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CATTLE TODAY

COMMODITY INSIGHT

by: Jerry Welch

January 25, 2008
-- He is being called a rogue trader because he lost $7.2 billion in unauthorized trades. Had he made $7.2 billion in unauthorized or authorized trades he would be called a financial genius. But bad timing and a stubborn refusal to take a loss caused rookie trader Jerome Kerviel, 31 years old and employed by the French bank Society Generale, to be accused of the largest fraud in banking history. Kerviel has been sacked and now faces legal action. His supervisors have received pink slips as well. In France and across the global financial community two questions are being raised. How could a 31 year old rookie trader rack up so many billions in losses without anyone knowing? And who is this guy anyway?

According to the New York Times, Kerviel, "failed in a bid for town council in his 20's, never rose higher than a green belt, a midlevel rank, after years of judo training because of his bad knees, and he attended an average college where he earned respectable but unremarkable grades." A spokesman for Society Generale described him as very quiet and a loner. More a shy person than an extrovert.

Bloomberg.com writes that Kerviel is at least the seventh individual singled out for unauthorized trading since 1994. The Tokyo based bank Daiwa lost $1.1 billion in '95 and was forced to shut its US branches when a rouge trader bet wrongly on the bond market. A year later, Sumitomo bank lost $2.5 billion in the copper market when it's chief trader known as, Mr. Copper, also placed bets that went wrong. He served seven years in prison as did a Baltimore based trader for Allied Irish Banks for his role in amassing $691 million in losses over five years that were finally discovered in 2002. Kerviels losses were made over ten days!

The most famous rogue trader, the one holding the dubious record for total losses (until Kerviel) is Nick Leeson. In '95, Leeson brought down Barings Banks when he lost $1.4 billion over several months. While serving three years in jail, Leeson wrote his memoirs called, "Rogue Trader." It was made into a film!

When the bank employing Kerviel uncovered the unauthorized trades they immediately began to dump the market positions to limit further losses. In doing so, they helped send all global equity markets lower which in turn spooked the US Fed into cutting rates a whopping 3/4 a point in a rare, unprecedented emergency meeting. The Fed was not aware of the problems created by Kerviel.

The emergency meeting by the Fed was such a shock and so out of character The Financial Times wrote, "the question being asked now by some in the markets is; was the Fed duped into a clumsy and panicked move by the cleanup operation for Jerome Kerviels's mammoth losses for the French Bank?" Obviously, there is no way of knowing for sure if the Fed panicked and lowered rates. It is an interesting question.

Kerviel's job was to hedge the bank's trading positions in European stocks by using stock index futures. He would make countervailing bets or trades on which way stocks would move as an insurance policy to protect the bank's portfolio. He has suppose to be a hedger not a speculator.

The New York Times quotes an official at the bank as saying, "Mr. Kerviel' s losses came from bets made on what they termed, 'plain vanilla products,' relatively simple futures contracts tied to major European stock indexes." He made bullish bets which were gradually unwound over the first three days of this week. "We have no explanation for why he took these positions, and we have no reason to believe he benefited from a financial point of view. We don't understand why he took such a massive position."

When investing or trading, the most difficult of all questions to answer are these: "when to get out with a profit? Or, with a loss?" There are no sure fire answers to those questions. You simply have to get out of the market and live with the decision. If you made money, be thrilled it was with a profit. It you realized a loss, be relieved it was not larger.

Mr. Kerviel did not intuitively know when to exit the market in order to limit his losses. He chose to be stubborn. As a result, he broke the law and will spend years in the Big House. The only plus is he will have plenty of time to write his memoirs and possibly watch them turned into movie. If, of course, you can consider that a plus in his favor.

With the US stock market off to its worst start in history for any New Year and the markets in Asia and Europe in nearly the same fix, being stubborn in 2008, will be a costly character flaw. It will be a year when investors and traders struggle daily to answer the most difficult of all questions and they will discover there are no easy answers.

(The information in this article is the opinion of Commodity Insight's Jerry Welch and subject to change without notice.)

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