The French Fraud King – $7.14 billion fraud by one man

PARIS (AP) — In what appears to be the largest trading fraud ever carried out by a single person, a young trader at French bank Societe Generale is accused of making unauthorized bets on stock markets that cost the bank nearly $7.2 billion but may not have netted him a cent.

The bank called the fraud “exceptional in its size and nature,” and said it apparently went undetected for more than a year by its own multilayered security systems.

It would place the young trader, identified as 31-year-old Jerome Kerviel, atop the pantheon of rogue traders for a scheme from which bank executives said he apparently did not make a personal profit.

Societe Generale Chief Executive Daniel Bouton said Kerviel’s motivations were “totally irrational” but gave no further clues to his motive.

The bank, France’s second-largest, said Thursday it had learned of the fraud last weekend. And the timing could not have been worse: The bank was forced to sell Kerviel’s contracts just as stock markets were plunging worldwide. It took the bank three days to unload them.

Societe Generale said the losses amounted to 4.9 billion euros, or about $7.18 billion — one of history’s biggest banking frauds. It led to immediate calls for tighter regulation.

The fraud also raised comparisons to Nick Leeson, the trader who bankrupted British bank Barings in 1995 after he lost 860 million pounds — then worth $1.38 billion — on Asian futures markets, wiping out the bank’s cash reserves.

Leeson himself told the British Broadcasting Corp. on Thursday that he was not shocked such a fraud had happened again, but “the thing that really shocked me was the size of it.”

Bouton insisted Societe Generale is still financially sound. But the bank said it would need to raise about $8 billion in new capital, partly by selling shares in a rights offer underwritten by JPMorgan Chase & Co. and Morgan Stanley.

The company said it expects to post a net profit of 600 million to 800 million euros ($874 million to $1.16 billion) for all of 2007 — even after the fraud and another 2.05 billion euros ($2.99 billion) lost in the subprime mortgage crisis.

Moody’s Investors Service late Thursday downgraded Societe Generale’s bank financial strength rating to “B-” from “B” and assigned a “negative” outlook to the rating, which means the rating could be cut later. Moody’s also downgraded the bank’s long-term debt and deposit ratings to “Aa2” from “Aa1” but kept those ratings’ outlooks “stable.”

The downgrade was primarily driven by the fraud losses but also follows Societe Generale’s announcement of the credit-related write-downs, Moody’s said.

Kerviel, employed by the bank since 2000, had worked his way up from a supporting role in an office that monitors trades to a job on the more glamorous futures desk, where he invested the bank’s own money by hedging on European equity market indices — making bets on the future performance of the markets.

Described as a “brilliant” student by one of his former university teachers, he shocked executives with the complexity and scale of his trades. Bouton called the fraud “extraordinarily sophisticated.”

Kerviel was involved in what the bank calls “plain vanilla,” or the more basic forms of hedging, with limited authority. He took home a salary and bonus of less than 100,000 euros, or about $145,700 — relatively modest in the financial world.

The bank said he went far beyond his role — taking “massive fraudulent directional positions” in various futures contracts, betting at the start of this year that stock markets would rise.

He apparently escaped detection by using knowledge of the bank’s control systems gleaned in his earlier monitoring job.

Most of his positions went unnoticed by colleagues and superiors as Kerviel covered his tracks with what the bank described as a “scheme of elaborate fictitious transactions.”

He got caught when markets dropped, exposing him in contracts where he had bet on a rise.

Jean-Pierre Mustier, chief executive of the bank’s corporate and investment banking, said he is convinced Kerviel acted alone. Three union officials representing Societe Generale employees said managers at the bank told them Kerviel was having “family problems.”

Analysts were stunned that such a huge fraud could have occurred more than a decade after the one at Barings.

It shows banks “are still under the threat that an employee with a good understanding of the risk management processes can (get around) them to hide his losses,” said Axel Pierron, a senior analyst with Celent.

Societe Generale said Kerviel had admitted to the fraud and had been dismissed along with some of his bosses. Bouton offered to resign, but the board rejected his offer.

The bank also filed a legal complaint Thursday accusing Kerviel of fraudulent falsification of banking records, use of such records and computer fraud.

Elisabeth Meyer, Kerviel’s lawyer, said on French television network BFM that her client “is not fleeing” and is “available for judicial authorities,” but did not specify where he was.

The lawyer said Kerviel had been suspended on Sunday, and was awaiting formal written notification of the suspension.

The Bank of France, the country’s central bank, said it was immediately informed of the fraud and was investigating. Its governor, Christian Noyer, said the trader had an abnormal knowledge of Societe Generale’s trading systems, and measures would have to be taken to prevent this happening again.

Traders are usually kept to tight spending limits, told “you may trade this much and no more,” said Robert Kolb, a professor of finance at Loyola University Chicago. Those controls apparently failed in this case.

Kolb said he expected “a lot of soul searching” in the industry, and predicted that one upshot might be new measures to prevent people who have previously monitored traders later becoming traders themselves.

“It shows that we are in a very troubled period for banks, and I think that it’s in such troubled periods that difficult things happen,” said Gilles Glicenstein, president of asset management at France’s largest bank, BNP Paribas.

Societe Generale’s shares, which have lost nearly half their value over the past six months, were suspended in Paris on Thursday morning, then dropped 4.1 percent to close at 75.81 euros ($111.16) after they resumed trading.

Founded in 1864 after a decree signed by Napoleon III, Societe Generale employs 120,000 people in 77 countries.

AP writers Matt Moore in Davos, Switzerland, Thomas Wagner in London, and John Leicester, Angela Charlton, Angela Doland, Jamey Keaten and Elaine Ganley in Paris contributed to this report.

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Recession 2008: How bad it can get

NEW YORK (CNNMoney.com) — The sputtering U.S. economy has gotten everyone from the financial markets to the Federal Reserve to Congress in a panic.

But here’s a disheartening message for those already worried about economic growth — it could get much worse.

Most economists who believe a recession is already here or at least near are looking for a relatively short and mild downturn, perhaps lasting only two or three quarters.

But many of those same economists say they also can envision a worst-case scenario where spending by consumers and businesses falls off sharply, unemployment heads higher than normal during a typical recession and housing and credit market problems worsen.

“I can easily imagine [the economy] going into a free fall,” said Dean Baker, the chief economist for the Center for Economic and Policy Research. “The danger is that housing prices continue to tumble and accelerate, people’s ability to pull out equity will evaporate, and you’ll see a serious downturn in consumption.”

We talked to three more leading economists to find out their biggest economic fears. Here’s what they had to say.

Greenback blues David Wyss, chief economist with Standard & Poor’s, said that among his biggest concerns is that overseas investors could pull back on investing in the dollar and other U.S. assets.

That could cause an even greater sense of fear among U.S. consumers and businesses, as stock prices fall and bond yields rise, which in turn would lift mortgage rates and be a bigger drag on the already battered housing market.

“Americans could just get scared by a barrage of bad news,” Wyss said. “The stock market could continue going down because of foreigners pulling money out, and between that and home values going through the floor, it could lead to a real pullback of spending, particularly by Baby Boomers who are getting close to retirement.”

Wyss said he’s also concerned that oil prices could shoot higher, even if a recession cuts into global demand. He said supply disruptions in the Middle East could send oil prices up to $150 a barrel and help deepen any recession.

Wyss said that in his worst case scenario, the unemployment rate would climb to 7.5 percent by early 2009, up from its current level of 5 percent.

He also believes gross domestic product, the broad measure of the nation’s economic activity, could wind up as much as 2 percent lower at the end of 2008 than it was at the end of 2007. That would be the biggest downturn since 1982. Many of those forecasting a recession this year are expecting GDP to show a slight gain by the end of the year.

House of pain. Edward McKelvey, senior economist at Goldman Sachs, agreed with Wyss that, in a worst case scenario, GDP could fall 2 percent this year..

His biggest fear is that home prices could fall much further in the coming months. In fact, Goldman and economists at Merrill Lynch have both predicted that home values could fall another 15 percent, on top of the 10 percent drop from earlier peaks that has already taken place.

McKelvey said further declines could cause much deeper problems for consumers and credit markets.

“One of the most likely candidates would be credit markets acting more violently than we thought, a tightening of the supply of credit to businesses and households,” he said when asked what could bring about his worst case outlook.

“You could also see a more substantial response by businesses to the downturn through layoffs, cuts in their spending and business plans,” he added.

Bank woes just beginning. Paul Kasriel, chief economist at Northern Trust, said he thinks there’s a good chance that the economic pullback will be much steeper than now widely assumed. This weak forecast is based on his belief that the billions in dollars of writedowns already reported by Merrill Lynch (MER, Fortune 500), Citigroup (C, Fortune 500), JP Morgan Chase (JPM, Fortune 500), Bank of America (BAC, Fortune 500) and other big banks are just the beginning of the problem in the financial sector.

Kasriel said that if banks have to report more losses due to bad bets on subprime mortgages, they will be unwilling, or unable, to make large loans to businesses and consumers.

So even if the Fed keeps cutting interest rates, the impact of the cuts may be “less potent” than rate cuts in previous recessions since consumers and businesses may not be able to borrow enough to keep spending. That could make this recession more like the one in 1991-92 than the relatively short and mild recession of 2001.

“Historically, and not surprisingly, recessions accompanied by declines in consumer spending tend to be more severe. And people are going to be constrained from spending by the declines in housing,” Kasriel said.

He added that state and local governments might have to cut back spending as a result of declining tax revenue. And that would be another sizable blow to the overall economy.

“People forget about state and local government spending, but it represents 11 percent of GDP,” Kasriel said. To top of page

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Inflation Monster Gobbling Consumer Pocketbooks Worldwide!

The U.S. Federal Reserve’s recent decision to sharply cut its benchmark interest rate prompted a happy response from investors, so it may seem strange that many other central banks aren’t making similar cuts. Jean-Claude Trichet, the president of the European Central Bank, stomped out speculation (Bloomberg) that he might follow the Fed’s lead. The Bank of England’s committee in charge of interest rates voted eight to one to leave them untouched (Times of London). In Australia, media reports suggest the central bank is likely to raise rates next month (Herald Sun). The explanation is simple — inflation — but it has complex implication for policymakers.

Worldwide, central banks face tightened credit and tumbling markets, but many remain just as concerned about sudden jumps in consumer prices. Australia announced January 23 that inflation has reached levels not seen in sixteen years (FT). The Aussies are hardly alone. Even ignoring statistical outliers — Zimbabwe, for instance, where recent International Monetary Fund estimates put annual inflation at roughly 150,000 percent — major economies around the world now face strong upward pressure on consumer prices. The Economist reports that global inflation reached 4.8 percent in the year to November 2007, up from 2.8 percent twelve months earlier. In the Eurozone, inflation stands at its highest rate since the introduction of the euro currency. In the United States, inflation remains lower but jumped 1.6 percent in the year leading up to November 2007.

The developing world presents a starker picture. Venezuela struggled with inflation rates over 20 percent in 2007 (Bloomberg). Argentina and Bolivia face similar concerns. Official data puts Russian inflation for 2007 at nearly 12 percent (Forbes). Several Gulf Arab states also find themselves with inflation over or near 10 percent. In China, rates near 7 percent registered in December 2007 represent the highest inflation in over a decade. China’s Prime Minister Wen Jiabao recently announced Beijing would freeze short-term energy prices in an attempt to curb consumer price increases (NYT).

Efforts to combat the problem in China and other countries are complicated by international monetary policy. CFR Senior Fellow Benn Steil said at a recent meeting that the United States is “exporting inflation worldwide,” given the number of countries, like China and several Middle Eastern states, which peg their currencies to the dollar, and thus to U.S. monetary policy.

How much does rising inflation really matter? Potentially a lot, economists say, particularly coming at a time when central bankers face tough choices about interest rate policy. Consumer price instability can be profoundly unsettling for an economy, and the ominous prospect of inflation limits the extent to which central banks will be willing to use monetary policy to bolster banks, many of which find themselves in a mess due to stingy credit.

Experts say the uncertainty of the overall picture leaves mixed messages for U.S. monetary policy. Sebastian Mallaby, the director of CFR’s Greenberg Center for Geoeconomic Studies, notes in a new podcast that several factors, including rising energy prices and the falling dollar, create price pressure upward in the United States. At a January 24 CFR meeting, Laurence Meyer, Bank of America’s chief economist and a former Fed governor, said if the Fed uses sharp interest rate cuts to mitigate short-term market risks, it must also be willing to raise them again quickly once the initial risks have been forestalled. If it doesn’t do this, the risks of inflation stand to heighten. “If the Fed cuts interest rates too much, it could get out of control,” Mallaby says. “You’d get a repeat of the 1970s where an attempt to keep on goosing the economy with stimulative policy just created inflation.”

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Zimbabwe Releases $10 Million Bill – Which is Worth USD $4

_44364462_banknote_ap300.jpgAs the US economy inches ever closer to a recession, it might provide a little perspective to look at what a real economic crisis looks like. Plagued by hyperinflation of over 50,000% a year, Zimbabwe’s central bank recently decided to issue $10 million notes– believed to be the highest denomination of currency in the world today. The bill, worth less than US$4, is barely enough to purchase a hamburger. One writer illustrates the rampant inflation:

“The bill is exactly the same color, layout and design as a $20 bill I’ve been carrying in my wallet since my trip to Zimbabwe 15 months ago… When I wrote about that $20, it was worth about $0.025 USD – a silly amount of money to represent with a bill, but still a functional piece of currency. At the moment, that bill is worth $0.00000005 cents, or 5 hundred-millionths of a cent.”

Residents of Zimbabwe have been forced to use brick-shaped stacks of worthless bills to purchase even everyday items, like groceries. This is what it took to buy a beer just a month ago– today the situation is still worse. The introduction of the $10 million bill is a response to this, but given the astronomical rate of inflation, the bill will only hold its value for a few weeks before it too becomes worthless

Despite the dismal economic situation, the central bank’s much-maligned governor, Gideon Gono, offers this risible bit of encouragement: “As monetary authorities, we once again assure the nation that we are in full control of the currency situation.”

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Taxpayers could get checks under economic stimulus plan

WASHINGTON (CNN) — U.S. taxpayers would get checks of several hundred dollars from the federal government under a plan to stimulate the economy, congressional and Bush administration officials said Thursday.

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“Tens of millions Americans will have a check in the mail,” House Speaker Nancy Pelosi, D-California, said at a Capitol Hill news conference. “It is there to strengthen the middle class, to create jobs and to turn this economy around.”

House Minority Leader John Boehner, R-Ohio, said, “I’m looking for quick action in the House. I hope that the Senate will follow quickly so that we can put this money in the hands of middle-income Americans as soon as possible.”Video Watch what the stimulus package means »

Speaking a few minutes later at the White House, President Bush said the package will “boost our economy and encourage job creation.” Video Watch Bush praise the plan »

Sources on Capitol Hill and at the Treasury Department said the plan would send checks of $600 to individuals and $1,200 to couples who paid income tax and who filed jointly.

People who did not pay federal income taxes but who had earned income of more than $3,000 would get checks of $300 per individual or $600 per couple.

A Democratic aide and Republican aide said there will be an additional amount per child, which could be in the neighborhood of $300.

Those who earn up to $75,000 individually or up to $150,000 as a couple will be eligible for the payments, said Republican and Democratic sources familiar with the tentative deal.

Pelosi said as many as 116 million American families will get a rebate check.

Checks could be in taxpayer mailboxes by June, according to an Associated Press report.

The agreement includes a robust package of business incentives and help for homeowners facing possible mortgage foreclosures.

The Treasury Department still must analyze the numbers to determine the price tag of the stimulus package, sources said.

To get to the agreement, Democrats dropped calls for increases in food stamps and an extension of unemployment compensation. Republicans agreed to allow people who pay Social Security taxes but not income taxes to get the checks, sources said.

“This package has the right set of policies and is the right size,” Bush said Thursday. “The incentives in this package will lead to higher consumer spending and increased business investment this year.”

He added, “This package recognizes that lowering taxes is a powerful and efficient way to help consumers and businesses.”

The stimulus package may face resistance from fiscal conservatives in both parties over worries that it would increase the federal debt. Auditors report that the federal deficit — the difference between what the government takes in and what it spends — is increasing.

The nonpartisan Congressional Budget Office estimated Wednesday the deficit would jump to $250 billion, mainly because of a weakening economy. That estimate does not include any additional spending that would be part of a stimulus package.

The proposal is intended to address economic worries stemming from a worldwide credit crunch created by the mortgage crisis and plunging stock markets. The president proposed the package last week. Video Watch a debate on whether the U.S. is heading into a recession »

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Officials in both parties credited Paulson, the former Goldman Sachs executive known for a shrewd grasp of the markets, with pushing the package aggressively.

“He’s been on the phone with practically every member of Congress — some of them a few times,” one Senate Republican aide said. “He’s not fooling around.” E-mail to a friend E-mail to a friend

CNNMoney.com’s Jeanne Sahadi and CNN’s Ted Barrett, Kate Bolduan, Ed Henry, Lesa Jansen and Deirdre Walsh contributed to this report.

Copyright 2008 CNN. All rights reserved.This material may not be published, broadcast, rewritten, or redistributed. Associated Press contributed to this report.

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Best Buy Cashes in on Heath Ledger’s Death

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Yale Sounds the Alarm on the Declining Dollar: Dire Straits

If today’s US budget deficit raises concerns, then tomorrow’s projections should sound an alarm, writes economist David Dapice. As the United States descends further and further into debt – by several trillion dollars over the next ten years – the value of US currency will decline. Should a worldwide “run on the dollar” result, shockwaves would resonate throughout the global economy. Dapice argues that if US legislators want to avoid drastic economic and political consequences, they must acknowledge the necessity of decreasing the deficit – and impose realistic cuts on spending, not taxes. “Without a reduction in spending on Iraq and entitlement reform and controls on other types of spending,” says Dapice, “it will be very hard to make a substantial dent in the deficit.” Washington’s continual denial of its fiscal responsibility may push the world economy past its tipping point. – YaleGlobal

Dealing with a Declining Dollar – Part II

If Washington fails to rein in the budget deficit, international bond buyers might force a painful adjustment
 
Since 2001, the Dollar has steadily dropped in relation to the Euro. (Image by Debbie Campoli, (C) 2005, YaleGlobal), Enlarged image
 

MEDFORD: US President George W. Bush’s US$2.57 trillion budget proposal has brought a tepid domestic reaction, and foreigners seeking a silver-lining have little reason to rejoice either. From politicians to Wall Street economists, critics remain doubtful that the Bush budget offers a realistic plan for deficit reduction needed for a stable world economy. The plan, which calls for across-the-board restrictions on domestic spending, requires Congressional approval – unlikely, especially considering the previous rejection of many proposed cuts. Realistically, only about 30 percent of spending cuts are feasible, an inadequate amount for substantial deficit reduction.

More so than this year’s deficits, the ten-year projections may truly raise eyebrows: Over the next decade, the United States may accrue several trillion dollars in debt. Should that be the case, the dollar will likely be in danger; a worldwide “run on the dollar” would bear incalculable consequences.

 
Deficit: Official and Likely Actual. Enlarged image
 

All major nations have problematic long-term public finances due to their aging populations and overly generous promises of pensions and medical care for the elderly. However, among these nations, only the United States requires international borrowing to finance its public deficits. The large and growing current account deficit – the shortfall between the country’s export and import – could trigger a sharp fall in the dollar, bringing in its wake rising interest rates and a recession, or worse. US trading partners could not be sheltered from the fallout.

The prospect of continuing budget and trade deficits poses a problem for potential foreign buyers of dollar assets. There is little doubt that the US economy has a faster long-run growth potential than Europe or Japan. Its financial markets are larger and more liquid. Its rate of return to capital is normally higher, and its accounting is no worse – arguably better – in spite of Enron-type scandals. The long-run public finances of the EU and Japan are in comparatively worse shape due to lower birth rates and more limited immigration, as well as more generous promised benefits. These are all good reasons to accumulate dollar-denominated assets, especially when the euro or yen buys more dollars than before.

 
 
 

On the other hand, the US consumers are mired in debt: Disposable income increased US$2 trillion from 1999 to 2004, while mortgages and other consumer debt increased nearly twice as much. Consumers, therefore, will likely be hit should home prices decline or interest rates increase. There is a real risk in buying dollar assets, even though the US government (unlike most other debtors) can print dollars to repay what it has borrowed. The large tax cuts have removed room for further stimulus. The Federal Reserve might lose control of interest rates if foreign buyers of government bonds stopped buying. Even Alan Greenspan and other Fed officials have expressed concern about the current and projected levels of current account deficits. If others began to sell dollars, there is little doubt that a “run for the exits” could develop, pulling the value of the dollar sharply down.

Buyers might assume that central banks would not allow a large dollar decline, since it would hurt the world economy. They would buy dollar assets, expecting that governments would safeguard their bets. This is called moral hazard, and it can make eventual adjustments even worse, as debtor nations found out in the Asian crisis. Even if central banks do prevent the dollar’s collapse, a large hedge fund or other investor might still place its currency bets on a losing scenario. Ultimately, this would disrupt financial markets, as nearly happened with Long Term Capital Management, the hedge fund that collapsed a few years ago.

 
 
 

Were there clear indications that reducing the US federal deficit were a priority, the chance and severity of negative outcomes would decrease considerably. However, while a minority of Republicans and some Democrats remain “deficit hawks,” a powerful group still maintains, as does Vice-President Cheney, that “deficits don’t matter.” This group prioritizes extended tax cuts and social security reform over deficit reduction. Without a reduction in spending on Iraq and entitlement (especially Medicare) reform and controls on other types of spending, it will be very hard to make a substantial dent in the deficit.

If US domestic politics make serious deficit reduction unlikely, the uneasy international bond buyers may ultimately force the administration’s hand. If the Republicans wish to avoid wearing a “Herbert Hoover necklace” (President Hoover’s policies brought about the crash of 1929.) around their necks for a generation, they may decide that preventing a dollar collapse is even more important than expanding spending and extending tax cuts. Or they might gamble that others have more to lose, and continue to run both federal and current account deficits that push the limits of foreign asset buyers’ acceptance. The willingness of foreign central banks to accumulate dollar assets for mercantilist purposes makes this bet seem safer in the short term, but also makes it riskier over time. The whole world has a stake in the outcome of this debate, but few can vote – except with their money. Investors might cast the deciding votes; though if it comes to that, there could be more losers than winners.

 
 
 

For those who wish to glimpse the “tipping point” – if indeed there is one – the pace of Federal Reserve short-term interest rate hikes might provide a clue. If foreigners begin to sell Treasury bills, which still yield little more than inflation, the Fed would have little choice but to raise interest rates more quickly than it has indicated. These increases would transmit themselves to longer-term interest rates as well, and would drive up mortgage and other borrowing costs. Corporate investment, construction, and durable goods purchases (cars, furniture) would all diminish. Exports would benefit, but the net impact would be negative. If the rate hikes were steep enough, a recession would likely ensue.

Foreign central bankers would understand the fragility of their own economies and would want to keep exporting to the US market. This would tend to push them to purchase more dollar debt. However, fear of private selling of dollar debt or of a “rogue” central bank getting out of dollar assets early might create a sense of caution. With the US current account deficit over US$700 billion this year, even a slowdown in buying of debt would push the dollar down and interest rates up. This has not happened yet, but without corrective action the risks are clearly increasing. Will Washington take heed or not?

David Dapice is Associate Professor of Economics at Tufts University and the economist of the Vietnam Program at Harvard University’s Kennedy School of Government.

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