As the UBS story unfolds, we clearly see that banks still believe the story that they have been telling over the years.
The story of the recent “rogue trader” loss is that he made large trades and faked the offsetting position.
That makes sense only if you believe the story that the traders have been telling for years that it is not the gross positions, but the net positions that count.
RISKVIEWS wonders at what ultimate cost they will hold onto that idea?
The other similar idea is that the notional amount of a derivative is not important, just the price and the recent price volatility.
You see, the gigantic gross position with another gigantic gross position offsetting is just like a derivative contract.
So the two ideas are really the same. And both totally wrong. They are only correct if things stay nice and tame.
But the flaw in the two arguments is that things are not really guaranteed to stay tame. Haven’t the banks noticed that yet?
When things are not tame, the recent price volatility is not any indication of future volatility. The amount of the notional becomes a giant level that can catapult the bank sitting with lots and lots of notional right out of the playroom.
It is starting to seem like the banks are making decisions on what ideas that they will believe based upon a a Peter Pan system. If they close their eyes and really, really believe then things will go back to when the playroom was really, really fun and they made lots and lots of money.
When things are not tame, those two gigantic offsetting positions are not guaranteed to move in opposite directions. Doesn’t anyone remember why LTCM went bust? For heavens sake, some of the offsetting positions that they lost hundreds of millions on were treasuries with only slightly different maturities. THERE ARE NO RELIABLE OFFSETS.
Banks may want to consider a simple rule that is used by insurers. For large transactions, have a limited number of responsible individuals who must personally authorize. (Note to bank HR departments – need to hire some.) For extremely large transactions require that the CEO personally authorize. For multi Billion transactions, require board approval.
Why would any rational person who is running a bank give a trader on a desk authority to make a two billion transaction, even if there is supposed to be an offset somewhere? What sort of playroom is a bank trading desk?
But the most important question, in RISKVIEWS mind, is why would anyone give these folks their hard owned money to go out and gamble like that, offsetting positions or not??????????
The insanity WILL continue until investors get some sanity and insist on only giving money to banks that have sensible and transparent risk management rules that they actually follow.