Barings Bank was a survivor. Founded in 1762 during the reign of George III, it endured through seven more kings and queens, two world wars, the Great Depression, and countless geopolitical upheavals. It saw the British Empire reach its pinnacle of power. Even as that empire began its decline, Barings Bank spread its influence around the globe, gaining a reputation for financial strength, stability, and endurance.

As the twentieth century neared its conclusion, the mighty Barings Bank was so well established that most assumed it would take a destructive force of a near-planetary scale to end its glorious legacy. Certainly, no one thought the indestructible institution could be toppled by one man.

Meet Nick Leeson, the Destroyer of Banks

Nick Leeson was the head derivatives trader in Singapore for Barings Bank. The 28-year-old had gained a reputation as a whiz kid with his financial savvy. In one year alone, he was responsible for ten percent of the bank’s total profits. Obviously, this was a guy who knew how to work the market.

He also didn’t know how to own up to a mistake. When you combine the fierce tenacity needed to make a successful businessman with a stubborn refusal to accept responsibility or admit wrongdoing, you have the recipe for something truly awful. Just how awful this particular carrier of stubbornness and duplicity would turn out to be stunned the financial world.

The story of our trainwreck started in 1992 when one of Leeson’s clients lost money through a mistake. One of the people Leeson supervised accidentally bought some futures for the client instead of selling them as the client intended. The result was that the client lost £20,000. Leeson reimbursed the client by creating an “error account” connected to the bank’s funds. He moved the money from the error account to the client account, thus fixing that particular issue, as far as the client was concerned.

It did, however, put the bank at a deficit of £20,000. Not good, but in the big picture, not the type of issue that will cause bank executives to lose much sleep, considering that the bank had £350 million of capital. These types of error accounts are created all the time, but internal control policies typically require full disclosure and appropriate steps to prevent that kind of error from repeating. Pointing out the mistake to his supervisors would have tarnished Leeson’s reputation as a whiz kid, however, so he did not report it and, instead, tried to replenish the bank’s money through some savvy trading.

Futures Trading 101

Understanding what happened next requires a brief detour for a lesson about how the market works. Most of us understand the simple buy-and-sell concept for stocks and bonds. This is where an investor buys a marketable security for a definite price and sells it at a time of his or her choosing. If it is sold for more than the purchase price, the investor makes a profit. If it sells for less, then it is a loss.

It gets a little more complicated with futures contracts. Buying a future means that you pay for a contract, in which you agree to buy or sell something at a stated point in the future at a price you establish right now.

For purposes of illustration, let’s say we’re talking about toenail clippers. They currently sell on Amazon for $6.99, but you are positive the price is going to go up. This is because you have it on good authority that one of the side effects of the COVID vaccine is uncontrollable toenail growth. You purchase a future, agreeing to buy 100,000 toenail clippers at $6.99 apiece, six months from today. When that day comes, if you were correct, and toenail clippers have doubled in price, you stand to make a killing by purchasing 100,000 of them at the laughingly-low price of $6.99 and quickly reselling them for $13.98 each. If, on the other hand, you guessed wrong and the vaccine actually causes everyone’s toenails to fall off, you will find there is no demand for clippers so the price has plummeted, but you’re still on the hook to buy them at the agreed-upon price.

Similar to futures contracts is the options contract. An option contract gives the investor the right, but not the obligation, to buy or sell. Two types of options contracts are the “call” and “put.” A call is a contract between a buyer and seller, where the buyer reserves the right to buy toenail clippers for an agreed-upon price on a particular date. To secure this right, the buyer pays the seller a premium, which is typically far less than the cost of the product. Basically, the buyer is hoping the price will go up so he can exercise his option and make a profit. The seller is hoping the price will go down so the buyer will choose not to exercise the option to buy. In that case, the seller gets to keep the premium and still has the product that can be unloaded later when the price returns to a reasonable level.

A “put” is the opposite of a “call.” The person who purchases a put pays a premium for the right to sell toenail clippers to that person on a fixed date for a fixed price. As in the case of the call, it is an option, not a requirement. When the date arrives, the person with the option does not have to sell anything, but if he does, the price has already been determined. If the market value of the toenail clippers has gone down, he can choose not to exercise his option, leaving him with his inventory that can be sold when the price is more favorable. The would-be buyer did not get toenail clippers, but he did get the premium that was paid for the option.

If you combine the concepts of call and put, you get something called a “short straddle.” That is when you purchase a call and put on the same item. You purchase the right to buy a certain number of toenail clippers at a fixed price on such-and-such a date. At the same time, you also pay another premium to give you the right to sell a certain number of clippers for a certain amount on such-and-such a date.

We should point out, however, that a significant downside to short straddles is that the liability is theoretically unlimited. Suppose you short straddle the options on 100,000 toenail clippers, betting that the price will remain unchanged at $6.99. On that fateful day, if you were wrong and the market value collapsed, you still have to shell out $699,000 for a bunch of worthless items. Even worse, if the price massively increased to $100, you have to sell your inventory for the agreed-upon price. Who is to say you ever had 100,000 toenail clippers to sell in the first place? You were counting on the option not being exercised, so you might not have any clippers. If that is the case, you will have to spend $10 million to buy the inventory that you will turn around and liquidate for $699,000, losing $9,301,000 in the process.

How does someone make a profit from a short straddle? It can be profitable for… well… reasons. We stop our explanation at this point to lull the reader into thinking we understand this way better than we do. It is not, however, necessary to grasp all of the financial nuances of a short straddle to see how the concept plays into our story.

Turning a Mole Hill Into a Smoking Crater of Death

Getting back to Nick Leeson, he was starting to get a wee bit nervous about his plan to cover his tracks. He designated the error account as “Account #88888” because the number 8 is considered lucky in southeast Asia. The way things played out, however, left Leeson feeling as if he was behind the 8 ball.

Leeson tried to recoup the bank’s money through futures trading. Unlike most of the trading taking place at Barings Bank, Account #88888 drew upon the bank’s money instead of client funds. started investing — this time with the bank’s money, instead of client funds. His hopes of recovering the lost £20,000 with a quick investment evaporated spectacularly. By the end of 1992, that £20,000 deficit had grown to £2 million. The next year, it was £23 million in the red. By the end of 1994, Account #88888 showed a deficit of £208 million.

Despite finding himself in a horrifying hole of his own digging, Leeson refused to report any of this to the proper authorities. Had he done so, he almost certainly would have lost his job, but Barings Bank would have squeaked by on its £350 million of capital. Instead, Leeson falsely reported a £102 million profit and set his sights on an ambitious way to get all of the money back at one time. To do this, he would make use of short straddles.

Leeson did not trouble himself with anything as insignificant as toenail clippers for his foray into short straddles. He set his sights on the Asian financial markets. Leeson looked at the Tokyo and Singapore stock exchanges and determined they were pretty stable and unlikely to fluctuate wildly in the near future. If he predicted accurately, he stood to get a lot of money back. On January 15, 1995, Leeson gambled a boatload of the bank’s money on his confident prediction that nothing would cause Asian investors to be at all uneasy about the future.

As if scripted for a Hollywood movie, the very next day Japan was rocked by the Kobe earthquake. The disaster killed 6,000 people, destroyed nearly 400,000 buildings, left 45,000 homeless, and, of course, sent the Asian markets into free fall. As the horror of his situation started to sink in, Leeson made one last desperate investment in the Nikkei exchange, certain that it would make a rapid recovery. It did not. Account #88888 was now in the hole by £827 million (US $1.4 billion) — roughly twice that of Barings’ trading capital. He had, to put it bluntly, bankrupted one of the world’s most prestigious banks.

Leeson responded to the grim reality of his circumstances by getting on a plane and leaving the country. To his credit, he sent a note of confession to Baring’s chairman Peter Baring on February 23, 1995. Not to his credit was that he continued to avoid responsibility, as is reflected in the curtness of the note: “I’m sorry” and the fact that he promptly went into hiding. At almost the same time the note was being read, the bank’s auditors uncovered the massive, smoking hole known as Account #88888. Three days later, Barings Bank ceased to exist.

The Bank of England worked with Barings to see if there was a way to avoid a shutdown, but the obstacles were too great to overcome.

Aftermath

Leeson was eventually located in Germany after a massive, international manhunt that lasted nearly nine months. He pleaded guilty to two counts of “deceiving the bank’s auditors and of cheating the Singapore exchange.” He was sentenced to six and a half years in a Singapore jail.

While in jail, he published his autobiography, Rogue Trader, telling the world how he pulled off one of the greatest financial crimes in history. A review of the book in The New York Times observed, “This is a dreary book, written by a young man very taken with himself, but it ought to be read by banking managers and auditors everywhere.” In 1999, the book was made into a film of the same name starring Ewan McGregor and Anna Friel. The movie was made with a budget of about £9.7 million. It generated less than £1 million in ticket sales, which seems oddly appropriate.

In July 1999, four years into his sentence, Leeson was given a compassionate early release, due to being diagnosed with terminal colon cancer. As of this writing, nearly a quarter of a century later, he is still alive and well and is in demand as a speaker and has appeared on Celebrity Apprentice Ireland.

Barings Bank, its investors, and employees did not fare quite as well. After declaring bankruptcy, Barings was purchased by the Dutch investment firm ING for £1. The Singapore office was forced to release 1,200 employees from their jobs.

Financial gurus and government regulators scrambled after the Barings failure to figure out what happened and to try to prevent it from happening again. While governments have taken great steps to avoid a repeat of the fiasco, it remains to be tested whether any government can successfully legislate against stupidity.