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He didn't pay all his bills. Last week the Financial Times obtained internal documents pointing to error account No. 88888, a piece of evidence overlooked by Barings auditors. It showed Leeson had already built up a $80 million deficit at the end of 1994, the year in which he supposedly earned huge profits for Barings and had become known unofficially as the Nikkei king on the SIMEX floor. His reputation was based on his ability to spot tiny differences in the value of Nikkei futures on the exchanges of Singapore and Osaka, Japan, and make millions by exploiting the spread, buying where the price was low and immediately selling where it was high. But those 1994 profits now seem almost paltry. In 1995 the losses would increase more than tenfold.
EARLY IN 1994 A NEW YORK CITY-BASED Barings banker introduced Leeson to a client whose identity remains a closely held secret at Barings. The client reportedly told his Barings contact in New York, "I hope you're getting some credit for this because your company is getting a lot of business from me in Singapore." It is still not clear where the mystery client's investing stopped and where Leeson's own-hidden in error account No. 88888-began. But right to the end, Leeson claimed that his huge, inexplicable investments were on someone else's behalf. "He always told us it was for this special customer," says one of his regional supervisors. "When we go back and listen to tapes of those conversations, it's unbelievable. He was so calm. It was a farce."
Leeson started buying and selling the simplest kind of derivatives, futures pegged to the Nikkei 225, an index of the value of 225 Japanese stocks that is Japan's equivalent of the Dow Jones Industrial Average. It was a straightforward process: in effect, Leeson placed open-ended bets on what would happen to billions of dollars worth of Japanese stocks and bonds. His wager was similar to what gamblers in Las Vegas betting on a football game call the over and under-meaning a bet on whether the final score of a football game will be above or below a certain number of points. Leeson was betting the over on the Nikkei 225. If he had been betting the Super Bowl and he went the wrong way on the over-under, he would have lost the amount of his original wager and no more. In the futures market traders only have to put a small percentage on the table--in Singapore, until last week, it was 6%--so losses can exceed the ante by many times.
Barings believed it was not exposed to any risk because Leeson said he was executing the huge purchase orders at a client's behest-and presumably with the client's funds. Furthermore, to Barings' delight, Leeson was also making a tidy profit by making those trades in conjunction with the bank's separate and official holdings of Nikkei 225s in Osaka and SIMEX."I won't tell you how good," says a Barings employee, "but it was a good business." Little did Barings know that it was responsible for error account No. 88888, which was unhedged and would turn out to be fatal to the company.