)); : GOTO 10
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'?"
Schroedinger's Brexit: The UK is both in and out of the EU at the same time!
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?
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.
The Singularity is closer than you think
Quant
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.
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.
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."
I do not fail; I succeed at finding out what does not work.
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.
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.
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.