Greed, fear, bright ideas: Money traders' only rules

Jill Treanor, Guardian News Service, London

Seven years ago Nick Leeson was found out, and he has been notorious ever since as the man who broke Barings bank. Just like Leeson, John Rusnak knows how it feels to be rumbled. While he might not have busted his bank, an offshoot of Allied Irish Banks, or been charged with any crime yet, it is certain his name will forever be linked to the US$747.3 million hole in the once infallible bank's accounts.

His alleged actions -- apparently he covered his losses with fictitious trades -- will earn him a place in the hall of fame in which Leeson is now thriving as a celebrity, and being paid for public appearances. Plenty of others have been there before him, such as Michael Milken, the junk bond king of the defunct Drexel Burnham Lamber.

Rusnak can lay claim to the first big financial scandal of the 21st century. But he will not be a solitary rogue trader for long. More will join him, suddenly catapulted out of the frenetic and introverted financial markets and into the glare of the wider world.

Rusnak's subterfuge took place in just one part of the financial arena, the foreign exchange markets. Here, on a daily basis, $1,210 billion of money changes hands every single day -- a figure that requires 13 digits to write it out in full. His specialization was in buying and selling just two currencies -- the US dollar and the Japanese yen.

He most likely achieved his deception by using sophisticated currency options markets, where $60 billion of trading is done every day, the same amount of money that Pakistan's economy generates in a year.

On Thursday, in the absence of any thoughts from Rusnak, Leeson (whose fraud involved Japanese stocks) was called upon to speak. "It takes a long time, sadly too long, to admit defeat in a career where confidence and a never-say-die attitude is everything," he said.

This bravado is essential for traders in financial markets, where only two emotions count: Greed and fear, the driving forces of capitalist enterprise. It is when the greed turns to fear that the problems start to mount. The greed is fed by taking risks every day to generate profits for employers and personal bonuses. The fear hits when the risks run out of control and profits evaporate into losses.

The trade-off between risk and reward is the barometer. The question that the bank's internal policemen -- the accountants and the auditors -- face is whether a risk is too great to take for its potential reward. This is the conundrum at the heart of much that happens on the world's financial stage. Paying traders to take risks to generate profits is one thing. Monitoring their risks is quite another.

Many lessons were learned from the Leeson saga. The way that traders' bonuses encouraged them to take risks was examined. There was much talk of linking bonuses to teams of traders, rather than focusing rewards on just one star. The banks and big financial firms made sure that whoever was doing the trading was not the same person (and was far removed) from whoever was booking and monitoring the positions. Yet Leeson said that he was stunned by the apparent similarities between his own fraud and the deception carried out by Rusnak.

The financial world will look for lessons from this latest scandal. The Allied Irish Bank is not bust, but it has been badly bruised. The managers of every other bank boss are certain to be checking their own rules and risks in case their bank might be next. Each bank will be asking if tighter controls should be put on traders to prevent them taking too many risks. The executives will be checking that the bank's back-office bean-counters are not in awe of the glamorous traders.

There will be inevitable questions about whether tougher rules are necessary to prevent similar infringements. Some changes might be recommended by the regulators as the dust settles in the coming years. But it is highly unlikely that any new rules will solve the problem. Rules and regulations can never be expected to keep up with the financial markets.

One of the most stimulating aspects of the money markets is that the big players are fast-thinking and innovative. By being quicker and cleverer than their rivals, they make higher profits. They keep ahead of the competition and beat the regulations.

The rules must be tough enough to protect the stability of the financial system, but flexible enough to allow new ideas. Idea generation is at the core of capitalism. Stifle innovation and capitalism itself is muffled. Rusnak is a symptom of thriving and expanding financial markets. A cure can be sought, but it will not be found.