Rogue accidents, and banging more shins

17th September, 2011

Another rogue trader?

Apparently so. The Swiss bank UBS says it has lost $2bn down the back of a sofa somewhere – or more specifically, that it suspects one of its traders did so in unauthorised trading.

An unauthorised loss of $2bn. Are there any authorised losses of $2bn?

Where have you been for the last four years? UBS “authorised” losses of €50bn during the subprime crisis.

In that case, what’s $2bn between friends?

It’s all about banging shins.

Banging shins?

Bear with me. A while ago I interviewed the psychologist James Reason, who specialises in human error and how human error contributes to accidents – oil rigs that explode, trains that crash, ferries that capsize, that sort of thing.

He used to give talks to banks about preventing accidents but, he told me, “they thought it was all about banging shins”. Then, he said, they realised what a risk really was when Nick Leeson came along.

The original rogue trader?

If you like. Mr Leeson wasn’t the first rogue trader – that was arguably William Pullinger, who in the late 1850s pilfered £263,000 in his role as chief cashier of Union Bank and played with the money on the London Stock Exchange. He wasn’t even the one who lost the most money. What sticks in the mind is that Mr Leeson managed to destroy, single-handedly, a 233-year-old bank. Admittedly, in the light of the past few years that no longer seems quite such an achievement, but it probably took some doing.

But Nick Leeson didn’t lose money “by accident”.

That depends on what you mean by an accident. Prof Reason has been using Mr Leeson as a case study in preventing “organisational accidents”. Once you start looking at these issues from an industrial safety perspective, you realise that whether a particular disaster was caused by honest error or deliberate malfeasance is not necessarily the most interesting question.

It’s the question that determines whether someone goes to prison.

Well, yes it is. Mr Leeson was sentenced to more than six years. But some illegal acts have minor consequences and some legal acts have tragic results. Some “accidents” involve serious wrongdoing – carelessness, sloppiness, poor procedures – but that does not make them less of an accident.

This sounds like tortured logic to me.

It shouldn’t. The point is that a system with a poor safety culture, slapdash attitude to checks and balances, and pressure to get results quickly will be vulnerable to things going wrong. The eventual trigger may be fraudulent or innocent, but preventing disaster means changing the system. Consider the sinking of the Herald of Free Enterprise, a catastrophe that killed almost 200 people. The ferry’s owners had already lost a ferry in a collision five years earlier; the ferry lacked indicator lights to tell the captain that the bow doors were closed; the ferry was overloaded and its bow was pointing downwards; the man in charge of closing the doors was asleep; crew were under pressure to depart in a hurry. It’s facile to blame the tragedy on any single action. The system itself was unsafe.

So this is why it matters if a UBS trader lost $2bn?

Yes – it suggests an accident-prone system. Now, perhaps UBS has superb risk controls and through great ill-fortune fell victim to a terribly determined and sophisticated fraudster. But you could forgive investors if they ask questions.

Still, a $2bn loss for UBS is a $2bn gain for somebody else. It’s a zero-sum game. Who cares?

By that reasoning, if I steal your car, who cares? You lose a car, I gain a car. But most of us would not wish to live in a world which was indifferent to such events. It’s not just the morality of the thing, but also the prospect of such activities forces you to take costly actions – buying a car alarm, investing in off-street parking – and makes you anxious. Similarly, there are costs in a world where banks cannot keep a leash on their traders. In the financial system, even apparently zero-sum bets can have severe negative consequences if they drag a bank into or close to bankruptcy: when Lehman Brothers collapsed, it wasn’t just a problem for its investors.

Is UBS going to collapse?

Certainly not because of a single $2bn loss. The bank has a capital cushion of about $50bn; investors have therefore lost about 4 per cent of their stake as a result of the trades – that’s a bad day, but most bank shareholders have had worse.

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