Deutsche Bank Reins In Top Trader After $1.8 Billion Loss

The definition of Master of the Universe is changing at large investment banks like Deutsche Bank where chess players were given wide latitude to take risky bets with the firm's capital.Over the weekend, I read a fascinating article in The Wall Street Journal profiling the fall of Boaz Weinstein, a top trader and chess genius at Deutsche Bank who left the bank with a $1.8 billion hole in 2008. Weinstein led a team of traders that bet the firm's capital on complex derivatives and used leverage to amplify the positions.

In previous years, Weinstein's group - known as Saba, a Hebrew word for grandfatherly wisdom - had earned the bank huge profits. According to the article, the group earned $900 million in 2006 and $600 million in 2007. Over seven years, the trading group had losses in just four quarters, stated an unnamed source. The bank must have had a lot of confidence in the trader's group, which in early 2008 was at the top of its game and had $30 billion in positions and $10 billion in capital, the WSJ reported. Weinstein was a chess "life master at 16," a card-counting blackjack ace at 20 and a player in the esoteric world of credit derivatives at 24." He rose to the top of Deutsche Bank's credit trading desk and hired traders who shared his passion for gambling and used to play poker in a back room at the bank after hours, according to the article.

Weinstein was famous for the "capital structure trade" based on price discrepancies between a company's various securities. He could take bullish bets on corporate bonds and then simultaneously bearish bets on its equities. The article goes into some of Weinstein's strategies such as using swaps to bet on a rise in the value of General Motors' debt while shorting against GM's stock.

But everything imploded in September of 2008, after the government takeover of Freddie Mac and Fannie Mae and then the failure of Lehman Brothers. Within days of that, the government had to bail out American International Group, a major player in credit derivatives. The group's positions in corporate bonds and loans declined in value as other investors sold these securities to raise money. It also became more difficult to trade credit derivatives because traders had fears of entering positions with banks that could collapse, noted the article. This left Weinstein's group with less protection in corporate bonds and loans it held because it relied on swaps as hedges. In all fairness, the article points out that other Wall Street firms and hedge funds were in the same boat as they had similar positions that also came apart after the Lehman collapse caused major dislocations in assets.

With the prices of corporate bonds and stocks falling, Weinstein reportedly wanted to buy more swaps to protect his exposures, but here's when the risk managers stepped in - nine paragraphs from the end of the sprawling two-page article. The risk managers at the bank told Weinstein to scale back his positions or sell them entirely, according to the story, which spoke to traders. The group's equity trading desk was told to sell every holding and was in effect shut down.

In the end, Deutsche Bank's risk managers reined in Weinstein's freedom to control his trading strategies. He left the bank with a $1.8 billion loss. After reading the entire article, one is left with the impression that perhaps Weinstein could have worked his way out of this hole just as he had done many times before. It's hard to know ...

On the other hand, if the risk managers had been involved, his profits would have been less spectacular and the mystique would have been manageable. Interestingly, Weinstein left the bank last week to start a hedge fund.The bank must have had a lot of confidence in the trader's group, which in early 2008 was at the top of its game and had $30 billion in positions and $10 billion in capital, reportedly. Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio