Nunfacazzismo: 2008

Two articles, one in the Wall Street Journal (2006), the other in the New York Times (2008). Are the "monks" from this school ?

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http://online.wsj.com/article/SB114187184703793317.html

http://www.nytimes.com/2008/02/05/business/worldbusiness/05bank.html?ref=business

Why Students Of Prof. El Karoui Are In Demand
French Math Teacher Covers Structure Of Derivatives;
Banks Clamor for 'Quants'
A Lesson on 'Smile Risk'
By CARRICK MOLLENKAMP and CHARLES FLEMING
March 9, 2006

When Xavier Charvet applies for a job at an investment bank next year, he thinks he'll have an advantage. The 24-year-old French student's resume begins with the phrase: "DEA d'El Karoui."

That stands for the postgraduate degree he is studying for under Nicole El Karoui, a math professor in Paris. She teaches skills required to create and price derivatives, the complex financial instruments based on stocks, bonds or loans. "When I talk about El Karoui's master's, everyone knows" about the degree, says Mr. Charvet.

As derivatives have become one of the hottest areas for the world's biggest banks, Ms. El Karoui, 61 years old, has become an unlikely player in the business. Her courses at the prestigious Ecole Polytechnique and a state university, in such rarefied subjects as stochastic calculus, have become an incubator for experts in the field. A resume with her name on it "is a shortcut because you don't need to train the person on the basics of derivatives," says Rachid Bouzouba, a former student who is now head of European equity trading at the London office of Lehman Brothers Holdings Inc.

The derivatives departments at banking giants J.P. Morgan Chase & Co., Deutsche Bank AG, Dresdner Kleinwort Wasserstein, and France's BNP Paribas SA and Societe Generale SA include many of her protégés.

The high demand for her students reflects big changes in the global banking industry. Investment banks used to make much of their money from underwriting and trading stocks and bonds, or providing mergers-and-acquisitions advice. They hired people with a wide range of academic experience, including liberal-arts and science graduates.

In recent years, profits from trading and selling derivatives have come to rival those from stocks and bonds at many banks. On average, revenue from derivatives based on stocks now accounts for about 30% of an investment bank's total revenue from stock-related businesses, according to a Citigroup Inc. report issued in January.

As a result, banks are hiring an increasing number of recruits who understand derivatives. Inside banks, they are known as "quantitative analysts," or "quants" for short. They are able to marry stochastic calculus -- the study of the impact of random variation over time -- with the realities of financial trading.

Derivatives are financial contracts, often exotic, whose values are derived from the performance of an underlying asset to which they are linked. Companies use them to help mitigate risk. For example, a company that stands to lose money on fixed-rate loans if rates rise can mitigate that risk by buying derivatives that increase in value as rates rise. Increasingly, investors are also using derivatives to make big bets on, say, the direction that interest rates will move. That carries the possibility of large returns, but also the possibility of large losses.

The 75 or so students who take Ms. El Karoui's "Probability and Finance" course each year are avidly sought by recruiters. Three years ago, Joanna Cohen, a specialist in quant recruitment at Huxley Associates in London traveled to Paris to meet Ms. El Karoui to ensure her search firm was in the loop when students hit the job market. Today, Ms. Cohen says she carefully checks résumés with Ms. El Karoui's name to make sure applicants aren't overstating their interaction with the professor.

"French quant candidates know that Nicole El Karoui's name has real clout, so many of them put her name on their [curriculum vitae] even if they've just taken one course with her. They want to give the impression that she has supervised their Ph.D.," Ms. Cohen says. "It'd be impossible for any one person to supervise the number of students who put her name on their CV."

Rama Cont, a former student and now a research fellow at the Ecole Polytechnique, describes a degree with Ms. El Karoui's name on it as "the magic word that opened doors for young people."

Headhunters say Ms. El Karoui's graduates can expect to earn up to about $140,000 a year in their first job, including a bonus, once they complete an internship that constitutes part of her course. After five years, they could be earning at least three times as much.

'IT'S VERY CHALLENGING'

Reporter Carrick Mollenkamp talked with student Christel Younes about her experience in Ms. El Karoui's class. Listen to the interview: Windows Media Player1 | Real Audio2In BNP Paribas's offices in London, the fixed-income interest rates derivatives research team, which totals six, includes three of her former students. On a recent day, Fahd Belfatmi, who took Ms. El Karoui's course in 2003, was working at the bank on a model to predict long-term interest rates. For help, he keeps handy a beat-up, paperback copy of Ms. El Karoui's French-language textbook, "Stochastic Models in Finance."

Ms. El Karoui's only hands-on banking experience in her 38-year career was a six-month stint about two decades ago at a French retail bank. "I'm still a theoretician. My knowledge of markets is patchy and I've never spent a year in a trading room," she says. "On many counts, I probably have a fairly naive vision of things."

Carving Out a Niche

But she was one of the first in the world to carve out an academic niche studying the underpinnings of derivatives transactions, starting courses in the late 1980s. About two dozen universities have moved into that field, setting up their own mathematical-finance departments, including Stanford University, Carnegie Mellon University and the Massachusetts Institute of Technology.

One of eight children in a middle-class family, Ms. El Karoui grew up a Protestant in a predominantly Catholic town in eastern France. Today she attributes her nonconformity to that background. "Protestants are rebels by nature," she says. Though her mother thought France's elite colleges were better suited for boys, her father, an engineer, encouraged her to take the tough entrance exams for Ecole Nationale Superieure, where she was accepted to study math. In 1968, around the time she was protesting the Vietnam War, she married a Muslim Tunisian economics professor, Faycal El Karoui.

"If you'd told the left-winger that I was then that I was going to end up working in finance, I'd never have believed it," Ms. El Karoui says.

France, the land of Descartes and Fermat, has a storied tradition in the study of math. Over the years, its engineering schools, including Ecole Polytechnique, a 212-year-old institution transformed by Napoleon into a military academy, have produced a steady stream of math students. Louis Bachelier's work in 1900 at the Sorbonne is considered the earliest effort to grasp how the markets work.

Ms. El Karoui first branched into finance in 1987. The government had just closed down the elite Ecole Normale Superieure in Paris, where she had been teaching. She took a six-month sabbatical to work in the research department of consumer credit bank Compagnie Bancaire.

At the time, many French mathematicians tended to deem the world of finance beneath them. "Finance meant selling your soul to the devil," she says. Her break with the French math establishment "took a lot of courage," says Marek Musiela, a leading figure in financial mathematics and the global head of fixed-income quant research at BNP Paribas.

At first, Ms. El Karoui felt out of her depth. "I didn't even know what a bond is. I took a dictionary to look up the financial words," she recalls.

But she soon realized that employees on the bank's newly formed derivatives desk were facing problems similar to those of stochastics scholars in trying to build models to predict the impact of interest-rate changes.

After her time at the bank, she took a post teaching at the Paris VI, officially known as the University of Pierre and Marie Curie. She and another academic, Hlyette Geman, launched a postgraduate mathematical-finance course. Demand for know-how in derivatives was growing rapidly among banks at that time, sparked by the development of specialized exchanges that could trade derivative products, such as futures.

"I said 'That's beautiful mathematics and it's teachable as a theoretical course,'" Ms. El Karoui says.

Amine Belhadj, head of BNP Paribas's U.S. equity and derivatives department in New York, says Ms. El Karoui played a crucial role in finding interns when the bank began handling derivatives for clients in 1989. "There was nobody on the options desk with a mathematical-financial background," he says. "Having someone like Nicole who was making a specialty of it was pretty timely."

Today, four of her five children have pursued careers in math and sciences, two as academics and two still as students. In her spare time, Ms. El Karoui plays classical piano, with a preference for Brahms sonatas.

She earns about 80,000, or about $95,000, a year as a professor, plus a smaller amount for consulting fees -- a fraction of what her students can make. She drives around Paris in a small Renault.

A Warning

Lately, Ms. El Karoui has been vocal in warning students to use derivatives carefully. She says she is perturbed that an instrument that began primarily as a hedge for banks and financial firms against market risk is increasingly being used as a way to make a profit. Investors can profit, for example, by betting that the prices of stocks or bonds will increase. Ms. El Karoui worries that those looking for quick speculative gains could ramp up their bets on derivatives, but lose sight of the underlying financial instruments on which they're based, actually increasing their risk exposure.

"Some clients aren't mature enough to understand the risks of products that are too complex," she says. "It's better to do business with those people responsibly, either taking the time to teach them or selling them a less complex product."

Some big banks are being criticized for selling derivatives to institutions that may not understand the risks. Last year, for instance, Bank of America Corp. and Barclays PLC of the United Kingdom each agreed to settle claims that they had missold or mismanaged derivatives that were purchased by smaller banks in Italy and Germany. The banks said the matters were settled amicably.

One recent afternoon in her classroom, Ms. El Karoui ran through a series of dense formulas designed to price derivatives. In class were about 50 students studying for the DEA, or "Diplome d'Etudes Approfondies," as a French master's degree leading to a doctorate is known.

Ms. El Karoui talked softly toward the blackboard as much as she faced her students. There were few questions. Only near the end of the two-hour class did she raise a faint titter as she gestured to a full page of equations headed "General Pricing Formula." "There might be some of you brave enough to go through this," she said, then continued on, breezing through arcane jargon such as "smile risk," "volatility of volatility" and "Vega hedging."

To some, Ms. El Karoui has been almost too successful in placing her students in top international banks. Ryan Taylor, a headhunter specializing in quantitative-finance candidates at Napier Scott Executive Search Ltd. in London, says some investment bankers are now starting to question how many French-trained quants are in the field. "France has got what borders on a monopoly of quant candidate production and we'd love to hear from quants in other countries," he says.

Write to Carrick Mollenkamp at carrick.mollenkamp@wsj.com3 and Charles Fleming at charles.fleming@wsj.com4

Corrections & Amplifications:

French math professor Nicole El Karoui attended Ecole Normale Supérieure. This article incorrectly said she attended Ecole Nationale Supérieure. Also, the French government in 1987 closed the Ecole Normale Supérieure in Saint Cloud, a Paris suburb, moving it to Lyon. This article incorrectly stated the government closed the Ecole Normale Supérieure in Paris.

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February 5, 2008
A Trader's Secrets, a Bank's Missteps

By NELSON D. SCHWARTZ and KATRIN BENNHOLD

PARIS — The first e-mail message arrived in Société Générale's offices on Nov. 7. The surveillance office at Eurex, one of Europe's biggest exchanges, alerted a compliance officer at the bank that for seven months a trader named Jérôme Kerviel had engaged in not just one but "several transactions" that had raised red flags.

Société Générale, taking its time, responded on Nov. 20, when another risk-control expert at the bank replied that there was nothing irregular. "The recent volatility increase on the U.S. and European stock markets explains our new need for after-hours trading," the bank official wrote about Mr. Kerviel's trades, according to e-mail messages reviewed by The New York Times.

A second e-mail message from Eurex came on Nov. 26. Not satisfied by the bank's explanation, the bourse demanded more details. Société Générale provided them on Dec. 10 — and both Eurex and the bank's own risk managers let the matter of Mr. Kerviel's trades drop.

By the time Mr. Kerviel set off another alarm, on Jan 18, five weeks later, it was too late. Though he had a profit on his surreptitious trading of roughly $2 billion by late December, his gain quickly went south. It would balloon into a loss of more than $7 billion as the bank frantically unwound Mr. Kerviel's financial positions on Jan. 21-22.

A spokeswoman for Société Générale declined to comment on the contents of the warning from Eurex or the bank's response, citing an internal inquiry by a special committee of independent directors now under way.

Overlooking the warnings by Eurex about Mr. Kerviel was only one of a series of missteps by Société Générale that led to his staggering loss.

The 144-year-old bank allowed a culture of risk to flourish, creating major flaws in its operations that enabled the rogue trader's activities to go undetected, according to bank officials, investigators and traders who worked with Mr. Kerviel.

Far from being discouraged from placing big bets, Société Générale traders were rewarded for making risky investments with the bank's money. It was not uncommon for traders to briefly exceed limits imposed on their trading before pulling back, despite controls meant to prohibit this.

"I have a suspicion that this was inevitable, given the way things were engineered," said Yves-Marie Laulan, a former chief economist at Société Générale and a longtime Paris banker. "It's a necessary warning that these things are so complicated that they are hard to control."

While management depicts the 31-year-old Mr. Kerviel as a lone operator who spiraled out of control, interviews with current and former Société Générale employees suggest that he was also the product of an environment where risk taking was embraced, as long as it made money for the bank.

"If this scam had been uncovered in November, when he was still up, he would have been fired but I suspect we would have heard very little about it," said a French financial official who insisted on anonymity because of his role in the investigation.

The Soldier-Monks

The damage wrought by Mr. Kerviel comes in the wake of two trends that reshaped Société Générale: the explosive growth of its derivatives business and its use of its own money to make bets on the market, known as proprietary trading.

Throughout Société Générale's sprawling derivatives business, said one current employee who used to work with Mr. Kerviel, traders were encouraged to make proprietary bets, even on desks that specialized in what top executives called "plain vanilla products," like the team where Mr. Kerviel worked, Delta One.

"You must take positions, even if you are not a proprietary trader," said this employee, who insisted on anonymity because he was not authorized to talk to the press. "During appraisals by bosses, they made it clear you were judged by how well you did your basic job, as well as how much money you made on prop trades."

Mr. Kerviel told French prosecutors as much. Asked if his superiors knew of his activities, he said, "at the beginning, just as at the end of my maneuvers, they didn't want to intervene," adding, "They know the machinery."

Kinner Lakhani, an analyst with ABN Amro in London: said, "Unlike some of their peers, Soc Gen was not shy about taking proprietary trading risks. Perhaps such businesses grew faster than risk management could cope."

Within Société Générale's corporate and investment bank, according to Mr. Lakhani, the percentage of revenue from market-making and proprietary trading rose to about 35 percent by mid-2007 from 29 percent in 2004.

The derivatives group started in the 1980s as a small team of highly trained and highly regarded engineers and mathematicians from the best schools. They quickly became known as "les moines-soldats," the soldier-monks. And as their importance inside the bank grew, their confidence, even arrogance, grew with it.

Like the devout and disciplined fighters they were named for — the monks who fought in the Crusades — the soldier-monks of Société Générale prided themselves on rising above the passions that moved the masses.

Similarly, Société Générale's soldier-monks believed that they could manage both the risk inherent in betting on the markets — through complex computer models — and the ardor of their regular traders, through controls.

Their hubris was having too much faith in their power to do either.

But they were dedicated to making Société Générale a world-class power in derivatives and, like the knights of old, they were fiercely competitive, both on and off the trading floor.

"We considered it a mission," recalled Antoine Paille, who recruited Jean-Pierre Mustier, now the head of Société Générale's corporate and investment bank. It was Mr. Mustier who ultimately confronted Mr. Kerviel after his fraud was discovered on Jan. 18.

While based in the United States in the 1990s, Mr. Mustier and another derivatives executive, Luc François, organized a sailing competition with other banks and steered the Société Générale boat to victory. Mr. François eventually rose to head the derivatives business but reportedly left last month after the revelation of Mr. Kerviel's trades.

A Red Flag Cited

Mr. Kerviel was never viewed as soldier-monk material. He was a provincial from decidedly middle-class stock — the son of a hairdresser and a metal- shop teacher — but he possessed an advantage that his better-bred superiors did not.

In his five years toiling in the back office before being promoted to Delta One in 2005, he had become expertly familiar with the proprietary system Société Générale used to book trades, known as Eliot inside the bank. While the risk-control department did monitor the bank's overall positions very closely, it did not verify the data Mr. Kerviel entered into Eliot. And Mr. Kerviel knew the timing of the nightly reconciliation of the day's trades by Eliot, so he was able to expertly delete and then re-enter his unauthorized transactions without being caught.

Mr. Kerviel's method of entering trades was one red flag cited by Eurex in its initial warning, along with questions about two "large" positions — one net short position in DAX futures and one net long position in Euro Stoxx 50 futures. In the same letter, they asked what his investment strategy was and why these transactions were often entered through a London-based Société Générale subsidiary called FIMAT Futures Limited. Eurex even inquired whether Mr. Kerviel had entered the transaction automatically or manually.

"Please explain the background for this procedure," two Eurex officials wrote to Xavier de la Maisonneuve, a compliance officer at Société Générale who has been questioned by investigators.

Vincent Duclos, another compliance officer in the equity derivatives division, not yet questioned by the police, provided the Nov. 20 and Dec. 10 responses to Eurex. His replies in part were based on accounts provided by Mr. Kerviel and his supervisor, as well as a compliance officer at FIMAT, said Jean Veil, a lawyer for Société Générale. Mr. Kerviel's "supervisor had signaled that there was no anomaly whatsoever," Mr. Veil said.

Mr. De la Maisonneuve, who received the initial query on Nov. 7, said the bank gets 15 to 20 queries from different exchanges each year, many of them from Eurex.

In a telephone interview Monday night, he insisted his team had been in telephone contact with Eurex after their two letters in November to ensure it would fully answer their queries.

"Their questions were based purely on strategy and procedure," he said. "At no moment of these conversations was there any mention of abnormal volumes. They considered our second written response adequate and satisfying."

He added that Eurex did not take up Société Générale's offer of a conference call to further discuss the matter after the Dec. 10 letter.

A top official at Société Générale, who insisted on anonymity because of the sensitivity of the matter, said that in the weeks after the Eurex warning, Mr. Kerviel was shaken, and took additional steps to cover his tracks. He tried to manipulate areas of the internal risk-control system he was unfamiliar with, which ultimately led to the discovery of his suspected fraud in mid-January.

In his testimony to the police, however, Mr. Kerviel identified two members of the Delta One team he said were familiar with his activities going back to last April. These colleagues, according to lawyers familiar with the case, were Martial Rouyère, head of the Delta One trading desk, and his deputy, Eric Cordelle. Mr. Rouyère has since been questioned by the French authorities. Mr. Veil said he expected Mr. Kerviel's "entire hierarchy," including Mr. Mustier, to eventually be questioned by the police.

Given that Mr. Kerviel was able to exceed trading limits and evade detection for so long, as well as Société Générale's handling of Eurex's November warnings, "we can easily infer that the internal controls were either inadequately designed or have not been operating effectively and efficiently," said Francis Hounnongandji, a corporate governance expert who is also president of the French chapter of the Association of Certified Fraud Examiners.

That conclusion is being echoed at the highest levels of the French government. On Monday, Finance Minister Christine Lagarde said, "Very clearly, certain mechanisms of internal controls of Société Générale did not function, and those that functioned were not always followed by appropriate modifications."

In meetings with investors in recent days, Société Générale's chief executive, Daniel Bouton, has admitted his bank's internal systems did not keep up with the pace of growth in the derivatives business. "He told them while our derivatives business was going 130 miles an hour, risk control was only going 80," according to one analyst who covers Société Générale but insisted on anonymity.

He added that with traders making so much money, the analyst added, "they were untouchable; they had the power."

Pascal Decque, an analyst who covers Société Générale in Paris for Natxis, agreed that the bank was more willing to take risks than any of its French rivals, including BNP Paribas, which is rumored to be considering a bid for Société Générale.

As an example, he cited Société Générale's loss of 2 billion euros stemming from subprime-related investments — twice the size of the hit BNP Paribas took, even though BNP is larger.

Suspiciously Good Timing

The Securities and Exchange Commission is investigating whether Robert Day, an American Société Générale board member, violated insider trading rules by selling shares worth 45 million euros before the bank's audit committee was informed of the subprime loss.

Société Générale and a spokesman for Mr. Day said last week that the share sales by Mr. Day and his family's trusts occurred in several transactions from December 2007 to Jan. 18, during a predetermined window when directors were allowed to exercise options. Both statements said all required disclosures were made, and "no inside information was used in any way" with respect to these sales.

As for Société Générale, the price of its hubris is still to be tallied. Like many observers, Mr. Decque believes it likely that the bank will eventually lose its independence as a result of Mr. Kerviel's losses, most likely via an acquisition by another French bank.

"Soc Gen was brilliant in their achievement, they were the world leader in derivatives," Mr. Decque said. "Maybe when you are that good, you think you will never fail."

Nicola Clark and James Kanter contributed reporting.