Cablegate: The Societe Generale Debacle: Some Possible Implications

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1. (U) The release of Finance Minister Lagarde's report on Societe
Generale's 4.9 billion euro loss by a "rogue" trader confirms
details that we have heard from banking contacts and which have now
been widely and well reported in the financial press. Insiders
comment that "rogue traders happen" and compare the case with
Barings or Sumitomo. More important, from our perspective, are the
implications of the SocGen affair for French finance and business
and its possible political impact. SocGen is one of only two major
French true private-sector, publicly-traded international banks and
it may not remain independent much longer. There is no question of
a bank collapse -- SocGen is France's top retail bank and has more
than adequate capital. However, its future in corporate and
investment banking - its real profit center - is in doubt. The
specter of this former crown jewel disappearing is a political hot
potato and brings out the most interventionist instincts from all
sides of the French political world, not least its President.

French Banking - a short history

2. (U) Large parts of France's banking sector were nationalized at
the end of the Second World War, followed by further
nationalizations in 1981. Francois Mitterrand later reversed his
own disastrous nationalization policy and began to privatize
state-owned enterprises. In 1987, SocGen was the first of several
major bank privatizations. It was followed by the listing and sales
of Credit Commercial de France, Suez and Paribas, with BNP following
in 1993. A significant, mostly market-driven consolidation of the
sector continued throughout the 1990's. Societe Generale acquired
Credit du Nord in 1997. Credit Commercial de France bought Societe
Marseillaise in 1998 and was in turn purchased by HSBC in 2000 in a
friendly acquisition. BNP won a tough battle (with Credit Lyonnais)
to buy Paribas in 1999, giving birth to France's largest bank and a
major player in global banking.

3. (U) In parallel with the consolidation of private sector banking,
France's two massive mutual banks expanded and reorganized as well,
moving far beyond their traditional roles of credit unions and farm
banks. Among the mutual banks, Credit Agricole acquired Indosuez in
1996 while Credit Mutuel purchased Credit Industriel et Commercial
in 1998. In the savings bank sector, Banques Populaires bought
stakes in the financial and investment banking entity Natexis
(product of the 1996-1998 merger of state-owned Credit National and
Banque Francaise du Commerce Exterieur) in 1998. Caisse d'Epargne
acquired Credit Foncier privatized in 1999. Several years later,
Banques Populaires and Caisse d'Epargne merged their financial and
investment banking subsidiaries into their jointly owned Natixis
subsidiary (independently one of Europe's top 25 banks, by

4. (U) This period of turmoil and consolidation also saw the rise
and fall of Credit Lyonnais. One of France's top banks across the
board in the late 1980's, Credit Lyonnais was kept out of the
Mitterrand privatization program. However, the bank was undone in a
sordid affair of massive lending to the US film industry and in
particular for the failed takeover of MGM. Credit Lyonnais ended up
owning the movie studio and eventually lost an estimated USD 5
billion in Hollywood. It also fell afoul of California insurance
regulators in its (unrelated) acquisition of Executive Life and
survived only by dint of a GOF bailout. The bank was privatized in
1999 and acquired by the mutual Credit Agricole in 2003 where it was
later renamed LCL and reduced to a retail bank network.

The Banking Sector v.2008

5. (SBU) France's mutual banks today represent just under 30 percent
of the banking sector (credit establishments) in terms of assets.
These banks are, in some cases, listed and traded even while a
controlling stake in the institutions is owned by the institutions
themselves or, in theory, by their members and depositors. The
former president of a major provincial bank which was acquired by
Credit Mutuel described the mutual banks to us as independent
fiefdoms with boards chosen by management and minimal accountability
for performance to depositors, shareholders or the GOF, though they
are, of course, regulated by the Commission Bancaire. Investment
banking subsidiaries of mutual banks are listed companies but,
again, overwhelmingly in the hands of the mutual banks (69 percent
for Natixis; 95 percent for Calyon.)

6. (SBU) Until last month, BNP-Paribas and Societe Generale were the
twin world class private sector, publicly traded international banks
in France. (Mutual bank Credit Agricole ranks second in Fortune
Global 500 for banks with a notional market capitalization of USD 77
billion, but it is largely self-owned and less of a player in
corporate and investment banking.) Part of the motivation for GOF's
aggressive privatization of the banking sector in the late 1980's

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was the view that a dynamic financial sector was essential if France
were to compete successfully with the UK and a newly united Germany.
The development of Paris as a financial center became a key
objective (the crowning moment of which was the 2007 merger of
Euronext with the New York Stock Exchange.) While London and
Frankfurt had significant leads in most areas of international
finance, the French banks focused heavily from the outset on the
emerging equities derivative business. One senior French banker
asserted that Societe Generale was generally ranked as the top bank
globally for equities derivatives trading while BNP-Paribas was
generally among the top five.

So what happened?

7.(SBU) In short, the scandal appears remarkably similar to other
"rogue" trader losses in recent years: a trader promoted from the
ranks of the back office green eyeshades, engaging in what are
supposed to be high volume low risk arbitrage trades, decides to
open an uncovered position, which is hidden by exploiting the
organization's internal control system. The trader builds an ever
larger position which eventually is either exposed or collapses.
The details of the Societe Generale loss have been widely reported
and are estimated at 6.3 billion euro for 2008, offset by gains of
1.4 euro as of late December. One of our senior banking contacts
previewed many of the details of SocGen's risk management failure
which have since been confirmed in the Lagarde report and the press.
SocGen ran a "permissive" trading operation in which oversight and
risk management always took a back seat to trading. The trader in
question never took vacation, refused to allow other traders to see
his book, and was allowed to log frequent cancellations of trades
(bogus hedge trades in this case.) It also seems clear that the
bank ignored a series of warnings and red flags raised about the
trader's activities from the Eurex exchange. In the week following
the scandal, another senior French investment banker told us not to
be hasty in judging SocGen management. Out of control traders can
happen anywhere, he said, and result from the trader mentality. He
cautioned that the damage to the bank could not be estimated until
the details of the risk management failure were known. Over the
last few days, the trader in question and others appear to have
confirmed that SocGen trading operated with extremely lax oversight.
Proprietary trading profits appear to have been the overriding
objective of the organization

8. (SBU) In terms of unwinding the open position, our contacts agree
that while the market was highly unfavorable, SocGen had no choice
but to liquidate the position quickly and in secret. According to
our banking contacts, the fraud was discovered by the bank on
Friday, January 18th. The bank had quantified its exposure by Sunday
and informed Bank of France Governor Christian Noyer and the
position was unwound over the next three days culminating with an
announcement to the Bank's board on Wednesday and a public
announcement the next day. The Elysee learned of the situation at
about the same time as the Commission Bancaire and the bank's

What does it mean?

9.(SBU) It is unclear at this point whether Societe Generale will
survive as an independent entity. Numerous breakup or takeover
options have been mooted, prompting French officials to warn off
foreign "predators." What is clear, is that the corporate and
investment banking business of Societe Generale have suffered a
severe and perhaps mortal blow and that the reputation of French
finance is badly tarnished, especially in equities derivatives, the
one area in which France has been a global leader. At the retail
level our investment banking contact assured us, SocGen is one of
seven major banking networks in France and its acquisition or merger
would have little impact. Retail banking in France is a saturated
and slim-margin business. Societe Generale's extensive investments
in retail networks in central and eastern Europe should remain a
valuable asset. At the corporate level, however, Societe Generale's
disappearance (whether by pulling back from the corporate finance
business or by merging into another group) could severely impact its
traditional French corporate investment banking clients, in the
midst of a global credit crunch and faced with the backdrop of a
slowing global economy.

10.(SBU) The possibility of a SocGen takeover raises issues of
French industrial policy beyond such a deal's impact on French
corporate clients. Despite the EU Financial Services Directive,
President Sarkozy and other senior GOF officials have made clear
their strong opposition to a merger or takeover by a foreign
"predator." The GOF has limited de jure means to block such a deal
but a great deal of de facto power and we consider that the GOF's
clear and strong interest in keeping SocGen "French" is consistent

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with an emerging Sarkozy version of French industrial policy that is
very much focused on supporting national champions or facilitating
mergers and partnerships to create champions that are world leaders
in their sectors. We plan to further examine how Sarkozy's approach
differs from previous versions of France Inc. but it appears that
maintaining adequate corporate banking support in French hands is
important to this strategy.

11. (SBU) Trading scandals can and do occur anywhere and it would be
wrong to pin blame for the Societe Generale debacle on French
business practices writ-large. But as this story unfolds, the
clubbiness of the upper reaches French business and government and
the tolerant environment it engenders is likely to come in for
further examination. Gerard Rameix, Secretary General of France's
market watchdog, the AMF, was subordinate to then Finance Ministry
Budget Director and current Societe Generale CEO, Daniel Bouton.
Banque de France Governor Christian Noyer was chief of staff and
subsequently an assistant secretary-equivalent at the Finance
Ministry while AMF President Michel Prada was also a former budget
director. All are "inspecteurs des finances," the most powerful of
the French administration's grand corps of graduates from the Ecole
Nationale d'Adminstration. None of this suggests wrongdoing --
Bouton, Noyer, Prada and Rameix are highly competent -- but it adds
to the perception that the country's homogenous grooming of its
elite contributes to myopia.

12.(SBU) Despite high-profile business scandals in recent years
involving members of the corps - Credit Lyonnais and Vivendi come to
mind - the inspecteurs des finances still dominate senior management
of France's most established companies. And President Sarkozy, for
all of his criticism of the country's traditional elitist governing
structures, has shown little appetite for shaking up a system that
produces CEOs attuned to balancing the interests of shareholders
with those of the state. The president's public suggestion that
Bouton resign ("accept his responsibilities") reflected views the
Elysee had also passed directly to Societe Generale board members.
But in the longer term we suspect that in sectors considered
strategic - finance being one - the Sarkozy government is just as
happy dealing with an old boys (and girls) club that knows how the
game is played.


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