Random Thoughts on The City, Wall St & Capitalism

Ahh, another year another scandal, plus ça change. It's déjà vu all over again. Deutsche has always been one of my favourite banks, for a number of reasons.Firstly the staff canteen at Winchester House always used to do excellent food at very reasonable prices, the grub in the meeting rooms wasn't too shoddy either. I also have a soft spot for their art collection , especially Bacon's Study for a Portrait of Pope Innocent X lithograph. It was outside one of the meeting rooms on the 8th floor if anyone's interested. So what's not to like?

Of late though, Deutsche seems to be a very accident prone institution. Not forgetting the Peter Young affair back in the mid-1990s, then the recent poor press and eventual disposal of the asset management arm to Aberdeen , loss of major clients, Josef Ackermann's criminal trial in Germany for the bonuses paid to executives in the Mannesmann takeover, and recently the 270 million dollar settlement for securities fraud in the US . Now the latest scandal with the young trader involving CDOs Mr Ashul Rustagi. He has apparently overstated his trading book by £30 million. Big Deal?, no literally what is the big deal ? Compared to the size and value of Deutsche's assets or even its industry leading trading book in these types of derivatives it's not even on the radar. It's simply not material.So what are the real issues? It's all about risk management in the widest sense.

• The truth is that Risk Managers are mostly ineffectual at actually managing risk and compliance functions generally do no more than rubber stamp decisions that the business has already made . They are there to be 'seen' and not heard. Essentially they keep regulators happy, ultimately the business pays their salary, so they are unlikely ever to say no. When is the last time you met a risk or compliance guy with any balls. I haven't yet. For further reading see my earlier piece on Risk management dated 11 Nov 2005.
  
  
• Secondly this kind of discrepancy is more common than most banks would have people believe, do you think it couldn't happen at Merrill , Goldman , Citi, or Morgan Stanley? Think again before pointing the finger at Deutsche.Just like the lottery, it could happen to you.The truth is that long after the likes of Barings the real quality of risk and controls in the investment banking world are not much better than 10 years ago. What you have is much better reporting of that risk and operational errors, etc. Yes there are more compliance and risk managers than ever-but more is not necessarily better.Yes you have much better quantification of risk through fancy Value at Risk models, but at the end of the day this is not much use. The reason for this is not, as the financial press would have you believe, because these are complex, exotic financial instruments. Derivatives are simple instruments, whether you re-package bonds with differing yields/maturities in a special purpose vehicle (CDOS) and flog it to punters or not. Financial journalists only insult their readership when they continue the mystique surrounding these products. Partly I suspect because they are too lazy to try and understand the products themselves. If you can count to ten using your fingers , you can become a pretty successful derivatives trader. If you can count to twenty without taking off your socks, there is really no reason why you shouldn't make M.D. immediately at some major bank.Think about it if they are so complex and difficult why is a 26 year old graduate trading them? So what's the real reason. It's simple, you can identify all sorts of financial,political,security and market risk,but there is no way to predict the undpredictable nature of people's behaviour.It's a behaviourial risk inherent in all organisations where there are people. You can't assess anyone's mental state through risk models, audit trails and sign offs. That's another reason why they call it a people business.

As the year goes on I look forward to more of these little scandals.

RB