Bright Air - Barry Maitland [87]
That was the theory, but of course policies and strategies, no matter how rational, depend upon inadequate human beings like ourselves to carry them out. We have our weaknesses. We have an undue respect for people with grand reputations, especially if they appoint us to much-sought-after positions; we develop an attachment, then a dependence, on the absurdly generous rewards they offer us; and we feel proud loyalties which cloud our view of those outside our circle, who increasingly appear stupid and obtuse.
We didn’t gamble recklessly on the Nikkei like Leeson at Barings, nor drown in commodity options like Hamanaka at Sumitomo. Our failure was more innocent, I liked to think, like sewing machine legs, or tidal waves, just one of those things that happen. Imagine a chemical engineering company in the north of England—let’s call it Sunderland Petchem—with a track record of supplying equipment to the North Sea oil fields. They have done business with BBK Bank before, and are regarded as a soundly managed small company. But now contracts in the North Sea are on the decline, and they have been forced to look further afield, to the booming oil business in Venezuela. There they have possibly secured a major contract, subject to final details. This project is much larger than any they have previously undertaken, and would require a major injection of capital for expansion. BBK’s loans staff are highly enthusiastic, having reached agreement on lending rates which would be extremely rewarding for the bank, not to mention the bonuses of the negotiating staff. However, the RMU is worried; Sunderland is inexperienced in this part of the world, and with this size of project our analysis rates the risks as rather high. Our boss, Lionel Stamp, calls a team meeting to discuss what we should do.
Lionel was an impressive fellow. In his mid-thirties, energetic, imaginative, with a startling memory, his reputation was outstanding. When I first met him I was most struck by his floppy hair and languid English accent, which I thought rather ludicrous, but I soon got over that when I realised how sharp he was. Now he hadn’t got to lead the central RMU of an organisation like BBK by being negative and obstructive. On the contrary, his mentor, Sir George Henderson, had picked him because he could not only sniff out possible problems, but also provide ingenious remedies. In the case of Sunderland, the problem basically was to reduce the levels of risk to BBK if something went wrong with the Venezuela contract. The straightforward way to do this would be to sell on part of our Sunderland loan to other lenders in the secondary loan market, or to investors in the asset-backed securities market. Either way, BBK would reduce its exposure on the deal to a more acceptable level. The trouble with this approach was that we would be legally obliged to tell Sunderland what we were doing, and obtain their agreement. In effect we would be telling them that we didn’t have complete confidence in them, upsetting not only our client, but also perhaps the whole Venezuela deal if word got out.
The answer was synthetic CDOs. Through the use of credit derivatives, these could imitate the operations of conventional collateralised debt obligations without requiring us to make public what we were doing. Synthetic CDOs were a favourite weapon in Lionel’s armoury, and he had refined them to an exquisite degree. He became quite evangelical as we discussed the intimate details of how it should be done, the array of subordinated and senior mezzanine tranches, the choice of first-loss investor, the ramp-ups and replenishments in the collateral pool. All very exciting, the more so for being clandestine and potentially dangerous.
There was a snag. It was referred to as a moral hazard problem, a term we liked, I think, because it made us sound like philosophers or priests, rather than loan sharks. The moral hazard problem