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Author Gapper: Rogue Traders a Feature of the System, Not a Bug

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Rogue traders pop up with some regularity, racking up nine- and ten-figure huge losses at well-known firms: Joseph Jett at Kidder, Peabody in the 1980s, Nicholas Leeson at Baring in the 1990s, Jerome Kerviel at Societe General in 2008. Earlier this year, Kweku Abodoli, a 31-year-old trader at UBS's London office, was busted after having notched some $2 billion in losses due to unauthorized trading.

It turns out rogue traders are features of the system, not a bug. That's the argument made by John Gapper, columnist for the Financial Times, in his smart new e-book How to Be a Rogue Trader.

As we discuss in the accompanying video, Gapper chalks up the persistence of rogue traders to the nature of banks, and to human nature. "When it comes down to it, banks are willing to take the risk that these individual exists within the organization," he said. Large investment banks only make money by taking risk. If they fret too much about the prospect of traders losing money, they wouldn't be able to make meaningful profits.

The impulse that creates rogue traders — the force that spurs people facing losses to take bigger gambles rather than fold -- is also deeply-seated within humans. In the book, Gapper looks at experiments and research done on sparrows, bumblebees, and their cousins who dwell on the more evolved branches of the evolutionary tree — people. Clear trends emerge. "When you're well fed, you take no risk, and simply go where you'll get a certain amount of food." But when animals are cold, or tired, or facing starvation, they start to gamble. "There's a parallel there," said Gapper. "When you're in trouble, you've got to double up. And that's what these rogue traders do."

The rogue traders Gapper assesses in his book share certain commonalities. "A lot of these rogue traders are outsiders," he said. "They've come from second-tier universities, they come from the back office and they want to make their mark." Typically, they are eager, clever, and charismatic. "When people ask questions, they charm their way out of the situation, and they're actually very good at bullying and menacing people and keeping those questions down."

In an age in which employers have all sorts of methods to monitor their employees' activity, it seems like banks should be able to catch rogue traders before they inflict too much damage. But Gapper believes otherwise. Even the best-managed banks don't have systems to monitor the intra-day trades on their vast trading desks. And if a rogue trader has a partner in the back office, then the monitoring system actually abets the crime.

Send an email to talkyourbook@yahoo.com, and we'll put your name in a drawing for a free e-copy of How to Be a Rogue Trader.

Daniel Gross is economics editor at Yahoo! Finance

Follow him on Twitter @grossdm; email him at grossdaniel11@yahoo.com