Book Review: Something absurd in the City

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The Independent Culture
Thanks to the collapse of Barings Bank, just about everybody has heard of "derivatives", the often exotically named financial instruments that get their name from the fact that they are "derived" from underlying assets, such as shares, bonds, commodities and currencies.

Share options are probably their most basic form, but they also include "Inverse floaters", "zero cost dollars" and other innovations conjured up by bankers for special circumstances.

As these strange names suggest, this is a strange world, made worse by the fact that the stakes are so high. As Richard Thomson, former deputy City editor of The Independent on Sunday, points out in his just-published book, Apocalypse Roulette (Macmillan), since it usually takes only a small down-payment (the margin or premium) to purchase the obligation to buy or sell an asset at an agreed price and time, "any movement in the value of the underlying asset above or below the agreed price can produce immense profits or losses relative to the original down payment".

Accordingly, Barings, brought down by the Singapore dealings of the so- called rogue trader Nick Leeson, is anything but the only big name to come a cropper through dabbling in this area of activity. Daiwa, Sumitomo, NatWest Bank, Union Bank of Switzerland, the food and drinks company formerly known as Allied Lyons and local authorities as far apart as London's Hammersmith and Fulham Council and California's Orange County have all found themselves on the losing end in a game that Thomson claims has grown from just about nothing in the early 1970s to one worth $64 trillion by 1996.

Indeed, the real value of this easily-read volume is as a primer to an area of activity that perhaps more than anything else has been responsible for the triumph of the bright young trader over the traditional well-connected City gent. Instead of lurid details about rogue traders and numbered offshore accounts, the reader is told of how the various scandals fit into context and help to form a pattern of a once-obscure technique getting out of control.

While share options have attracted their own high degree of interest because of their role in enhancing executive pay, they are not the centre of the action as far as derivatives as a whole are concerned. Not surprisingly, it tends to be at the more exotic end that all the trouble occurs. For the simple reason that not enough people understand them.

The result has been a host of codes, guidelines and revised accounting rules as industrialised countries have sought to control the worst excesses of the early years of this decade. But Thomson's highly entertaining gallop around the field will only confirm cynics in the belief that the financial markets are - whatever may be said about the efficiencies of capitalism - full of absurdities.

"However efficient the checks and balances become, the financial system is inherently more fragile than it used to be," he writes. "Derivatives, the freedom of the markets and tyranny of the traders make it easier than ever before for excessive concentrations of risk to build up into pressure points which may prove more than the system can bear."

Having pointed out that the pressure on often young and highly ambitious dealers to produce ever bigger profits has caused bigger dealing disasters in the past few years than ever existed in the supposedly money-obsessed 1980s, Thomson concludes: "The unavoidable fact about derivatives is that while helping to limit risk, they have also encouraged unprecedented speculation."