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Did SocGen Spark Global Selloff? Fed’s move?

By The Prince ⋅ January 24, 2008 ⋅  Email This Post ⋅  Print This Post ⋅ Post a comment

There is a theory circulating around Wall Street today about why markets got hammered on the 21st of January globally and on the 22nd in the U.S.  It is pretty interesting and may hold some grains of truth.  It also offers some insight into how the federal reserve may act at their up coming meeting.

At its core the theory blames the precipitous declines in markets on Monday and Hang Seng on forced selling in the futures market and equities markets by Société Générale as it tried to shore up its capital base and wind-down trades related to its rogue trader, Jérôme Kerviel.  Presumably, SocGén found out on January 18 about the fraudulent trader and moved to unwind its future positions and equity trades on Hang Seng, the first major liquid market to open. 

When the Federal Reserve unexpectedly cut 0.75 percentage-point in the federal-funds target on Tuesday morning, the provocation was concerns about a U.S. recession that had hit the the markets.  WSJ’s MarketBeat write, "Sure, the thinking went, the Fed was in danger of looking like it had responded to market action rather than an economic report, but if markets were reacting to economic reports, well, it’s all the same in this world these days."  Now there is a sense that the Federal Reserve may have acted for the wrong reasons after being dupped by forced selling by SocGén.  This may mean that the fed stands less likely to cut rates when they next meet.  Trading in the federal-funds futures suggests a less aggressive move by the Fed next week.  As of yesterday, the market was still pricing in 100% odds on a half-point cut at next week’s Fed meeting and even a decent chance of another 0.75-point cut - but the odds on a half-point drop have declined to 91% today.

Officials at Societe Generale did admit that the firm was in the markets trying to close positions in the last few days before telling people what was going on. FT.com’s Alphaville blog did a live-blog of the firm’s call, where officials said that “with the chance of good fortune, it was possible to liquidate these positions over three days, which was quite exceptional.”

Regardless of what hand SocGén may have played in the recent sell-off the embarrassment that their brand has taken is staggering.  How could one trader lose so much money?  Where was compliance?  Did other traders on the defrauders desk have knowledge of his fraudulent trades?  Where were the risk management professionals?  Could this happen at other banks?  The list goes on and on.

For now the markets attention is focused on the next Fed meeting.  Maybe the Fed will consider how SocGén may have caused the sell-off on Monday and hold firm after its .75 cut on Monday.  Of course, the blow to confidence could hurt the entire financial sector.  Of course, something similar, or worse, could still happen in London, New York, Hong Kong.

America’s CEO of SocGen, Jean-Jacques Ogier