The SocGen debacle caused by Jérôme Kerviel was a prelude of worse things to come, writes Lara Marlowe

WHEN THE Société Générale (SocGen) revealed last January 24th that it had lost €4.9 billion due to unauthorised operations by a 31-year-old arbitrage trader called Jérôme Kerviel, no one imagined that eight months later the entire world financial system would teeter on the brink of collapse.

The SocGen debacle was a prelude of worse things to come. France's second largest bank was a world leader in derivatives - financial products whose value is derived from underlying assets.

Derivatives trading grew far more rapidly than control and surveillance mechanisms and SocGen's experience should have served as a warning to financial institutions around the world.

The bank made two fundamental errors: the excessive growth of its derivatives business and using its own money to bet on markets, known as proprietary trading.

The staggering losses caused by Kerviel prompted immediate calls for tighter internal controls and a backlash against the "bonus culture" that was amplified by the subsequent global crisis.

President Nicolas Sarkozy has denounced "insane markets" fuelled by the bonus system. Kerviel was a prime example.

He was a low-ranking trader who in theory was not authorised to engage in proprietary trading, yet by December 2007, Kerviel had bet nearly €50 billion - equivalent to the GDP of Morocco or SocGen's entire capitalisation - of SocGen's money on the derivatives market, escaping detection by hacking into its computer system.

When he was interrogated by the financial brigade of the French police last January, Kerviel said his base salary was €48,000. At the end of December he had a secret "mattress" of profits belonging to the bank, then valued at €1.4 billion.

Kerviel swears he made no personal gain, that "above all else, I wanted to earn money for my bank". But because he didn't know how to explain his secret trading, he admitted to having earned "only" €55 million for the bank in 2007. He argued with his bosses over the amount of his bonus. Kerviel wanted €600,000; SocGen, he claimed, was prepared to give him €300,000.

Kerviel's interrogation reveals in stunning detail how trading floors became the world's biggest casino.

He had started in SocGen's middle office - responsible for surveillance of trading operations - in August 2000. His transfer to the trading desk two years later has been likened to asking a locksmith to become a burglar.

In July 2005, Kerviel made his first big coup, betting that Allianz shares would fall, shortly before the London suicide bombings. It was, he told police, "the jackpot - €500,000". Kerviel felt a gambler's euphoria. "I was proud and surprised at the same time. It makes you want to keep going; it snowballs."

By the summer of 2007, Kerviel's virtual secret earnings for SocGen had ballooned to €500 million. With the knowledge he had gained in the middle office, he was able to hack into SocGen's trade booking system, which the bank called Eliot.

Kerviel knew the timetable by which Eliot reconciled each day's transactions, so he was able to delete and re-enter his deals, undetected. "I masked my results through fictitious trades," Kerviel told police.

The €1.4 billion he had accrued by December was equivalent to half SocGen's annual share-trading profits.

"I didn't know what to do. I was happy, proud of myself, but I didn't know how to justify it, so I decided not to tell the bank and to hide the sum I did a fictional operation in the other direction."

Last January, markets plunged and Kerviel's investments with them. On January 18th, a bank controller discovered a strange transaction during a routine inspection. A purchase order had been sent, but there was no vendor. When questioned, Kerviel didn't make sense. The inspector alerted the head of SocGen's investment bank, who discovered thousands of similar transactions hidden by Kerviel in the bank's computer system.

Kerviel's defence is two-fold: SocGen should have known what he was doing and, by liquidating his €50 billion secret portfolio during the week of a "mini-crash", SocGen seriously aggravated the losses.

On Monday morning, January 21st, Kerviel's investments represented a theoretical loss of €1.4 billion. Then the Asian and European markets fell dramatically and by the time SocGen unwound Kerviel's contracts, it had lost €4.9 billion.

At the same time, the bank lost €2 billion on the US subprime market. To save SocGen, the bank's chairman, Daniel Bouton, sought a capital injection of more than €5.5 billion from the US banks JP Morgan and Morgan Stanley.

Kerviel spent five weeks in prison before he was freed on bail. In April, a computer company called LCA, in the Paris suburb of Levallois, hired him as a computer consultant. He has been charged with breach of trust, falsifying documents and hacking SocGen's computers to enter false information.

Although several executives at SocGen have resigned, Kerviel and his former assistant, Thomas Mougard, who is accused of helping to enter false data into the computer system, are the only two to face prosecution over the bank's multi-billion euro losses.

In July, France's Banking Commission fined SocGen €4 million for serious breaches in internal controls.

Under French law, judges Renaud Van Ruymbeke and Françoise Desset must complete their investigation before a trial is scheduled. The judges had intended to wind up the case in July, but Kerviel's lawyers dragged proceedings out with a demand for a "confrontation" between Kerviel and Daniel Bouton. That demand was rejected on December 5th.

Judge van Ruymbeke grew impatient with Kerviel's continuing claims that his superiors tolerated his actions as long as he earned money for the bank. "Why do you make up such stories?" van Ruymbeke reportedly asked him.

If Kerviel's bosses knew what he was doing, why did he go to such lengths to hide his positions?

In the meantime, the disgraced trader has become something of a folk hero. Three books have been published about his escapade.

Groups with names like "Jérôme Kerviel Should be Awarded The Nobel Prize in Economics" have sprung up on the internet. Young women have been seen wearing T-shirts saying, "I am Jérôme Kerviel's girlfriend". And there are rumours that a feature film is planned about Kerviel, in which he may play himself.