Matt Stoller: Authorized Losses – The Lehman Lesson UBS’s Rogue Trader Missed

By Matt Stoller, the former Senior Policy Advisor to Rep. Alan Grayson and a fellow at the Roosevelt Institute. You can reach him at stoller (at) or follow him on Twitter at @matthewstoller

I read this headline in Bloomberg: UBS Has $2B Loss; Man Arrested in London. Apparently, a rogue trader lost $2 billion, and is now sitting in jail because the trade was unauthorized by senior management. Since it’s the 3rd anniversary of the Lehman Brothers bankruptcy, I figure it’s a good time to be nostalgic about who is authorized to lose what. Here’s bankruptcy trustee Anton Valukas, talking about Lehman Brothers and the losses that led to its bankruptcy.

We found that Lehman was significantly and persistently in excess of its own risk limits. Lehman management decided to disregard the guidance provided by Lehman’s risk management systems. Rather than adjust business decisions to adapt to risk limit excesses, management decided to adjust the risk limits to adapt to business goals. We found that the SEC was aware of these excesses and simply acquiesced.

The SEC knew. So did Lehman management.

So an appropriate governance plan was in place to set risk limits. But management did not observe the limits. For example, Lehman committed to what was its largest single investment – Archstone – in May 2007, with closing to occur later. It was clear prior to the commitment that the Archstone transaction would put Lehman over its then existing risk limits, but the deal was committed anyway. With the inclusion of Archstone, Lehman was clearly in excess of its established risk limits. But in the face of exceeding its risk limits, Lehman did not take steps to reduce risk; rather, it simply raised the risk limits.

Losses were authorized.

Senior management made the conscious decisions to exceed risk limits and complete the Archstone and other deals because they believed, erroneously, that those deals would be profitable.

Well it was a decision. And they thought it would be fine. Losses were authorized.

Archstone was the largest, but not the only instance in which risk management’s view was overruled or disregarded. Lehman was in breach of its established risk appetite limits on a persistent basis during the second half of 2007. Lehman ultimately cured the breaches at the end of the year, not by reducing risk, but by raising risk appetite limits again.

Once again, losses were authorized.

Lehman also had in place a “single transaction limit” framework to limit the size of individual transactions as a risk control. But in late 2006, Lehman management made the affirmative decision to disregard the single transaction limit because it had cost Lehman significant profit-making opportunities. As a result, Lehman committed to and closed dozens of transactions that were vastly in excess of that business unit’s risk limits.

Authorized losses, again.

At that time, a senior Lehman officer, Ian Lowitt, observed: “In case we ever forget; this is why one has concentration limits and overall portfolio limits. Markets do seize up.”

They do seize up. Here’s the thing, though. A UBS trader is now in jail for losing a few billion dollars. That’s probably reasonable. In Lehman’s case, no one went to jail, and Dick Fuld if a multi-millionaire, even though the losses run into the trillions.

Moral of the story: Make sure your losses are authorized.

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    1. ambrit

      Dear CB;
      It’s very much like inventing your own ‘alternate reality’ and then trying to live in it. Everything goes fine until the electric company tells you that it does not accept bitcoin for satisfaction of debts.

  1. Yearning to Learn

    what most of us want to know is this:
    were these unauthorized or not?

    I see two possibilities:

    these were “unauthorized” trades but management gave the wink wink nod nod allowing them. if they go well, riches for everybody and record bonuses. but they din’t go well so now the trader is “rogue”

    these were truly unauthorized and this trader racked up $2B without management knowledge. If so, where the hell is the risk control in this bank? what the hell are managers doing if a lowly trader can lose $2B in the wink of an eye?

    thus, either management were liars/crooks, or fools.

    I’m pretty sure these were “unauthorized” in name only, and all management was complicit making them all criminals and liars. But if they weren’t authorized, then it shows how incompetent these fools are.

    I change my mind. they’re both fools and also criminal liars.

    1. R Foreman

      The question I was wondering was did this loss coincide with the Swiss government pegging its currency to the Euro. If you recall that event the Swiss franc lost about 40% of its value in about an hour (or less).

      Was UBS privy to this information beforehand ? It’s easy to see how lots of people got caught on the wrong side of that trade.

    2. Lyle

      Various stories hinting that the trader said a few days before discovery that he needed a miracle, imply that there was a trade that went bad, and rather than fess up, he doubled down and did so again. This of course is typical behavior for a gambler if you loose keep trying because you might win some day. Of course it does suggest that a lot of traders are really gamblers in semi-disguise except that they play with other peoples money, not their own.
      Now note that as with Nick Leason at Barings the guy started out in the back office and presumably knew how the systems in place could be worked around. It does suggest that no one from the back office should be allowed to trade at the same company, to go to trading they have to change companies so they don’t know how to circumvent the IT systems.

      1. Gallam

        It is not quite right to say that Nick Leeson got around the backoffice systems. Senior management had to meet some fairly dramatic margin calls, so they knew that something was going on.

        At the moment the management of UBS appear to be claiming that they knew nothing. Short of the trades being in very illiquid level 3 type assets its hard to understand how roughly $2bn did not actually leave the UBS office, so someone’s signature is on it somewhere.

        1. Yves Smith Post author

          No, there was a Bank of England report on the Barings failure, and as well as Leeson’s book. They actually agree on much of the substance. I read them both.

          He DID get around the back office systems, because amazingly, he had a back office position while trading! Talk about putting the fox in charge of the henhouse.

          Management was NOT aware of the massive cash bleed because it took place over a period of a mere three weeks and they were a bunch of merchant bankers. Barings was a late entrant into trading and senior management didn’t come from that side of the business and was terrible at oversight, particularly of back office.

          1. Gallam

            The senior management of Barings wired several hundred million pounds to support Leeson’s positions. They were certainly aware of the requirements for cash. The fact that they thought that the positions they had were profitable, whilst wiring out half of the bank’s capital because Nick Leeson told them it was OK, does not indicate that Nick Leeson subverted Barings back office systems.

            It indicates that Barings did not have any back office systems to subvert. This may appear to be semantic, but by a back office system what I mean is an iron-clad third-party verified method for determining your positions and P&L(at the very least). If you do not have such a thing you should not be trading, and that’s that. Barings management were not children after all.

            Btw, suggesting that Management was not aware of the massive cash bleed because they were a bunch of duffers is not an excuse for what happened. I would not offer to fly an aeroplane because I am not a pilot, and I would not want to crash it and kill everyone on board. Vast paychecks would not persuade me otherwise.

            We are about to hear a very similar line from UBS I suspect. It is really quite extraordinary that we keep jailing the young men who commit the act, whilst doing nothing more than occasionally firing the senior management who are responsible for guarding shareholder’s capital. I wonder what the mafia would in similar circumstances?

          2. Gallam

            Sorry to bang on about this, but mentioning the fact that the whole Barings thing happened in 3 very short weeks is also a bit misleading.

            Suppose I was working for you and I said “Don’t worry, we’re winning. But I need you to send me £100 million right away.” Would you:

            (a) Wire me the money.
            (b) Get on a plane with your most experienced back office people and find out where the money was going.

            If the answer is (a) then I may have a CV I would like to sell you.

          3. Yves Smith Post author

            Senior management does not wire funds.

            You don’t know how little old merchant bankers knew about trading. You are projecting contemporary notions back onto an senior management that had 1980s at best levels of expertise. And the old style partnership models as that you deferred to the guy who was running the business. The old partnership model meant he was at unlimited personal risk and therefore was presumed to be minding the store well. Many firms did not make the transition from an investment banking model to a more trading oriented business successfully (look at Kidder and Joe Jett. His position got massive before anyone took serious interest, for some issues his positions were bigger than the entire issue, and Jett hid nothing. And Kidder was less badly run than Barings).

            Barings did have a back office, Leeson was effectively in a position where he was overseeing the marks on his position. He hid his secret account (he somehow persuaded people it was a customer account) and engaged in trader double speak to the extend he was asked intrusive questions.

            His positions were in Nikkei warrants, if I recall correctly, and they did blow up in a short period (as in he’d had growing but still manageable/hidable losses for some time, they exploded in the three week period I mentioned)

    3. Armchair Revolutionary

      How about a third option? The trader did the trades knowing full well that he was going to lose. It could have been a few or many sitting on the other side of those trades. If it was a few, that would mean that someone just robbed UBS of $2B. That’s big money. I could imagine this trader having $50M sitting in a few accounts around the world when he gets out of prison in a couple of years.

  2. Sunny129

    When the regulators are sleeping with the regulated for a plum job after stint in the Govt, nothing else matters.

    There are apparently at least three dozen GS alumni through out the Global Financial regulatory landscape in outside the US! the grip of Financial oligarchy on our so called democratic Govt is absolute!

    AMERICA, the Best Democracy Money can Buy!

  3. Brett

    William Cohen has a good piece on Bloomberg about this. He asks the question I’ve been asking myself:

    “Why is it that a trader who exceeds his trading limits and makes a fortune is a hero, but a trader who exceeds his trading limits and loses a fortune is a rogue?”

    The truth is that their risk management models are all based off the normal distribution, VAR or some form of it. Yet asset values, stock values, commodity prices, etc. fluctuate according to a different distribution. What they think is hedged turns out not to be hedged during times of high volatility and panic in the market.

  4. john newman

    It seems to me the only lesson learned from the Lehman failure by those inside the government/finance condominium was if finance is not bailed out access to political money is compromised.

    Financiers must not suffer losses or their servants in government will too. So the perverse incentives for control fraud remain in place everywhere and, as I believe Mankiw put it, financial executives would be “irrational” to not take fullest advantage.

    Europe’s banks have now been given a direct feed to the Fed’s money creation power so there is no incentive for any modification of Euro bank behavior. I expect full bore looting of the real economy to continue until there is physical resistance to it in some form.

    The ECB sits above Europe as a rogue entity answerable to no one. When faced with the real threat of the collapse of the system by which it controls the European economy without any electoral legitimacy it has turned to the American government/finance condominium where industrial scale bribery has purchased the electoral forms as a decoration for a now virtually identical central bank run economic system.

    With its thin remaining veneer of legitimacy the Fed at Geithner’s behest will pump liquidity as required into Europe until most holes in bank balance sheets are sufficiently filled that bankers can draw their regular bonuses and extend the devastation of the real economies both there and here for another several years.

  5. Brett

    I don’t know if this story is accurate or not, but quite frightening if it is:

    UBS didn’t even know about the losses until the trader told them about them. If so, what if the trader didn’t tell them? Could they have spiraled even further out of control? It’s insane to think they had no warning… which makes me doubt the story. But either way you look at this, it’s bad if UBS didn’t know (and the trader was truly “rogue) and it’s bad if UBS was complicit and knew about the risks.

    1. Deus-DJ

      How the hell is this even fraud? This is simply a lack of internal controls, and nothing more. Why was this person jailed? Whats to say the trades weren’t authorized? Taking someone to jail simply because he lost a lot of money does not show guilt of anything. This is the risk UBS took and they need to accept it.

  6. thornybush

    Rogue traders are also a convenient way to explain losses. The banks calls large losses rogue and abnormal, but the corresponding wins and gains are considered normal. The banks gains and losses balance out. The real cause of the losses is elsewhere, somewhere that the bank doesn’t want to attract attention to. The so called rogue trader is merely an employee who’s sacrificed to deflect attention from other losses in other deals that cannot see the light of day.

  7. Lyle

    A new report on the uk telegraph says that the trader made up long dated hedges and entered them in the system. Since they had not yet blown up no one noticed them. Apparently this was the same technique the Soc Gen trader used. That the system does not provide confirmation that the hedge is in and real suggests a material weakness in internal controls to use an accounting phrase. I guess confirmations don’t happen with these sort of trades. One would think that the parties would exchange confirmations that both agreed to the terms of the hedge,and that they were reviewed by someone other than the trader. Perhaps this should be required that both sides confirm to their counterparty what was done.

  8. pj

    Authorization. Authority.
    Who has authority here?

    “The power or right to give orders, make decisions, and enforce obedience: ‘he had absolute authority over his subordinates’.”

    Seems to me that the one to blame is the one who failed to enforce obedience.

    But then, authority is whatever the authorities say it is, isn’t it?

  9. rd

    The key lesson to me from Lehman’s is that highly paid people can be incompetent at core elements of their business.

    All the more reason to structure the financial system so that its individual parts can fail without the entire system coming down like a house of cards. All of these people, including the Chairman and shareholders, have the absolute right to go bankrupt at will.

    People and institutions learn from failure, not success. We are training an entire generation of financiers that failure is not permitted and is instead rewarded with higher profits and bonuses. It can only end more disastrously than 2008.

    1. Meli

      Someone made a case on these forums a while back that the whole ‘rogue trader’ thing is about insurance. Apparently, insurance doesn’t cover fraud unless it is the action of a rogue individual or something. As a former trader, that made a lot of sense to me. Traders don’t operate in a vacuum.

  10. RPL

    Combine this post with Barry fRitholtz’s today and you get to the truth. There are no rogue traders, only rogue firms. Rogue traders are the result of management failure, or in some cases, management decisions and complicity. But the trader has to be arrested because otherwise the management, who should be arrested, cannot avoid accountability, both legal and financial. The world was a much better place when all investment banks were partnerships. That is how you self-police the level of leverage and take care of rogue traders.

  11. DANI


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