The Wall Street Journal is reporting Societe Generale Hit By Fraud, Write-Downs.

Massive fraud by a rogue trader at Societe Generale SA has led to a €4.9 billion ($7.16 billion) write-down and is roiling markets as far away as Asia and further shaking investor confidence in Europe’s biggest banks.

The bank, France’s second largest after BNP Paribas SA, revealed early Thursday that it had detected a case of “exceptional fraud” due to a single trader who had concealed enormous losses through a scheme of “elaborate fictitious transactions.”

Though Societe Generale says it first learned of what it termed “massive fraudulent directional positions” on Jan. 19, it waited until it could close out those trades before going public with the problem. Winding down the trades, the bank said, resulted in a €4.9 billion write-down, making it potentially the largest loss ever from an alleged rogue trader.

But that wasn’t the only bad news Societe Generale announced Thursday. It also said it was taking additional €2.05 billion write down in assets related to subprime exposure, and it would launch a capital increase of €5.5 billion in the “following weeks.” The write-down and losses related to the trading incident will lead the company to post a net profit of €600 million to €800 million for all of 2007.

Mr. Bouton said SocGen had to unwind the positions taken by the trader before they were revealed to the market because of their size. The trader, whose motivation was unclear, helped unwind the positions, he said, adding that Bank of France Governor Christian Noyer and the French market regulator, AMF, were informed Sunday.

Trader Bets Market Will Rise

Bloomberg has additional information on the nature of the trades in Societe Generale Reports EU4.9 Billion Trading Loss.

“The transactions that were built on the fraud were simple, positions linked to rising stock markets, but they were hidden through extremely sophisticated and varied techniques,” Bouton, 67, said in a letter posted on the bank’s Web site.

His approach was to balance each real trade with a fictitious one, and his “intimate and perverse” knowledge of the bank’s controls allowed him to avoid detection, co-Chief Executive Officer Philippe Citerne told reporters. He rolled over his real trades before they reached maturity.

“In the Money”

By the end of December, he was “massively in the money,” said Philippe Collas, the head of asset management at the bank. Since the beginning of the year his trades became unprofitable.

The trades first came to management’s attention on the evening of Jan. 18, when a compliance officer found a trade that exceeded the bank’s limits, Mustier said. When Societe Generale called the counterparty, they were told the trade didn’t exist.

Fed’s Folly: Fooled by Flawed Futures?

Barry Ritholtz is asking Fed’s Folly: Fooled by Flawed Futures?

Was it a misunderstanding of their mandate, inexperience, or just plain hubris?

Regardless, it took only 2 days to learn just how ill-considered the Fed’s emergency market rescue plan was: To wit, a fraudulent series of losses led to a major European bank unwinding a huge trade: Societe Generale Reports EU4.9 Billion Trading Loss.

SG’s $7.1 Billion dollar unwinding led to panicked futures selling on Monday and Tuesday.

Hence, we quickly learn what sheer folly and utter irresponsibility it is for the Fed to use its limited ammunition to intervene in equity prices. Their panicky rate cute were not to insure the smooth functioning of the markets, but rather, to guarantee prices.

As we have been saying for the past two days, this is not the Fed’s charge. They are supposed to be maintaining price stability (fighting inflation) and maximizing employment (supporting growth) — NOT guaranteeing stock prices.

Tuesday’s panicked 75 basis cut will prove to be an historical embarrassment, a blot on the Fed for all its days. Failing to understand what their responsibilities are is bad enough; allowing themselves to be bossed around by Futures traders is inexcusable.

Fed Fund Futures Show More Cuts Coming

Regardless of what the problem is or was, the Fed Fund Futures show more rate cuts are coming.

click on chart for sharper image.
Above chart thanks to Cleveland Fed.

I agree with Barry 100% about the Fed attempting to cajole the markets and such actions are inexcusable. However, if the stock market was the only problem at hand, the Fed Fund futures would be unwinding the odds of another cut later this month.

Instead, I see odds of another cut as much as 75 basis points, even 100 basis points having a greater chance than the Fed standing pat. That’s pretty amazing. If the chart is accurate, at least another 50 basis points is coming.

A €4.9 billion loss is nothing to sneeze at, but this is just the tip of the tip of the iceberg of what’s to come. There are over $500 trillion in derivatives out there. A loss of even 1% of them would be staggering. That day is coming. It’s only a matter of time before a big counter party failure sinks the good ship credit bubble once and for all.

Mike “Mish” Shedlock
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