Monthly Archives: September 2011

Ring-fencing rogue traders

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Kweku Adoboli managed to cost UBS over $2 billion with his rogue trading, and has now cost chief executive Oswald Grübel his job. While this time the buck stopped at the top, it is more than can be said for many previous rogue trading cases. Grübel was called out of retirement to take the helm of UBS as it faced the global financial crisis, so perhaps a return to retirement was an easier choice than it would have been for the chief executives of Société Générale, NAB*, Allied Irish and other past victims of rogue traders.

But what has surprised me about this latest rogue trading incident is reactions like this one from the Economist:

For UBS and its shareholders, the immediate questions should be why it was still vulnerable to this sort of alleged manipulation more than three years after Mr Kerviel’s [the Société Générale rogue trader] loss.

Of course banks are aware of the risk of rogue trading, but it does not mean that protecting themselves against this risk is a simple matter. Trading businesses are complex, with many interconnected computer systems, some old, some new, most dealing with transactions in real time. It is a case of asymmetric warfare: the bank has to defend itself against every possible attack, but the rogue trader only has to find a single point of weakness. The UBS loss may be another reminder for banks of just how much an insider can cost them, but I am confident that there will be another spectacular rogue trading case within the next five years.

Little wonder then that Sir John Vickers, in his report on UK banking, has recommended that banks should “ring-fence” their investment banking operations (including financial markets trading businesses) from their retail and commercial banking arms. The idea is that, while governments will always want to protect the financial system that is so central to their economy, tax-payers should not end up on the hook for losses arising from risky investment banking activity.

Banking regulators around the world have been intently pursuing ideas like this over the last couple of years and the Adoboli case will only add to their determination to impose some form of “recovery and resolution” framework on banks. Before this work is complete, I would not be too surprised if UBS have spun off their investment banking arm. It is becoming all a bit much for Swiss shareholders to cope with.

* UPDATE: My memory served me poorly: the CEO of NAB, Frank Cicutto, did in fact resign after their FX trading fraud.

Unblock Us

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A few months ago, I complained that more and more online music sites have blocked access from Australia. Of course, the arcane licensing of intellectual property has also led to many other sites being blocked for Australians. Anyone living down under trying to access BBC TV via their iPlayer, or trying to stream US TV on Hulu will find themselves out of luck. The list of sites offering movies, TV shows and music online is a long one. The list of these available in Australia is a very short one.

However, I have now discovered a Canadian company offering one way out of these geographic shackles. For US$5 per month, Unblock Us will allow you to configure your computer or router so that, when you try to access a selection of media sites, your connection will pop out from a server outside Australia so as to ensure you will not be blocked from accessing the site.

But is it legal? That’s an excellent question, and one I do not know the answer to. Not being a lawyer, I will not even speculate. Where I am happy to speculate is on the question of the ethics of the site.

On Friday, a colleague said he was planning to watch a downloaded movie over the weekend. I asked him where he had downloaded it from. While he said he had bought it from the iTunes store, he did indicate that was not the only place he had downloaded movies from over the years. His philosophy was always to try obtaining movies legally first but if—and only if—all legal means failed, he would resort to shadier sources. To me, this seems like a fair approach, legal or not.

As I would be more than happy to pay the copyright holders for access to e-books, online music or videos, I find it extremely frustrating when this is impossible, simply because I am in Australia. In the absence of such legal means, loopholes like Unblock Us start to look very appealing.

There are a couple of other considerations before leaping in to using the service:

  • Privacy: since your internet requests would be initiated through Unblock Us, you would have to be comfortable with them knowing about the pattern of your internet usage, although they do note on their site ” will not actively monitor user activity for inappropriate behavior, nor do we maintain direct logs of any customer’s Internet activities”.
  • Performance: having the extra check for each internet request to see whether it should be bounced through Unblock Us could make your internet performance a little slower than going directly through your ISP. I do not know whether this would be significant.

I am certainly tempted.

Dissonance and Debt

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Ever since Standard & Poor’s downgraded the US government from AAA to AA+ I have been drawn into debates about the risks posed by growing US government debt. Ever since reading the book Mistakes Were Made by Carol Tavris and Elliot Aronson I have been fascinated by cognitive dissonance and as my debt debates kept following the same pattern I became convinced the explanation for this pattern lay in cognitive dissonance. Coincidentally, I then read a post by Bill Mitchell discussing a paper by Adam Kessler analysing the views of mainstream economists in terms of cognitive dissonance.

For those as yet unfamiliar with the concept of cognitive dissonance, it refers to the discomfort people feel when faced with conflicting information. The brain tends to react to cognitive dissonance by quickly eliminating the conflict and restoring consonance.

One of many examples of cognitive dissonance in Mistakes Were Made arises when people with prejudices are presented with evidence that contradicts their prejudices. Tavris and Aronson quote Gordon Allport, who wrote The Nature of Prejudice over fifty years ago. Allport illustrated a typical pattern of dissonance-blocking in the following dialogue:

Mr. X: The trouble with Jews is that they only take care of their own group.

Mr. Y: But the record of the Community Chest campaign shows that they give more generously, in proportion to their numbers, to the general charities of the community, than do non-Jews.

Mr X: That shows that they are always trying to buy favor and intrude into Christian affairs. They think of nothing but money; that is why there are so many Jewish bankers.

Mr Y: But a recent study shows that the percentage of Jews in the banking business is negligible, far smaller than the percentage of non-Jews.

Mr X: That’s just it: they don’t go in for respectable businesses; they are only in the movie business or run night clubs.

Time and time again Mr X. shakes off contradictions to his prejudice with a non-sequitur, responding with a completely unrelated argument in support of his prejudices. My conversations about US debt have been eerily similar:

Me: This Standard & Poor’s downgrade is a bit silly. The US has got past the farce of the debt-ceiling and, unless they choose to default next time they run up against that ceiling, their debt is much safer than euro sovereign debt from the likes of Greece and Ireland.

Mr. Z:  But they’ve just kicked the can down the road. Unless they do something about their deficits and cut all their entitlement spending, they are basically bankrupt.

Me: But the US government is effectively the monopoly issuer of US dollars and all their debt is denominated in US dollars: they cannot run out. So, they never have to default, unless their crazy politicians choose to.

Mr Z: Oh, sure, they can fire up the printing presses and simply print money, but that will always be inflationary.

Me: What about Japan? They ran deficits and their government debt has been growing for years and that hasn’t led to inflation. In fact, they could do with a bit of inflation, but have been unable to generate it. Government deficits will only be inflationary if the government is spending at the same time as the private sector and is overheating aggregate demand.

Mr Z: But Japan has been a basket-case for years, no-one would want the US to end up like Japan!

See the similarity? Almost every time I try to make the point that countries which control their own fiat free-floating currencies and only borrow in that currency (such as the US, UK, Australia, Canada and Japan) can never be forced to default on their debt, the conversation quickly veers away to inflation, Japan and anything but the central point. That’s cognitive dissonance for you.