Thursday, September 15, 2011
Synthetic ETFs, Fraudsters and No Understanding
Another HUGE fraud causing a $2 billion loss for UBS!
"Synthetic" ETF trader, Kweku Adoboli was arrested this morning in London, charged with the fraud.
He lived off Brick Lane in the East End of London (see picture)and was part of UBS Global Synthetic Equities Trading Team.
(See Link Below)
Warren Buffet once said he never invested in anything he didn't UNDERSTAND.
Any financial instrument with a the word "synthetic" or "exotic" before it conveys massive potential for MISUNDERSTANDING!
When will these easy-money-hunting-bankers and traders realize that there is no such thing as a SURE THING?
Such activities have a direct and reckless effect on those areas of a bank that ARE MAKING MONEY.
This reckless and fraudulent behavior will result in further job lay-offs at UBS and probably the implosion of a hedge fund or two or three.
The big question now is: What other banks will be affected by this?
In the late 80s and early 90s, there were complicated derivatives that had emerged as a result of the work of two financial economists - Black and Scholes.
They both studied the pricing of derivatives and in 1973 came up with the Black-Scholes formula.
(See Link Below)
Almost forty years later the emergence of much more complicated and "synthetic" derivatives has caused the proliferation of financial weapons of mass destruction, many of which the OMOTS has no clue about.
Even those who trade these things have little or no understanding of the POTENTIAL DOWNSIDE if things go awry!
Further, after the collapse of the Berlin Wall 20 years ago, and the implosion of the former Soviet Republics, hundreds of thousands (millions even) of people fled toward Western Europe and the US.
Of these economic and political refugees, there were many VERY QUALIFIED MATHEMATICIANS and PHYSICISTS, who had a wealth of knowledge in applied and advanced mathematics.
With no jobs and no prospects in their countries' they arrived in the advanced market economies with advanced mathematical theories and so began the era of FINANCIAL ENGINEERING.
It all sounded great! Apply these complex formulae to financial markets, make a pile and live happily ever after - right?
WRONG! DEAD WRONG!
Many of these complex and mostly theoretical financial algorithms did not take into account the REAL WORLD of human greed, fraud and upheaval across the globe.
So something that might not have been included in the algorithm, i.e. house prices falling for example, would render the entire financial derivative WORTHLESS. Some traders I know operate massive excel spread sheets, so complicated that a marginal change in one tiny cell with a number like .00000011 has a disastrous effect on the valuation of a derivative.
The number might represent the probability of something ACTUALLY OCCURRING a default, a mortgage not repaid, a destabilizing political event in a country, or a host of other events.
A Black Swan event as the book says. (See Link)
THE IMPACT OF THE HIGHLY IMPROBABLE! This is the essence of what we are dealing with in the modern financial engineering age and there are several improbable events that have not been considered by those who, in their arrogance, invent financial weapons of mass destruction that negatively affect the masses while minimally affecting the few!