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Did Societe Generale trades trigger market rout, Fed cut?

Section: Daily Dispatches

By Sitaraman Shankar and Blaise Robinson
Thursday, January 24, 2008

Societe Generale's shock disclosure of a fraud that lost it $7 billion has left investors wondering about a link between the fiasco and Monday's European stock market rout.

The sharp fall, which was followed by an emergency U.S. rate cut, came as SocGen tried to close out positions built up by one of its traders.

SocGen, France's second biggest bank, said on Thursday that it had been the victim of a massive and "exceptional" fraud by a junior trader resulting in losses of 4.9 billion euros, and announced a large capital increase.

SocGen said the trader, responsible for futures hedging on European equity market indexes, had taken massive fraudulent positions in 2007 and 2008 beyond his authority.

The bank said it had decided to close the positions as quickly as practicable after they were discovered on the weekend of Jan 19 and 20.

This has brought under the microscope the massive declines in European shares on Monday, January 21, when over $350 billion was wiped off the value of top British, German and French shares -- an amount equal to the combined gross domestic product of Hungary and Greece.

The FTSEurofirst 300, a pan-European stock market benchmark, fell nearly 6 percent on that day, its biggest one-day fall since the attacks of September 11, 2001.

And the U.S. Federal Reserve served up a surprise 75 basis-point interest rate cut on Tuesday, a move that managed to limit declines in U.S. stocks when they resumed trading after Monday's Martin Luther King Day holiday.

"The huge amount of futures selling could be one reason why markets fell off a cliff on Monday, and maybe that was an ingredient in forcing the Fed to bring forward a part of its interest rate cuts," said Andrew Bell, European strategist at Rensburg Sheppard.

A Fed source later said the central bank had not known about the SocGen fraud when it made its rate decision on Monday.

The stock slide on Monday has contributed to making January the worst month in more than five years on European bourses, and European shares have lost 12 percent so far this month, compared to a 3 percent gain at this time last year.

This was even after a sharp increase on Thursday, as hopes for a rescue package for monoline bond insurers in the United States, and strong results from handset maker Nokia offset any impact SocGen's announcement might have had.

...Huge volumes

Reuters data showed that the volume on DAX futures on Monday, Tuesday and Wednesday were the highest in at least five years and twice the average for the month, despite the United States holiday on Monday.

Talk swirled on Wednesday of a huge writedown at SocGen, and traders said it was possible that this was due to the bank unwinding massive positions.

Trader Rik Zwaneveld at AFS Brokers in Amsterdam said: "On Wednesday there was talk of a 40 billion euro writedown at SocGen. With the news today, a 5-billion-euro loss on 40 billion euros of positions is possible," he said.

L'Autorite des Marches Financiers (AMF), France's market watchdog, declined to comment on SocGen's unwinding of bad positions.

...Trigger for rate move?

The U.S. Federal Reserve cut its discount rate, or the rate at which it lends directly to banks, in August, soon after BNP Paribas, another French bank, spooked investors worldwide by freezing 1.6 billion euros worth of funds due to problems in the U.S. subprime mortgage sector.

Traders speculated that this time round, the travails at SocGen had played a similar catalytic role in the Fed's move.

Said a credit trader in Germany: "It kind of begs the question now: Did the Fed cut rates courtesy of a rogue trader at SocGen having to close out a massive position and sending the stock market into turmoil?"

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