The Blogger Comments on the Société Générale Affair

“I never dreamed this day would arrive. I’ve never been considered witty or clever… but now, how the tables turn! Look at me: the life of every social function in Paris. Paris? Why be modest? My fame has spread to Amsterdam, London, New York. Listen to them! In the world’s smartest parlors. I’m the one who lifts their spirits!“

-Rene Gallimard in David Henry Hwang’s                                                                          1988 Tony Award winning play M. Butterfly

Our P2 Finance class was taught by a Belgian with perfect hair who owned a sweater collection that would put Mr. Rogers to shame. I can’t say that I understood everything in his class, but I remember spending a lot of time discussing sports cars and hockey sticks. I won’t go into details about the sports cars, but hockey sticks served as graphical payoff diagrams for the potential profit or loss inherent to various options and futures positions. A northeastward pointed hockey stick handle represented an unlimited upward profit scenario, while a southeastward pointed hockey stick represented unlimited potential loss.

And so (we were lead to believe that) banks and responsible traders never expose themselves to the vulgar risk of having a unilateral risk exposure. They always cover their positions with offsetting counter positions in the market, scraping out razor thin profits on temporary arbitrage spreads between the buyers and sellers. Well at least it makes for a good story.

Société Générale’s jaw-dropping $7 billion dollar loss has been linked by the bank to Jérôme Kerviel’s market activity, where it seems that the hockey sticks all conspired to point in the wrong direction. As the war of words between lawyers, PR reps, and even the French President continues, I am struck by the failure of the bank’s risk management department to appreciate that Kerviel’s department could potentially generate such a large loss. A month ago if anyone had suggested that a unit which generated $20 million in profit a year could wipe out the entire bank’s annual profit, if the stars (or hockey sticks) aligned correctly, they would have been ridiculed. Their failure to appreciate the true risk was caused by an overconfidence in the control mechanisms. Did the risk managers assign a probability to the chance that the bank’s passwords and trading limits could be circumvented? I can only assume that they valued this risk as zero, preferring to obsess over more technical market trading threats even though humans are invariably the weakest link in any system.

But for now the ridicule has been directed at the bank’s management, and the media campaign for and against Kerviel… Modern day folk hero, or parlor conversation fodder.

The Blogger Reflects on his First Two Periods at INSEAD

The photo above shows the Guggenheim Museum in Bilbao, Spain. I’m back in Fontainebleau after spending the break in Barcelona, Lisbon, Madrid, and of course Bilbao. Despite being in close proximity, each city has a completely different aesthetic, culture, and language. Barcelona had an intimate Mediterranean feel. Madrid was the only city that felt like a world-class metropolis, with skyscrapers and traffic. Lisbon was a welcome surprise on my wallet, with 50 Euro cent espressos and surprisingly cheap clothes, despite the 21% VAT. Zara, Springfield, and all the other European clothing chains sell their wares in Portugal for 20-30% less than they charge in France or Germany. Being unable to speak Spanish, Catalan, Basque, or Portuguese, I found Portugal to be the most welcoming spot. Everyone I talked to in Lisbon spoke excellent English and perhaps more importantly, I found that I could understand written Portuguese.

The break has also given me time to reflect on what I’ve learned at INSEAD since August. Before I arrived in Fontainebleau, I set some very specific expectations of what I had hoped to derive from the MBA program. On the pedagogical side, I was hoping to: 1) Improve my ability to read and interpret financial statements; 2) Learn how to correctly value a company; 3) Learn how to make correct investment decisions in the financial markets; and 4) Learn how to make convincing business presentations. On the social side, I was hoping to learn from the diverse experiences of my fellow participants and make business connections that would help me in my career.

My experience during P1 and P2 brought into sharp focus the unchallenged assumptions which underlie business education. As someone who doesn’t come from a quantitative background, what struck me most about business school was the dogmatic use of quantitative models. Following the trail blazed by social sciences, academic business education has seized on quantitative finance models in a quest to bolster its perceived authority. Although mathematical approaches are useful for solving some business problems, I am always surprised when organizational behaviour or marketing professors attempt to counter the insecurity of their disciplines, by ‘dressing up’ their arguments with a quantitative shroud.

Even within disciplines like finance or economics, the obsessive belief in mathematical modeling as a cure-all, usually goes unchallenged. My favourite article about the current sub-prime lending credit crunch is “’Perfect Storms’ – Beautiful & True Lies In Risk Management” by Satyajit Das. Das does an excellent job of questioning the dogmatic use by Wall Street of the language of mathematics to obfuscate risk. According to Das, common sense went out the window when pseudo-scientific quantitative models were used to hide the inherent uncertainty and variability of both the capital markets and the business operating environment. Yet despite their vulnerability to manipulation and misuse, business schools continue to arm MBAs with quantitative problem solving tools without regard to the pragmatic skills needed to correctly employ such tools and to properly contextualize the results. In the classroom, I always tried to challenge these unspoken assumptions, although I was usually rewarded for such dissent with odd looks from my fellow MBA participants.