Two weeks ago, French bank Société Générale announced that off-balance sheet speculation by a single “rogue trader” had cost pany 4.9 billion Euros ($7.2 billion). The scandal had enormous repercussions in international markets leading mentators to decry the rotten nature of global “casino” capitalism and to call for the reversal of financial liberalization. However, the actual circumstances of the case do not justify more government intervention in financial markets but illustrate individual moral failings and poor internal governance on behalf of the bank.

A new report also suggests that a lack of internal controls and weak enforcement of existing rules may be the real source of the problem at one of the oldest banks in France.

On January 24th, Société Générale said that it had discovered a “massive fraud” through “a scheme of elaborate fictitious transactions.” The event caused a great stir not only for the magnitude of the bank’s losses but also because it is partly blamed for the worst European stock market collapse since September 11, 2001.

Jerome Kerviel, who worked as a junior trader in the arbitrage department at Société Générale, was responsible for betting on markets’ future performances. The bank claims that he had made unauthorized and concealed bets of around 50 billion Euros on European markets. According to the New York Times, Mr. Kerviel told prosecutors that his bets would have resulted in a profit of 1.4 billion Euros for the bank if they had been cashed out by the end of December. However, at the start of this year, stock markets experienced a sharp downturn turning the projected profits into losses.

The French bank discovered the bets in mid-January when auditors in the risk management office noticed a series of fictitious trades on its books. Société Générale then conducted a dramatic market sell-off operation in order to neutralize Kerviel’s deals. Traders estimate that the bank unwound contracts in the range of 20 billion to 70 billion Euros from January 21st to 22nd.

Many suspect that selling all these positions into an already volatile European market contributed to the shocking stock market performance in Europe around that time. This in turn, provoked an unexpected and controversial interest rate cut by the Federal Reserve of 0.75 per cent in order to protect the New York Stock Exchange which had been closed on the day when European markets dived. The curious series of events was summed up by a hedge fund manager who told Reuters that: “The real story here is basically, this guy, paid 100,000 Euros a year, sitting in some office at SocGen, forces the Fed to cut interest rates by 75 basis points, which is basically what happened”.

The huge and wide-ranging market repercussions have given ammunition to the critics of financial liberalization. An editorial of the French newspaper Libération sarcastically entitled “Casino” laments that no one controls the huge sums of money moving around in financial markets and demands tighter regulation of financial markets. It also claims that the scandal embarrasses President Sarkozy’s alleged embrace of laissez-faire capitalism.

An article in the British weekly The Observer regards the Kerviel incident as a symptom of the flawed architecture of international finance and says that it is time “to blow the whistle on financial market liberalization” since “financial market freedom embeds short-termism, guarantees lower investment, works against business building and innovation, generates booms and busts, inflates house prices, creates system-wide risk and excessively rewards those who work in them.”

Judging by these fundamental criticisms, the scandal at Société Générale could be regarded as exposing all that is wrong with the world economy. However, the case is ill-suited to justify such frontal attacks. Even EU internal missioner Charlie McCreevy said that financial liberalization cannot be blamed for the events at the bank: “No regulation in the world could have foreseen what happened last week in France.”

The problem is not financial market freedom but how to guard against rogue operations. Preliminary charges filed against Kerviel include breach of trust, falsifying documents and puter security. It has also emerged that Eurex, an international derivatives exchange, had warned Société Générale about some of Kerviel’s deals. But when the bank asked the trader about these positions he allegedly produced a fake document to justify the risk.

Before being promoted to the arbitrage department in 2005, Kerviel had worked in the back offices where trades are monitored. In that role, he may have been familiar with passwords and counter trading facilities. Because he is being charged with puter security, this many indicate an investigation that is focusing on inside knowledge of these data operations.

The question about how Société Générale’s gigantic losses could be incurred therefore should not focus on financial market liberalization. While the article in The Observer claims that new plex financial products are creating inherent instability, the events at Société Générale merely show that internal monitoring procedures were unable to prevent problems at one bank.

On February 4th, the French government produced a preliminary report trying to draw lessons from the scandal. It outlines some obvious guidelines which the bank would now certainly enforce without any need for outside regulators such as puter security and the imposition of what the French finance minister calls a “Chinese wall” between back, middle and front offices. The report also says that “certain mechanism of internal controls of Société Générale did not work” thus acknowledging that the problem mainly concerns the lack of enforcement of existing internal rules rather than the need to create more from the outside.

In addition to that, the report makes two mendations which may be more motivated by the government’s desire to be seen to do something rather than to address the actual scandal. Firstly, it calls for higher penalties for fraud which is not strictly relevant in Kerviel’s case since prosecutors have not indicted him for fraud. Secondly, it proposes the elaboration of unified international standards to monitor bank operations. However, while the scandal had huge international repercussions, there is so far no sign of wrongdoing or negligence outside the Paris office of Société Générale.

Beyond the need for the proper enforcement of internal security procedures, the events highlights the need for a greater awareness of the personal responsibility which individual actors in the financial world carry. However, such moral awareness cannot be introduced through regulation.