Byrne's Eye View

Let's say a smart, avaricious, amoral person wound up as chairman of a major investment bank. Let's say that on his first day at work, his CFO carefully explains that the company has made some obscene arcane bet on the correlation between Thai mortgage refinancing and Idaho soybean plantings, which -- whoops! -- whiped out all the company's equity, and then some. The amoral chairman doesn't want to hurt his options, and figures this happened under his predecessor's watch, anyway. The question: given access to all the SIVs, VIEs, prop traders who can mark anything to market, and Level III assets -- how long can they keep up the appearance that everything is normal? I'd bet that the answer is 'at least a decade'. Jerome Kerviel was ahead by up to $2 billion for a while; if SocGen had been the company in question, how hard would it be to convert that massive fraud into earnings? Paying Jerome a $2 million bonus and sending him on his way would be more than enough, and there can't be just one Kerviel Cookie Jar waiting to get raided.

The odds of this situation being anything like true are probably tiny -- 1% or less. But the derivatives market is based on a chain of perfectly reliable counterparties -- when JPM makes a trade with MS, but cancels it out by talking to GS, and they hedge their bets with RBSGC, etc., etc., etc., the fact that one of those parties might be only 99% reliable can really foul things up, especially if you don't know which bank it is. If the derivative market becomes a derivative-and-credit-to-the-n^th market, it would be as jarring as when the market in US government debt turned from a pure interest rates game to a rates and ratings problem.