Unlike most people, I am de lighted by the collapse of barrings, the investment bank that counts the Queen of England among its clients. Many are dismayed at seeing a venerable 200-year old institution biting the dust. But neither size nor age guarantee competence, and often hide incompetence or crooked-ness ( Barings stupidly allowed its star dealer in Singapore, Nick Leeson, to bet billions that the Tokyo stock market would rise, doubling his bet every te lost).
In the imperfect markets of old, only small companies went under if they were foolish, while giant companies manipulated the levers of power to escape the consequences of their not infrequent folly. An efficient market is one where even the biggest, oldest institution can go bust as easily as new pygmies. Two decades ago, when the old school tie matt than competence, Barings would have survived such a fiasco. This time it has gone under, and that needs to be celebrated as progress.
Many are giving lectures about the evils of casino capitalism. I I cannot understand the fuss. Bar ings lost $ one billion, but other traders gained as much, and it is senseless to add up only the losses and call it a tragedy. If rich megalomaniacs gamble for high stakes and the incompetent ones lose to the less incompetent, why should the public worry?
A public issue arises only if many innocent bystanders get hurt. It is too early to say whether this will happen in the Barings fiasco. But an efficient market is one where fools go bust without hurting innocents. Barings is not a commercial bank taking deposits like BCCI, so no depositors face a loss of their deposits. It is an investment bank, meaning it performs financial services like Arranging mergers and new issues, •trading and managing assets on behalf of clients, and so on.
When buying on financial markets, every trader has to make a safety deposit (called a margin) with the stock exchange to cover the risk that he may not be able to fulfil his contracts. Fluctuations in share prices on any one day rarely exceed 5 per cent, so a margin of 5 per cent may suffice provided it is adjusted daily in the light of changing prices. If a trader keeps doubling his bets (as Barings did), he has to keep depositing more and more margin money. The day he goes bust, the stock exchange should take over his trading positions, and use the margin money to settle his outstanding contracts with other traders.
But even if this happens in Singapore, what will happen to those having outstanding contracts with the bankrupt company in other stock markets like Hong Kong or New York? There too, the exchanges should take over Barings’ outstandings and settle them using the margin money. That way no innocents are hurt.
In some sorts of trading, the regulators have not imposed margins large enough to cover potential losses (this may be the case in Singapore). I can only say that people who knowingly enter risky markets with insufficient margins do not deserve protection from the consequences of their risky behaviour. Hopefully, the fiasco will now oblige all exchanges to impose realistic margins, dampening speculative activity but improving safety.
What about clients (like the Queen) who have asked Barings to manage their portfolio of shares and other assets? The assets in such cases belong not to Barings but to and will be handed back to them. What remains will be the assets of Barings itself, which are insufficient to cover its liabilities to creditors, who will queue up to recover what they can from the official liquidator. Barings has assets of around $ 500 and liabilities of $ 1000 billion, so unsecured creditors may recover 50 cents for each dollar of outstanding debt. They are not innocent bystanders-they should suffer for lending so much money to Barings without sufficient collateral.
Some people fear the great Barings name will now disappear. In fact the name has considerable brand value and can be sold tin-deed, the company may be taken over, debts and all, by another bank which prizes the name highly). If liquidated, the company’s reputed employees will be rehired by other companies (the tainted or surplus ones will not); and the assets of Barings will, after being auctioned by the liquidator, Reappear in the market under new owners. The beauty of an efficient market is that no worthwhile assets ever dies-employees, assets and brand name are simply’, re-distributed to new entities and deployed again. The only losers are the shareholders and creditors of the company that behaved stupidly.
Ah say some, but maybe “the company was cheated by charismatic employees like Leeson (though this is not certain yet). Well, all companies can insure themselves against fraud-to innocent ones can recover their losses from insurers. But where managements collude with wild-eyed dealers, or fail to create managerial checks and balances against risky trading, they deserve to suffer. The Barings fiasco carries the lesson (which needs constant repetition) that neither size. age nor charisma are substitutes for common sense in the marketplace, that great leveller.