15 December 2008

Rogue Nation

Explanations of significant losses at investment firms are often attributed to rogue traders. These are traders who have schemed to defeat security measures. These rogues extended their trading portfolios credit exposure far beyond the limits of compliance, racking up substantial losses to be taken, if not risking the actual solvency of their firms. If they do not incur losses they are often not discovered. It is the losses that precipitate the collapse.

Nick Leeson of Barings, Toshihide Iguchi of Resona Holdings, Yashuo Hamanaka at Sumitomo, John Rusnak at Allied Irish Banks, Luke Duffy of Australia National, Chen Jiulin of China Aviation, and Jérôme Kerviel with Société Générale are examples of rogue traders operating since 1995 with combined losses of approximately $12 billion disclosed.

All of them together cannot begin to match one of the great Ponzi schemes in history. This was recently disclosed to be the work of Bernard Madoff, a highly respected executive and former chairman of the NASDAQ, who was apprehended when he confessed to losses of $50 billions.

Not all of his investors were innocents. His returns were literally too good and too mysterious to be true. Many thought that Madoff was trading on insider information or some other fraudulent scheme that was cheating the 'little people.' They did not realize it was they who were being cheated. It is the basic principle of a confidence scheme that you rely on naivete, or the greed and moral indifference of your victims.

The SEC was well aware of problems at Madoff from whistleblowers, and even a cursory examination of the fund's holdings would have exposed the fraud. The SEC was routinely blind to outrageous excesses on Wall Street in the past fifteen years because of the cult of deregulation and chronic underfunding from a Congress in the grip of lobbyists.

In a fraud this large, when it seems as though all those in the know are getting paid, people ignore it when they see it, discourage disclosures, and go along to get along. There is no better example of this on a private scale than the mortgage market in the US where fraudulent valuations and organized collusion were rampant among the banks, appraisers, title companies, the government agencies, Wall Street, and government regulators.

Is there a correlation between rogue traders and market bubbles? History seems to suggest that there is. Yet there are rogue traders every so often even in less ebullient times, but those tend to be isolated and specifically related to secular market innovations such as leveraged buyouts.

In a general monetary bubble rapid and steadily rising asset prices make compliance lax, trading stories that would otherwise be suspect believable, and of course when the money is flowing everyone is getting paid, so there is an atmosphere of general easiness, laissez-faire, and corruption.

Are we near the end of this? Is Bernard Madoff the ultimate rogue trader, the maestro of pyramid schemes, of well-heeled deception?

The status quo likes to blame a 'rogue' because it makes it seem as though the system itself is fundamentally sound. A clever individual acting alone has managed to outsmart the system and find some loophole to exploit until they are caught and exposed. This is a story to maintain confidence in the institution. It promotes unexamined, non-critical trust in the full faith and credit of a system that permits fraud to exist and flourish.

Sadly, this is not the end of the revelations, write-downs and losses.

Bernard Madoff was exposed because declining prices crippled the mechanism of his fraud, as they always do. To his detriment he was not an integral segment of the banking system. If he had been, he might have merely been declared insolvent, retained his honor and his bonuses, been backstopped by the NY Fed, and put into an arranged merger.

Bernie Madoff's mistake was in not incorporating his fraud on a broader scale. He operated on a relatively specialized area of turf in Palm Beach and New York, with collateral damage to the usual suspects on the international stage who are always willing to buy mislabeled American risk.

We believe that there are much greater deceptions being covered up now as we speak, not involving individuals so much as entire companies who have engaged in wanton accounting and securities fraud for the past twenty years.

The losses will eventually top 15 trillion dollars worldwide, and threaten to plunge the world economy into a serious economic dislocation.

Where will the losses come from that will break down the rest of the Ponzi schemes?

History informs us that most of the perpetrators will never be prosecuted, and even though exposed will eventually once again become respected members of society. This is how it was after the Crash of 1929.

The reason for this is that the frauds cut so deeply into the establishment and so far and wide beyond the financial system into the government that they are literally too big to jail.

Indeed, we are already see many of the characters who helped to set this credit bubble rolling in the 1990's coming back into government service with the new 'reform' administration.

The last bubble to fail that will expose these remaining Ponzi schemese is the US dollar and the Treasury bonds. They are the products of a nation that has been overtaken by a rogue culture of sociopaths and swindlers.

Bernie Madoff was no rogue trader. He was successful for as long as he was because he blended in, he was one of the crowd, he was an independent player within the greatest financial swindle in history, the US financial markets and ultimately the US dollar.

Experience suggests that you will ignore this warning, wishing to think of yourself as an insider. After all, it is the weak, the naive, the unsuspecting, the under-developed, the unsophisticated others that are the victims, and indeed they are. After all, what can stop this? The returns are so good, and have been paid steadily for so many years. And you are among the smart ones, the elect.

The endgame will come and strike the astonished like lightning.

You will not realize what has happened until you wake up one day and the accounts are empty, the returns cannot be paid, the promises are proven false, and the principal is gone.

And you will be facing the teeth of the storm with pockets full of empty promises and worthless paper, and no one will be able or willing to help.

And those responsible will say that you were lazy and foolish, and need to be smarter and work harder like them. Those who you imagined were shepherds will be revealed as ravening wolves.

How do we know this? It is already happening again.