‘Oh, Anna …’ I put my arm around her shoulder and pulled her close.
A blast of cold wet air, more vicious than the rest, slapped us so hard it sucked our breath away. ‘Oh!’ Anna gasped, gripping me tight. ‘This is terrible.’
‘Yeah, marginally worse than working at the Walter Murchison Memorial Nursing Home, I should imagine.’
She dug me in the ribs with her free hand, then said, ‘So, go on then, tell me about your bank.’
‘It’s very boring. You wouldn’t be interested.’
‘Try me. I think we’ve got all day.’
So I began to tell her about credit derivatives and risk management. It seemed quite surreal in such a setting, and as I spoke I found it hard to believe that I had once found that stuff incredibly interesting. It was all so remote now, so utterly devoid of real meaning. Yet in the city, where the real world rarely set foot any more, it had seemed close to the vital essence, the purpose of life. It was sexy. I was doing what every young man wants, to be involved in something clever and important that hardly anyone knows about.
It became sexy, as I said before, after the Barings Bank and other disasters.
In the post-Barings wisdom, the essential principles of risk management require a separation of powers within an organisation between the front-of-house traders and dealers,
who are greedy for contracts and commissions, and senior management, with its more sober perspective on risk. Between these two groups should sit the RMU, the Risk Management Unit, assessing the dangers of promised deals and ensuring that the policies of the board are implemented on the shop floor. No longer would it be possible for a rogue trader to approve his own deals, as Nick Leeson had at Barings, getting deeper and deeper into trouble without senior management having a clue what was going on.
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 lay in the fact that, since our dealings were not public and transparent, the CDO investors onto whom we were passing some of the Sunderland loans would only know as much about the risk involved as we were prepared to tell them. The riskier they thought the loan, the more they would charge us for it and the more our profit on the whole deal would be eroded, so there was a temptation for us to massage the information a little. Of course, if things went wrong and our secondary lenders suspected us of hiding the true risk, then BBK’s name would stink. To Lionel, this, like all moral problems, was just another risk management issue. It was clearly important that the board of BBK in general, and Sir George Henderson—the director charged with oversight of the RMU—in particular, be shielded from some of the trickier details so that, if worst came to worst, they could honestly deny all knowledge of any moral hedging. This, of course, is a risk management technique perfected by our political leaders in recent years.
For a while things went very well in Venezuela, so much so that BBK offered Sunderland further and larger loans,
quietly offsetting them with more synthetic CDOs. Then one spring day, four years after I had answered that fateful email from Gary McCall urging me to come to London, things went abruptly wrong in Venezuela. It was a political rather than an engineering problem, but its financial consequences were just as devastating. Sunderland Petchem, massively overstretched, collapsed, and BBK was faced with huge unpaid debts, which it promptly passed on to a cascading series of CDO investors. As the Sunderland story became public, its history painstakingly revealed by investigative reporters, the investors became more and more belligerent and the BBK Board increasingly defensive. There were whispers of legal action, fraud and criminal charges.
Once again, Lionel recognised this as a risk management problem, the logic of which he explained to Gary and myself over a rather tense lunch at an excellent little restaurant overlooking the river. The bank was wounded, Lionel explained, and surgery would have to be performed before gangrene set in. There were really only two options. Option one entailed the removal of the whole RMU, including its board supervisor. Criminal charges would be brought against Lionel, Gary and myself, and very possibly Sir George. There would be a nasty public trial in which, to demonstrate the bank’s innocence and resolve, our names would be dragged through the mud before we were given exemplary prison terms. Option two was the discreet route. It would be quietly explained to the secondary lenders that the bank would cover their losses after the discovery that two of its staff (reckless antipodean colonials, naturally) had bypassed internal controls and procedures.
The board was in a bloodthirsty mood, Lionel explained, and currently favoured option one. But he had carried out a very detailed worst-case scenario analysis calculating all the
possible eventualities of both courses of action, and he was confident that cooler heads could persuade board members to go for option two. That, of course, would depend on Gary and myself making a full confession of sole responsibility for the debacle, making token reparations to the bank (basically everything we owned), signing a binding confidentiality agreement, and returning to the far side of the world, never to be seen again.
But what would happen to you, Lionel, we asked, and Sir George? Solemnly, and without a hint of shame, he explained the irresistible logic by which it would be necessary for the bank to demonstrate the limited nature of the breach by rewarding those who had isolated it.
We really had no choice. Within a couple of weeks Gary and I were boarding a plane at Heathrow, all risks neatly managed, moral hazards expunged.
‘So you didn’t even make any money out of it?’ Anna said.
‘That’s right. Then on the plane, just before we reached Bangkok, Gary mentioned that Lionel had been screwing my girlfriend all along. He thought I must have known.’
Anna said nothing for a while, then murmured, ‘Yes, I don’t really think you were cut out for risk management.’
In the fading light I watched small gulls hurled backwards through the air in front of us by the force of the wind.
About the only thing that could be said for our ledge was that it was free of centipedes, probably because it was too inhospitable even for them. Soaked through and frozen, I passed the night in a semi-comatose state in which hellish winds swept in and out of nightmares steeped in guilt.
Just before dawn I jerked awake with the certain knowledge that Anna had died during the night. I felt for her hand and it was stone cold. I thought, oh, so this is the end. I didn’t want to try to go on without her, and I was filled with the same sense of calm I’d experienced when I realised I was going to fall on Frenchmans Cap and nothing could be done. I didn’t feel afraid. I reached for the clip attaching our rope to the anchors. My fingers were clumsy with cold as I worked to release it so we would plunge down into the ocean, as Luce had surely done.
Then the corpse stirred and mumbled something about scrambled eggs. I had actually just managed to unfasten the clip, and any movement would have sent us slithering over the edge. I refastened it quickly, and we clung together as the first glimmer of light grew in the sky.
With dawn we untangled ourselves and speculated about raiding seabird nests, but the thought of a raw gull’s egg was only marginally more appealing than that of a raw gull. While I was groping around in my pack to see if there was one last cracker hiding in the lining, I came upon Luce’s chalk bag.
I had a look inside, but all I found was the remains of a large black insect curled in the chalk dust. It didn’t look edible.
The important thing, Anna said, was to get back down to the southern tip of the Pyramid, where we might hope to attract the attention of a passing boat. And surely, we agreed, they would have to send out boats today. We said this forcibly, to cover up the fact that there was no reason why anyone should think to look for us out here. So when the rain died away we unhooked ourselves and stretched our aching limbs, and started abseiling and traversing down the cliffs in short, cautious stages.
In the late morning, as we reached Winklestein’s Steeple, the weather closed in again and we were forced to take shelter in the centipede cave. This time we weren’t in a mood for compromise, and swept and beat the little bastards back to the deepest recess. The weather was so foul and the visibility so limited that we could see no signs of a rescue boat out on the stormy water. Later, when the rain eased a little, we continued further down the ridge until we found a sheltered ledge free of wildlife. Then the rain began to pour down again and we tied ourselves in for our third night on the Pyramid.
The following morning dawned with a brilliant calm, the first rays of the sun sparkling on clear water, white birds swooping across the swell, as if the storm and our struggle down the rain-lashed mountain had been no more than a bad dream. We continued on down, step by step, pitch by pitch, until we stood on the rock platform at the southern tip on which we had first landed. And there, as if according to some prearranged schedule, we heard the purr of an engine, and Bob’s boat circled into view, just fifty metres offshore. We waved and shouted, and the boat came to a stop. It stayed out
there, bobbing in the swell, and we made out the figure in the wheelhouse, looking at us through binoculars.
There was something rather eerie about the way he just waited out there, and finally I said to Anna that I would swim over. I was worried about the weight and drag of the rope across that distance, but unless he came closer there wasn’t much I could do. At least the sea was relatively calm, and if the worst happened I’d just have to untie the rope and let it go. So I stripped off and dived in. As I thrashed through the water I became aware of the engine noise increasing, and saw that he was heading towards me. Then he was alongside and hauling me aboard.
I lay in the bottom, spluttering, while he freed the rope from my waist and waved to Anna, who had tied our bags to her end of the rope, and now jumped in. I pulled myself up onto the seat and watched, shivering, as Bob hauled her across. And as I watched him, strong and capable, a nasty thought came into my mind. He had rescued us, yes, but what now? Whatever had happened to Luce on Balls Pyramid, he’d been a part of it, and it seemed to me entirely possible that he might prefer that we, too, should disappear into the ocean. I looked around, wondering if there was anything that I might use as a weapon, but I could see nothing apart from some fishing rods, an esky, a bucket and some lengths of rope. As a fisherman I assumed he would be carrying a knife. I tried desperately to think.