Regular readers are familiar with our Masters of Finance series featuring such legends as Bill Gross, Warren Buffett and Ray Dalio. But there are other different financial ‘masters’ who have wreaked havoc on institutions and private investors alike. Nick Leeson is on that list.
He is the trader known for single-handedly bringing down the 233 year-old Barings Bank of England. This was no small feat, considering that Barings was once instrumental in financing the Louisiana Purchase and the Napoleonic Wars.1 And thanks to reckless derivatives trading Barings Bank is no more. Here is the story…
Aspiring finance professional Nick Leeson was a relatively unimpressive student at University, yet eventually found his way into Barings Bank in the late 1980’s. His first major assignment was to clean up a large back-office mess in Indonesia, hardly a glamorous job starting a career in finance. But after successfully navigating the issue, he was promoted to a trading position in Singapore-an upgrade in both position and location.2 He had won the trust of the Barings brass, ultimately the banks undoing.
Leeson was supposed to be primarily facilitating trades on behalf of clients (or as agent) with only a small amount intended to be proprietary. And even the proprietary trading was supposed to be low risk. Leeson had authorization to capitalize on arbitrage opportunities between Japan’s Nikkei 225 futures prices traded on the Osaka Exchange in Japan and the Singapore International Monetary Exchange.3
You must remember the context. The Nikkei has just finished one of the most epic bull runs of all-time. But the bubble burst in 1991 and the Nikkei started dropping. The index collapsed from a high of 38,957 at the end of 1989 to 22,984 in roughly two years. 4
By the early 1990’s, Leeson became more comfortable trading Nikkei futures, he started to make speculative, directional bets. Essentially, he did one-half of the arbitrage trade, the buy, but decided against the other side, the immediate sell on the other exchange. Leeson became net long the Japanese Nikkei because he thought the Japanese market would go higher when the bull market resumed. But that is a losing strategy if the market keeps cratering, as it did.
Leeson’s trading losses, relatively small at first, began to mount over the next few years. At one point, Leeson’s operation was trading half of the open interest in the Nikkei futures.5 Then the Kobe earthquake hit and the jig was up. By 1995, his losses, still unknown to the bank, had grown to an astounding 827 million pounds (well over $1 billion).6 That type of loss is devastating for any bank, but it was catastrophic for Barings as it represented twice the bank’s total capital, rendering the bank insolvent.7
The Bank of England attempted to orchestrate a weekend bailout to no avail. Had this occurred a decade later, there may have been a chance for a bailout of the bank, as occurred on a few occasions during the financial crisis.
Ironically, a century earlier Barings had been the beneficiary of a bailout (called a restructuring) when they had underwritten too many South American bond offerings.
In a push to expand their influence into lucrative new markets, Barings had underwritten Argentinian government bonds which Argentina eventually defaulted upon (known as the Panic of 1890) leaving Barings dramatically overexposed. A bailout by a consortium of banks gave Barings a lifeline to continue operations.8
Lack of Compliance Control
The obvious question was “How could this have happened?” Leeson was able to hide his trading losses because he essentially ran both the trading and operations divisions at the Singapore branch. By running the operations himself, Leeson was able to create a hidden ‘error account’ where he stashed the trades which remarkable remained out of view from his managers back in London.
While it certainly should have been caught, remember in the early 1990s automation was nothing like today.
And when Leeson started making bigger and bigger trades, he forged the signatures of Barings managers, giving him trading authorization and capital necessary for the trades. Today, it is the job of any operations professional to look for ‘red flags’ and report findings immediately to a compliance officer.
Soon after the Kobe Earthquake, Leeson realized he was heading to jail and attempted to flee to England rather than be sentenced to time in a Singaporean jail. Understandably, Britain didn’t fight for his extradition home. Leeson was sentenced to six and a half years in Singapore’s maximum security Tanah Merah prison for forgery and fraud.9
He eventually served just four years after being released upon detection of colon cancer, which he eventually beat. Upon his release, he allegedly drank champagne and dined on smoked salmon on the flight back to London with British journalists.10
Leeson has had several stints since prison release, including working for a professional soccer club and ironically as a debt counselor.11 Leeson also gives after-dinner speeches, often to the tune of 6,000 pounds (roughly $7,000) each.12
Leeson reportedly made 200,000 pounds from a book deal and received a share of the profits from the movie about the Barings debacle, Rogue Trader, starring Ewan McGregor.13 Many are still furious that Leeson is able to profit from his prior indiscretions.