March 17, 2002

Trying to feel sorry for Rusnak

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Not only do these sentiments sum up the average mind of a football yob, they also capture the mentality of the typical foreign exchange trader. Trading is about being macho, being hard, it’s about being the biggest swinging dick of the trading floor. It’s also about winning and celebrating victory in the most ostentatious style. But most importantly it is arbitrary. The difference between success and failure can be infinitesimal.

Living with a big-betting foreign exchange trader reflects all these emotions. When things are going well it’s happy days. When he’s in the soup, the mood swings of the trader are legendary.

If you want to get an idea of what living with John Rusnak must have been like over the past two years, check out the dollar/yen exchange rate. Up to October 2000 things might have been bearable as the dollar traded in a range around 105 to110 yen. Clearly Johnny-boy wasn’t in clover, but his well-documented churchgoing may have been more in observation than desperation.

From October 2000 on his life became a nightmare. The yen began to fall precipitously — from 110 to the dollar to 135 — a fall of nearly 23 per cent.

Yet, even during this period there were short-term blips in February, May and August of 2001. These insipid rallies in the yen must have given Rusnak hope. But the overall trend was against him. As Rusnak’s bets were based on the yen rising, not falling, the lower the yen the greater Rusnak’s deception.

It is hard not to feel some sympathy for him as he hoped against hope for a change in fortune like any gambler on a losing streak.

Let us imagine what would have happened if there had been a change in fortune. What if the yen had recovered rapidly against the dollar in the final six months of last year?

This would not have been inconceivable; after all, it happened before. For example, in 1985, the yen rose 30 per cent against the dollar. In such circumstances, Rusnak would have been a hero.

He may have reversed most of his losses and the fiasco at AIB/Allfirst internal control systems would have gone unnoticed.

This is one of the crucial aspects of the entire debacle. The whole saga was arbitrary. Not only was the net profit and loss position arbitrary, but the amount of money ultimately lost was equally random.

For example, had the yen reversed rapidly — or more probably had the dollar nosedived in sympathy with the Nasdaq, as many expected — AIB treasury would still be operating like a mad hatter’s tea party and none of this would have come to light.

Equally, it is worth reiterating that alarm bells were signalled not by a sleuth at Allfirst’s back office but by the enormous amounts of cash demanded by the desperate Rusnak.

What if this had not happened? What if Rusnak had been able to raise more cash by selling his ‘deep in the money’ options for another six months? The entire bank could have gone under.

So lax were AIB’s controls that the management would have been none the wiser. In short, Michael Buckley and Co were exceptionally lucky that when they finally realised something was awry the total losses only came to $690 million. It could have been much worse.

The $690 million figure is the result of a simulation of all Rusnak’s open trades and the cost to AIB of settling them. For all AIB’s management knew, this simulation could have resulted in a figure of $2 billion, $4 billion or $6 billion.

AIB’s management from top to bottom broke all the rules in the book. They failed to put a risk management system in place, to gather correct information, to spot fictitious trades, to carry out valuations of the positions and audit operations in a timely manner. They failed when Rusnak broke his trading limits and when he bullied the back office.

They obviously failed to cultivate close relationships with the counterparties who were buying what can only be described as joke options from Rusnak. They broke the cardinal rule of banking that all profits should be related to the amount of capital required.

What is the point of making £2 profit if it took £2,000 of the bank’s capital to make it? In Rusnak’s case, it appears that huge amounts of the bank’s capital were used just to achieve neutral exposure. Even allowing for Rusnak’s chicanery, it is amazing that the size of the gross trades were not questioned.

That not one of Rusnak’s colleagues, not one person in the back office, not one member of the treasury management group, not one of the supervisory board seems to have asked any hard questions and demanded satisfactory answers is quite amazing.

This is the reason that many investors, shareholders and press commentators believe that the Ludwig report has not gone far enough.

AIB aside, the central problem with all trading operations is cultural. A culture has emerged over the past 15 years in which the policemen in management are scared of the traders.

In an industry where money is the yardstick that defines everyone, the fact that the back office gets paid a fraction of the traders’ pay means they are not respected.

The back office is usually comprised of young blokes whose career aim is to become traders, and often they are in awe of the self-styled masters of the universe they are supposed to be watching. Further up the chain, most managers have never traded and do not understand what traders are doing.

In the macho, face-saving culture of a trading floor, nobody admits that they do not understand, least of all the management who are paid to act as policemen.

Because everyone’s bonus — from the lowest trader to the back office middle manager and the senior executive — is typically generated by the trading desk, there is no incentive to rock the boat.

Traders almost always override, bully and dominate those who police and settle contracts.

Much of the comment centres on who was to blame and who should lose their jobs, but this is more theatre than analysis. The personalities are incidental to the lessons that can be learned.

Of all the recommendations of the Ludwig report, the most progressive seems to be the one that goes to the heart of the cultural faultline of the trading floor.

Ludwig recommends that an independent non-board member should be engaged specifically to oversee risk control. This makes sense.

Banks should employ specialist independent risk managers. These new beefed-up policemen will have experience in a trading room, be afraid of no one, understand all aspects of risk management and put in place the best information systems to spot breaches in controls.

We see this type of approach all the time with police forces. When crimes are complicated, the special branch is called in. When white-collar crime gets tricky and important managers are implicated, internal auditors may be compromised.

When all the name-calling and mudslinging has died down, shareholders will rest much easier if this significant (yet ignored) recommendation of Ludwig is implemented.

Today’s media moral outrage won’t save a penny when the next John Rusnak finds himself in hot water.