Bernie Ebbers, Brian Hunter and Nick Leeson: Financial hanky-panky!

Bill Bonner - Wed 27 Sep, 2006

...Bernie Ebbers, Brian Hunter and Nick Leeson...What went wrong? Hedge funds are supposed to be good at numbers, after all...

 
 
Poor Bernie Ebbers. His number's up. The man drove up to the Oakdale Correctional Complex in Louisiana in the US yesterday. He got out of his Mercedes and joined the former governor of the state, Edwin Edwards, in the federal pen. Hizonner faces 10 years in the hoosegow for extorting money out of riverboat casinos. Ebbers got 25 for his role in a telecom scandal. Accountants working under his direction took some whole numbers out of the operational columns, they say, and slipped them into the capital budget.

Both men did naughty things, we don't deny it. But putting poor Bernie behind bars for a quarter of a century for some financial hanky-panky seems excessive. When it comes to numbers, after all, anyone can make a mistake. The things are downright slippery.

Just look at poor Brian Hunter. He would tell you. The man was making $75 to $100 million per year, as an ace energy trader. He was so good that even the savviest players in the industry wanted in on his game. Both Morgan Stanley and Goldman Sachs had invested money with Hunter's employer, Amaranth Advisors, the $9 billion hedge fund that blew up last week.

What went wrong? Hedge funds are supposed to be good at numbers, after all. They hire people with advanced degrees in mathematics simply to make sure they've calculated the odds correctly and offset their risks with their expectations in a logical manner.

"Somebody was not monitoring this correctly," said one pro, referring to the extraordinary bet that Hunter placed on gas prices, a bet so large that at one time, he held about 10% of the global market in natural gas futures.

As far as we can tell, these are the numbers in a nutshell: Hunter was long. And investors were short as much as $6 billion.

"It appears we have had a major malfunction," might have been another way to put it. But that famous under-statement has already been taken. That was on January 28, 1986 with 50 million TV viewers watching. It was the day the spacecraft Challenger exploded into smithereens.
Nobel prize-winning physicist Richard Feynman described the NASA catastrophe as an institutional failure. The scientists and engineers at NASA, he charged, has been upstaged by bureaucrats who had been allowed to 'pervert standards.'

But in the financial world, standards are perverted so easily they must have a twisted gene to start with. [See the letter from a dear reader, below, about slipping standards during the Roman era credit collapse. "Rigor at the outset," says Tacitus, speaking broadly about financial affairs, "becoming negligence at the end."]

That's why we can't help but feel sorry for Brian Hunter. Like Ebbers, he came from nothing to make a fortune. He went to college in Alberta, where he was a star at mathematics, of course, specializing in financial models. But the poor 32-year-old had barely gotten used to being extraordinarily rich and extraordinarily talented, when a very ordinary little slip-up with numbers derailed his extraordinary career.

We are reminded of the now legendary Nick Leeson whose rags-to-riches rise also came apart over some mundane, barely noticed figures; figures of eight, in his case.
Leeson, the working class son of a plasterer, who failed his final maths exam, made such an impression at Britain's prestigious Barings Bank that he was quickly promoted to the trading floor and then given a new operation in futures markets on the Singapore Monetary Exchange (SIMEX) where he began pulling in millions for Barings by gambling on the movement of the Japanese stock market (Nikkei Index). The whiz-kid seemed to have it altogether. By the end of 1993, he had made more than £10m for Barings - nearly 10 per cent of its total profit that year.

What Barings didn't know was that Leeson, by now both Chief Trader and also in charge of settling accounts in the office (jobs that were usually done by different people), was hiding his mistakes in an account, numbered 88888, for which the company was liable. By December 1994, the numbers in 88888 had piled up...to over half a billion. A desperate Leeson then placed his most desperate bet - that the Nikkei would not fall below 19,000 points. It would have been a reasonable assumption under ordinary circumstances. But then came one of those fat tail events that give bell curves their shape - on January 17, 1995, a 7.2 earthquake hit Kobe in Japan and the Nikkei crashed by 7% in a week.
Leeson's gambling spiralled out of control as he piled on more and more debt hoping to push the index back the other way. Most of the $1.3 billion he eventually lost for Barings came from trying to cover up what had happened.

On the verge of turning 28, the whiz kid could take it no more. Leaving a scribbled apology, he fled with his wife to Borneo and then to Frankfurt, where he was caught.

The numbers then looked pretty bad: The futures market was in shock, a 233 year old bank to the Queen was bust; more than a thousand bank employees were out of jobs; and investors were wiped out.

And all for a string of single digits. Ordinary insignificant set of numerals – 88888.


Regards,

Bill Bonner
The Daily Reckoning