One of the aspects of the UBS rogue trader affair that seems to have escaped much comment so far is the role that organisational culture can play in high profile trading scandals. The common thread that runs through the Leeson, Soc Gen and UBS disasters is not just that management supervision and risk controls failed to stop the disastrous losses of their delinquent traders.
An equal failure was that none of the traders felt able to confess to what they were doing in time to stop the losses escalating from an embarrassment to out and out disaster. As in other forms of gambling, a rogue trader’s most serious crime is almost invariably to try and recover mounting losses by doubling up on his losing bets, using knowledge of back office procedures to cover up his activities for as long as possible.
Lax financial controls, and a willingness to look the other way when trading profits are apparently rolling in, clearly are an important part of the narrative which allows a rogue trading scandal to evolve, but the culture of an organisation also plays its part. At Barings, where the largest shareholder was a hands-off charitable trust, it never seems to have crossed the minds of its patrician senior management that any employee would actively falsify their trading performance in the way that Leeson did.
When the Bank of England report into the collapse of Barings eventually appeared, it transpired that Leeson had never made a genuine profit from trading in any of the years he and his colleagues in Singapore were reporting profits back to London. In his autobiography, Leeson records how desperately at times he yearned to be discovered. Yet, for whatever reason he did not feel able to own up to what he was doing. Had he been able to do so, events would have turned out differently. It was only in the last year that the losses grew so big that they brought the firm down.
At Soc Gen and UBS, like at many investment banks, the culture of the organisation is clearly very different to that which prevailed at Barings, but, one can speculate, no less conducive to deterring early disclosure of trading mistakes. In a robust and macho trading environment, where results are everything, the idea that a trader might confess to losses no doubt appears unconscionable. Yet it is – or should be – the mark of a well run business that employees feel able to own up to mistakes without fear of recriminations. Only by encouraging such an attitude can serious problems be prevented from becoming a disaster. In this as in other aspects of management practice, it seems that investment banking has a lot to learn.
Having presumed to draw attention to its hubristic performance a couple years back, I am glad to see that the Harvard endowment fund was back on form for the second year running after the disastrous year of 2008-09, when it lost $9bn, more than a quarter of its value in the fallout from the global financial crisis. According to its latest Annual Report, for the year to 30 June 2011 the endowment was up 21.4%, 1.2% ahead of its policy portfolio benchmark and 1.9% ahead of a simple 60-40 bond-equity portfolio (which, in a triumph for simplicity over sophistication, would have performed spectacularly better in the year of the crisis, although not over the longer haul).
The endowment is still some way short of recapturing the $36 billion in assets it had before the crash, however, when its heavy holdings in private equity, real estate and hedge funds, proved a costly wake-up call about the dangers of holding illiquid assets during times of financial stress. Having been its biggest source of added value before the crisis, private equity in particular now ranks as the biggest drag on the endowment’s relative performance over the past ten years.
Making a virtue out of necessity, Harvard has scaled back its private equity commitments, some of them expensively as a forced seller, and says it expects future returns to be modest from this asset class. This was in contrast to Yale, which has yet to report its 2010-11 results, where the CIO David Swensen said last year that, despite its only marginally less severe losses during the financial crisis, the university endowment was increasing its exposure to private equity to 33% of its total portfolio. Harvard has also rationalised its holdings of hedge funds.
This year’s report by the Harvard Management Company’s CEO Jane Medillo ends by noting somewhat ominously that the renewed market volatility since its June year-end has had an “inevitable” impact on the value of the endowment, but that its greater flexibility “allows us to take some advantage of declining valuations under the right circumstances”. It is notable that some welcome humility has returned to the way Harvard and other exponents of the so-called super-endowment model describe their prowess. The model is far from broken, and for early exponents the long term results have been impressive, but its exponents will be hoping as fervently as anyone, I suspect, that we are not in for a full scale rerun of the 2008 liquidity crisis.
It is still too early to know for sure whether the Eurozone will be able to cobble together a sufficiently convincing package of measures to stave off a disorderly default by Greece and all the unpleasant short term consequences that are likely to flow from it (as opposed to the orderly default which at long last now seems to have been accepted as inevitable, and something which can finally be discussed openly in public). If so, there is every chance that we will get a strong stock market rally to the end of the year. I will then have to dust down one of my favourite quotes from the economist J.K.Galbraith: “Historians rejoice in crucifying the false prophet of the millennium. They never dwell on the mistakes of the man who wrongly predicted Armageddon”. It is hard to recall a period however when the odds on triumph or disaster appear to be so finely balanced. Whichever way the crisis ends, we are going to have to live with a litany of “told you so” for years to come.