Allfirst fiasco retraces steps of trader who sank Barings

February 10, 2002|By Jay Hancock

ALLFIRST'S John Rusnak isn't the first trader to get scorched by Japan. And he isn't the first to react to the damage, allegedly, with unauthorized and phony deals that rocked his bank to the roots.

Nick Leeson of the British investment bank Barings was sure Japanese stocks would rise in 1995, and he made huge bets that would profit the company and himself -- through bonuses -- when it happened.

It didn't. The Nikkei stock average opened 1995 at 19,700. Then it started to sink.

Having lost money on his original hunch, Leeson made even bigger wagers to get back to par. He doubled down, as they say in Vegas, and broke every risk-management rule his bosses had thought of along with a lot they should have thought of.

By the time the Nikkei touched 16,700 at the end of February, Leeson had lost a stunning $1.4 billion, and an insolvent Barings was ready for the auction block.

It is too early to know all the details of what happened at Baltimore's Allfirst Financial to cause the loss of $750 million, disclosed last week. But there is strong evidence that Rusnak's alleged fraud played out in a manner very similar to those of Leeson and recent history's other rogue traders.

Like all financial black holes, it began with a bet on the future. Like too many financial black holes, it involved Japan -- exasperating, alarming, poor Japan, which basically has been in recession since the Reagan administration and now seems to be poised for total collapse.

There have been a dozen false Japanese dawns in the past decade, but the one that mattered to Rusnak and Allfirst looked especially promising.

In April, Japan installed a new prime minister, Junichiro Koizumi, who seemed to break with his drab predecessors by speaking plainly and promising market-driven reform that would purge bad debts and attract foreign investment.

It made sense to buy yen, the Japanese currency, which was selling then for about 0.8 U.S. cents and had traded as high as 1.2 cents in the mid-1990s. That's what Rusnak did, his Allfirst bosses say.

For the first few months after Koizumi took power, owning yen paid off. The Japanese currency rose to 0.86 cents by September -- a 7.5 percent increase from early April.

That 7.5 percent could have been multiplied into much bigger gains through the magic of financial leverage, in which small amounts of cash control larger investment positions in somewhat the same way that a 5 percent down payment buys a house.

But leverage works both ways, and when prices head south the losses also are magnified. That's apparently what happened to Rusnak, because in late September the yen took a hard right toward Antarctica and hasn't stopped.

Since last fall Japanese politics and bureaucracy have smothered Koizumi's reforms, and now there is speculation that his administration is near its end. Late last month the yen hit 0.74 cents, and the Nikkei is almost half the level it was when Leeson was being led in cuffs to a Singapore lockup.

At some point, perhaps after his losses began ballooning, Rusnak started hiding them by putting fake transactions on the books, Allfirst alleges.

In concept this would have been easy. Financial traders routinely straddle both sides of a trade, making a primary bet in one direction but simultaneously hedging it with an opposite move of lesser magnitude. Rusnak could have faked tickets for selling the yen even as he was buying it, making the bank look less exposed than it was.

In reality, it's hard to understand how Allfirst, one of the country's top 50 banks, allowed this to go on until $750 million had evaporated. True, the bank's expertise is retail deposits and routine business and consumer loans, not global finance. But it had a foreign exchange desk, and it should have heeded the Leeson lesson.

There is no evidence so far that Rusnak kept or spent Allfirst's missing money. Rather, it seems likely that he pulled a Leeson, making a bad bet and then trying to trade his way out of trouble with bigger and bigger positions as the Japanese market, dammit, kept falling and falling.

If nowhere else, the funny business at Allfirst should have been uncovered sooner in the bank's trade-clearing operation. In the real world, currency contracts require two parties -- the bank and someone else -- and the transfer of cash at settlement.

A rogue trader can cover his tracks for a time with fake options contracts that seem to negate big losses or by rolling over expiring positions into new deals, thus postponing settlement. Allfirst officials said Rusnak may have had help, which could have prolonged deception.

But the cash will tell the truth, if you bother to listen. Allfirst did, but not until much damage was done. It was Rusnak's growing demand for money from internal accounts that set off "alarm bells" late last year, said Michael Buckley, chief executive of Allfirst parent Allied Irish Banks PLC.

Buckley said he was "hugely disappointed that our Allfirst control procedures failed to uncover this situation at an earlier stage," which doesn't bode well for Allfirst management, although the bank's solvency is not in question.

But nobody seemed more outraged last week at the Allfirst blowup than a 35-year-old, Jaguar-driving Englishman named Nick Leeson.

"I am shocked that nothing has been learned from my case," Leeson, who served four years of a six-year sentence and now travels the speaking circuit, wrote in the London tabloid Daily Mirror. "It is staggering that financial security at these huge firms is so lax. Where are the checks and regulatory audits?"

A bit cheeky, coming from old Nick. But good question.

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