80 ATaleofTwoMarkets
simultaneously sold put options and call options on Nikkei 225 fu-
tures. This was a medium-ris kstrategy, very effective in stable mar-
kets but dangerous in volatile ones.
An earthquake that rocked Kobe, Japan, in January 1995 plunged
the Nikkei and terrorized Leeson. As the market roiled, Leeson acted
like a heroin addict and adopted the high-risk strategy of buying
more Nikkei futures in the vain hope of propping up the fallen mar-
ket.
When the dust settled, Barings’s exposure on the futures con-
tracts ran to a staggering $1 billion, far in excess of Barings’s total
capital. The ban kfell to its knees. Investigators discovered that Lee-
son’s positions had been covered by Baring’s margin accounts while
he was trading, but after the crash—and after Leeson fled Singapore
for Germany—they were not.
During his trading, Leeson told Barings’s main branch in London
the plausible story that he was hedging his long futures positions
with private contracts and was also making hedged trades on behalf
of a client of the bank. In fact, the client did not exist but was a
fictitious name given to an account that Leeson invented earlier for
his own use.
Leeson allegedly funded that account with proceeds from other
trades and used those funds to maintain the margin account balance.
He apparently used the fictitious client account to convince Barings
in London to provide additional firm capital, which Lesson in turn
used to shore up the margin account. In the end, none of that was
enough.^9
The Leeson lesson is admittedly an extreme psychological case
tripped up in a mix of exotic securities, excess margins, and fraud.
But the drama is a memorable warning that margins and exotica can
get you in over your head and that mixing them can get it handed
to you on a platter.
Options
A final warning on exotica takes us back to Ben Graham’s opinion
on options. Even before stoc koption awards to managers became
commonplace, Graham disparaged the instruments on more general
grounds.
Options originally were attached to bonds and by the 1920s had
expanded as part of other financial innovations Graham regarded as
abusive. When they reappeared more widely in the 1960s, Graham