Nick Leeson and the Kobe Earthquake

5/1/2019 - Monocle Journal

At 5:46 am on the morning of 17 January 1995, most people in Japan were probably lying in their beds, savouring the last few minutes of sleep before their alarms rang out through the stillness of the early morning. Suddenly, the world around them shook violently. Buildings began to crumble and screams of shock and fear could be heard from those who had instantly been buried under beds, refrigerators and slabs of concrete. Gas lines were torn open and fires erupted between the piles of rubble that had appeared where just moments before houses had stood, separating their inhabitants from the neighbours who desperately tried to dig them free. An earthquake had hit the entire Hanshin region – Japan’s second-largest urban area – and it left more than 6 000 people dead, 40 000 injured, and 300 000 homeless. As the city of Kobe had been closest to the epicentre of the earthquake and had suffered the most loss of life – about 4 600 people – the disaster became known as the Kobe earthquake.


In the aftermath of the Kobe earthquake, the Japanese population wanted desperately to know why no warning of the impending disaster had been issued – for surely, in these modern times, scientists must have identified the signs of imminent seismic activity. Yet, more than twenty years after the tragedy suffered in the Hanshin region, earthquakes remain notoriously hard to foresee and are as deadly as ever. In 2010, 316 000 people lost their lives in an earthquake that hit Haiti, whilst in 2004, an earthquake in the Indian Ocean caused a tsunami that killed 230 000 people. In 2005, over 87 000 people lost their lives in an earthquake in Kashmir, in Pakistan. These are just a handful of recent examples from around the world that show that although scientists have considered everything from changes in ground water levels to unusual animal behaviour, they have not yet found any reliable way of predicting earthquakes with sufficient warning and accuracy. In fact, the US Geological Survey states on its website that “neither the USGS nor any other scientists have ever predicted a major earthquake. We do not know how, and we do not expect to know how any time in the foreseeable future.”

The inability to predict earthquakes with any kind of certainty proved tragic for the people of Japan, causing significant loss of life and devastating infrastructural damage, estimated to be in the region of $100 billion. However, the aftershocks of the disaster travelled even further afield than anyone could have imagined – for it was not only the skyscrapers and apartment buildings of Kobe that came tumbling to the ground as a result of the earthquake, but the walls of London-based Barings Bank as well.

Established in 1762, Barings Bank was the second-oldest merchant bank in the world after Hamburg-based Berenberg Bank, which was founded in 1590. Having weathered a close encounter with financial failure in 1890 that resulted in the Governor of the Bank of England having to broker a bailout from a consortium of other banks, Barings Bank had remained a staple feature of the UK banking environment – even the Queen of England had an account with Barings. From 1989 until the bank’s collapse in 1995, its star employee was Nick Leeson, an aggressive trader who, it appeared, could do no wrong when it came to speculative trading. By 1992, at the age of only 25, he had been appointed general manager of Barings’ offices in Singapore and by 1993, his profits alone amounted to £10 million – almost 10% of Barings’ total profits. But shortly after the Kobe earthquake hit Japan, Leeson disappeared. The last sign of him was a note that said, “I’m sorry”, which lay on his empty desk as Barings crumbled around it.

Investigations revealed that whilst Leeson had kept up the appearance of being near-infallible when it came to his business decisions, underneath his cool, confident exterior was a man in panic. Leeson’s job had been to trade the arbitrage between derivative contracts that were listed on both the Osaka Securities Exchange and the Singapore International Monetary Exchange. The bank’s strategy was conservative: buy on one exchange and sell on the other for a profit, making money off the arbitrage that appeared to exist in derivative contracts with the same underlying. But Leeson had become more aggressive and began to make unauthorised directional bets on futures contracts by buying and holding them. Sometimes these paid off, but sometimes they did not and when his luck failed, Leeson hid the losses in one of Barings’ error accounts – account 88888 – in an attempt to protect his stellar reputation. This would not normally have gone undetected, but Barings’ management structure had enabled Leeson to hold both the position of chief trader and head of settlement operations – jobs usually performed by two different people, given that the latter person is responsible for ensuring accurate accounting for the unit. Initially, Leeson had regarded the use of the error account as a temporary measure, resolving to make back the losses through other speculative trades. But as he desperately tried to cover his tracks, engaging in ever more risky positions, he started to make even bigger losses. Unbeknown to his employers, by the end of 1994, he had lost Barings £208 million.

Leeson’s last attempt to stem the flow of losses occurred on 16 January 1995, when he placed a short straddle on the Nikkei – a stock market index for the Tokyo Stock Exchange. A short straddle is a derivative hybrid that essentially involves combining a short call and a short put position on the same underlying asset, and at the same strike price. The only way that it can make money is if the price of the underlying asset does not change substantially until expiration. However, if the price of the underlying asset either increases or decreases, it loses money. In addition, Leeson combined the short straddle with a long futures position, selling several short straddles for every futures position he took. An increase in stock prices on the Nikkei would result in losses on the short straddles that would greatly surpass the gains on the futures contracts; a decline in stock prices would produce simultaneous losses on the straddle positions and the futures positions. Essentially, Leeson had bet that the Japanese stock market would not move significantly overnight. And he had bet big – in total, Leeson sold 70 892 put and call options with a nominal value of $6.68 billion. Barings Bank had a reported capital amount of $615 million on its balance sheet at this time.

This was an extremely risky move, as stock prices had to remain within an exceptionally narrow range for Leeson to make money. But if everything went according to plan, he would be able to offset the losses in the 88888 account. To Leeson, there was no reason to believe that anything would cause any major changes in the Nikkei, after all, it was just an average Monday. Like scientists all over the world, Leeson had no way of knowing that the Kobe earthquake would hit early the next morning, sending the Nikkei and other Asian markets plummeting.

The irony was profound – all that needed to happen for Leeson to remedy the disastrous losses he had accumulated, was for the Nikkei to remain stable over a relatively short period of time and instead, there had been an almighty, wholly unforeseeable movement of both the earth and the markets. One can only imagine the panic that overcame Leeson as he sat anxiously watching the markets do exactly what he had convinced himself they never would. Leeson attempted to recoup some of his losses by taking positions based on the recovery rate of the Nikkei, but again he made the wrong decision, betting on a rapid recovery that would never materialise. In total, Leeson lost $1.3 billion – over twice the bank’s available trading capital – and a month later, on 27 February, the bank went into receivership with outstanding notional futures positions on Japanese equities and interest rates that amounted to $27 billion. To protect the bank’s depositors, administrators moved quickly to sell Barings as a going concern. On 6 March, the bank was officially acquired by Dutch investment group ING for the nominal sum of £1, assuming all of Barings’ liabilities and forming the subsidiary ING Barings.

Before his losses were discovered, Leeson fled Singapore, but he was caught at the airport in Frankfurt and extradited back to Singapore. There, he pled guilty to two counts of deceiving bank auditors and cheating the SIMEX, receiving six and a half years in prison, although he only served four as a result of a colon cancer diagnosis.

In the aftermath of Barings’ failure, many people raised criticism of the bank’s own internal control structure and risk management practices, which had enabled Leeson to get away with taking such substantial risks. And they certainly had a point, as Barings had essentially handed over its entire Singapore operation to an inexperienced 25-year-old trader, who was left to run his unit completely unsupervised. This was how he had managed to hide his losses for so long and with such ease. Yet, the enormity of the responsibility that had been placed on him in running the Singapore unit had no doubt been a factor in driving his actions in the first place. Indeed, others have pointed to the highly competitive nature of the investment banking environment, blaming the stress of Leeson’s position for pushing him into a whirlwind of bad decision-making. But whatever the mitigating factors in Leeson’s story, the fact is that he had defrauded his employer, hiding significant trading losses and taking extreme risk on the bank’s balance sheet. He had manipulated weaknesses in the internal corporate structure and single-handedly bankrupted the second oldest merchant bank in the world.

For many, the ending of Leeson’s story thus seems fitting, with him accepting guilt for his actions and serving his punishment in one of the harshest prisons in the world, Changi Prison, where judicial corporal punishment by caning is routinely carried out. But ironically, Leeson’s jail-time also served to boost his infamy in a way that has proven highly beneficial later in his life. In 1996, whilst still in prison, Leeson published an autobiography entitled Rogue Trader and in 1999 the book was made into a film, with Ewan McGregor playing the lead. A second book, Back from the Brink: Coping with Stress, followed in 2005. In 2013 he appeared in Celebrity Apprentice Ireland, and in 2018, he starred in the UK’s Celebrity Big Brother TV series. Today, he jets around the world in high demand as a guest speaker at corporate events, where he warns of the importance of sound risk management programmes and corporate ethics.

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