Institute for Financial Transparency

Shining a light on the opaque corners of finance


Merrill Lynch Rogue Trader says system is broken

Another book on the financial crisis has been published.  This time the author is a former trader who Merrill Lynch claims went rogue and lost $456 million.

Let the size of this loss sink in for a second.  How does one trader lose this much money?

Here is his story:

Alexis Stenfors was working as a currency trader for Merrill Lynch in London. With 15 years’ experience, he was good at his job and he prided himself on his ability to read the markets. His view was that the whole financial system was going to go “belly up”. That was what he was betting on.

And boy did he bet. He took increasingly extreme positions and when they failed to return dividends, he covered up losses in his trading books that he estimated to be around $100m (£78m).

In describing what he did, Mr. Stenfors doesn’t try to hide the fact he was “betting”.  Don’t be fooled by his being a currency trader with the implication he was making markets between buyers and sellers.  He saw himself as being paid by Merrill to gamble.  He took a gamble that lost and then doubled down to try to recoup his losses.

The extent to which Merrill tried to shift the blame for its troubles in 2009 by calling him a “rogue trader” can be seen from the simple fact:

there was never a criminal investigation, or even a hint that it could be criminal.

So what exactly did Mr. Stenfors do that was would have allowed Merrill to call him a rogue?

his deceit, deliberately mismarking his books, … “the process of valuing a book, we did it ourselves as the traders.”

Even Mr. Stenfors suspects there is something wrong with having traders value their own positions which are hidden from the market behind a veil of opacity.

“Looking back, how on earth can you have such a set up?”

This set up just invites misbehavior.

“I had this feeling that there was something really wrong with the system,” he says, and notes that the problems have continued with the massive Libor and foreign currency manipulations.

The cure for what is wrong with the system is transparency.

If Mr. Stenfors and other traders like him had to disclose their positions at the end of each business day, market discipline would eliminate the many opportunities for misbehavior that traders engage in.

First, it would eliminate gambling.  Nobody plays poker where they have to disclose all of their cards during the game and everyone else at the table gets to hide some of their cards.  The reason nobody does this is everyone knows the return to winning hands will be minimized and the losses on losing hands will be maximized.

Second, it would eliminate mismarking the value of the securities.  When the market can see what the securities are valued at, the market can exert discipline if a bank overvalues these securities.