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Bankers love Darwinian finance - until they're faced with extinction

Somehow, we knew we would find Satyajit Das in Paris just as the banking world's most shocking trading scandal was sparking outrage in France, rattling global markets and further undermining confidence in a financial system already reeling from the U.S. subprime mess and a major credit crisis.

The renowned derivatives expert had no way of knowing that a minor equity derivatives trader would bring venerable French bank Société Générale to its knees through billions of euros in unauthorized bets on stock index futures.

But Mr. Das has long warned of the dangers posed by the explosion of poorly understood financial instruments, huge amounts of leverage, inept risk management, lax regulation, ignorance-is-bliss senior managers, directors and auditors, and outlandish bonuses that encourage traders and their bosses to take outsized risks with other people's money.

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"These types of episodes happen in the banking world with a fair degree of regularity, although not usually of this magnitude," he said the other day from his hotel near the Louvre.

When the markets are buoyant and everyone's rolling in dough, "these things get pushed under the carpet," he said. "Whenever markets turn, you see a lot of ugliness exposed."

An independent consultant, he was already in Paris when the SocGen scandal broke. He extended his stay to help calm the frazzled nerves of worried clients.

Mr. Das is appalled by the "studied casualness" of financiers in reacting to the still unfolding mess at the bank, whose explanations he finds nonsensical. No wonder he calls it "ShockGen."

"People actually said to me: 'Wasn't it good that the losses occurred and yet the markets could function.' "

His response: "Well, that's one way of looking at it."

Another way is that this is a grave problem because the financial system is so dependent on public confidence and remains extremely vulnerable to meltdowns involving much more complex and less liquid products than simple equity derivatives.

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"We're basically relying on Darwinian finance in the markets to sort it out. Except the moment things go wrong, the Darwinian financiers run to mother and hide behind the apron." Meaning that they expect protective governments and central banks to bail them out of their self-created disasters.

Next Friday, the author of Traders, Guns and Money: Knowns and Unknowns in the Dazzling World of Derivatives, will take his message directly to a Canadian audience for the first time when he comes to Winnipeg at the invitation of Jory Capital, a small investment firm that signed him on as an adviser.

He will talk about how the financial world got into its current pickle and how it will play out over the next year or so.

One cause identified by Mr. Das is our mad love affair with financial innovation, unaccompanied by any real understanding of its impact or risks.

It's an affair that has ensnared everyone from market speculators to conservative central bankers. Yet, "it has often been innovation without substance. And it's achieved nothing. It's been cosmetic."

How will the crisis be resolved? Not through the rate slashing and inflationary pump-priming of a panicky Fed or the lame economic stimulus package being proposed by U.S. policy makers.

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"The central banks have reached a point where they are no longer in control of events and they're behaving like it."

Mr. Das sees two painful choices: Keep asset prices where they are, build up inflation and let real prices adjust. Or "adjust asset prices brutally, which obviously the stock markets were basically trying to do earlier this month."

Jory CEO Patrick Cooney lured Mr. Das to his advisory squad after reading some of his ground-breaking work on derivatives and calling him out of the blue. The two certainly share a gloomy view of the banking system.

"There's only one way, in my view, you can be long financial institutions," Mr. Cooney said. "You have to mainline heroin for breakfast. You'd have to be that delusional not to understand the risks."

But how did he manage to persuade the resident of Sydney, Australia, to make personal appearances in the middle of a frigid Prairie winter?

"For some mysterious reason, I thought February was a very pleasant month [in Canada] because it is in Australia," Mr. Das said with a laugh.

Regardless of the weather, Winnipeggers aren't going to hear an upbeat forecast.

He describes the last half of 2007 as "the phony war" and sees 2008 as a time of real bloodletting, with soaring default rates, trouble in the commercial property sector, more extreme volatility in emerging markets and further pressures on banks and battered bond insurers.

"We are not looking as if happy days have arrived."

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About the Author
Senior Economics Writer and Global Markets Columnist

Brian Milner is a senior economics writer and global markets columnist. In a long career at The Globe and Mail, he has covered diverse business beats, including international trade, the automotive industry, media, debt markets, banking and the business side of sports. More


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