Infectious Greed (5 page)

Nevertheless, Krieger's strategies obviously wouldn't have been appropriate for many investors. The strategies resembled an average investor putting her savings into stock options, or a tourist putting his travel budget into currency options. These strategies worked for Krieger for two reasons: first, he used his superior knowledge of pricing models to buy cheap options during periods of market inefficiency; second, he used his misdirection play to take positions he believed were good bets. A little luck wouldn't hurt his strategies, either.

Krieger was clever, but not
that
clever, and soon other traders would grasp what he was doing. When they did, Krieger would shift to a more dependable, lower-volatility trading strategy, which would prove to be more appropriate for individual investors. But until then, Krieger's misdirection strategy was the $20 bill on the ground. It wouldn't be there for long.

 

 

D
uring 1987, Bankers Trust's newly appointed chairman and CEO, Charles S. Sanford Jr., was encouraging his traders to speculate with the bank's capital, and he seemed to believe Krieger had a winning strategy. Sanford reportedly gave Krieger a whopping $700 million of capital to use as a base, much more than he gave other traders.
³¹
With that much capital, Krieger easily could control billions of dollars of currency positions. Suddenly, the 29-year-old trader had access to more capital than virtually any other trader. He could place bets that rivaled those of many central banks.

Although Krieger's bets during 1987 were quite complex, his strategy essentially was to bet that the dollar would fall. As Krieger settled in at Bankers Trust, his bets got bigger and bigger, and as he made money he “played with his gains,” increasing the size of his trades. In June 1987, Krieger sold $1 billion of German marks and mark options, betting that the U.S. dollar would appreciate relative to the mark; he made more than $70 million on that trade. Later, Krieger referred to the risk associated with a $3 billion position in German marks.
³²
He also told
Institutional Investor
magazine, “As a straight open-spot position, I wasn't happy going
any more than $700 million—so I was comfortable with, say, a 2 percent loss of $10 million to $15 million. But if I wanted to take a really serious view, I would take an option position, which might start as an investment of, say, $4 million or $5 million. The position might end up controlling $1 billion or $2 billion of currency.”
³³
A billion here and a billion there—and pretty soon Bankers Trust was betting some serious money.

During 1987, Krieger made such huge bets against the New Zealand kiwi that his trading caused a ruckus in Wellington, where—as one trader recalled—the kiwi fell “like a wounded pigeon.”
³⁴
As the currency plunged, some of New Zealand's banks lost huge sums, because their assets were denominated in kiwi. At first, banks couldn't identify the source of the downward pressure on their currency. But, eventually, they found their man, through private investigation of the unregulated and anonymous over-the-counter markets. According to public reports, when government officials eventually traced the trading to Bankers Trust, New Zealand's chancellor of the exchequer telephoned Chairman Sanford to complain.
³⁵
But New Zealand officials privately told Bankers Trust they had known about Krieger's bets against their currency and were happy about the decline, which would make exports cheaper and help spur economic growth. In any event, Sanford paid no heed; Krieger had made too much money for Sanford to worry about a miffed central banker.

After the U.S. stock market crashed on October 27, 1987, the dollar briefly increased in value, as foreign investors rushed to put their money into U.S. Treasury bonds, which were regarded as the ultimate safe investment. Oddly, the higher price of the dollar began creating
higher
demand, the opposite of what basic economics suggested (economists generally believed that higher prices led to lower demand). At this point, Krieger thought it was so obvious that the dollar would crash that “it was just a gift—it was almost disgraceful to make money on this trade. It was one of the easiest trades I've ever seen, a special opportunity.”

Again, Krieger bet against the dollar; again, the bet paid off. He also made money trading other currencies, including British pounds and German marks, in various complex strategies. Krieger described his sense of the market during this time as “preternatural.” He was extremely confident he could make money trading in the panic of the post-crash markets. All totaled, his options trades represented roughly $40 billion of underlying currency positions; these trades were fluctuating in value by as much as $20 million a day. Krieger referred to such changes as “just
noise.” He felt $50 million was an amount he “easily could make up in trading.” In December 1987, Krieger finally stopped trading for the year, and left for the British Virgin Islands. At the time, his positions were so large that he wasn't sure exactly what his profits for the year had been, but he believed he had made perhaps as much as $250 million. By any measure, it had been an incredible year.

By late 1987, Bankers Trust had become a one-man show, and Krieger's profits were carrying thousands of other employees. Without Andy Krieger, the bank was having a terrible year. Many of Bankers Trust's businesses were losing money, and the bank had huge losses on loans to the Third World. The stock-market crash had hurt other parts of Bankers Trust's business, and from the outside it looked as if Bankers Trust might have its first losing year in the bank's fifty-year history. As the year closed, shareholders of Bankers Trust nervously awaited news of the bank's earnings.

On the morning of January 20, 1988, Bankers Trust sent out a press release reporting its preliminary, unaudited earnings for the prior year. Thanks to Andy Krieger, the bank had squeaked out a tiny $1.2 million profit. Shareholders cheered. Miraculously, the bank's losses in several areas were offset by $593 million of income from currency trading, including $338 million during the fourth quarter of 1987.
³⁶
According to Bankers Trust, more than half of the total profits—about $300 million—was from one person: Krieger. In all, Bankers Trust reported more income from currency trading that year than any other bank in the world. It was a remarkable feat, and to many employees Krieger was a hero. Before he had arrived at Bankers Trust, the most any currency trader had made for the bank was $18 million.

Shareholders were relieved, but some employees questioned how a 30-year-old trader could have made so much money in such competitive markets. They wondered how much risk he was taking. Stock analysts were skeptical, too. Was it really possible for one person to make $300 million in markets that most economists argued were efficient? Rumors were swirling that Krieger hadn't really made so much money, and that someone at Bankers Trust had misvalued Krieger's options.
³⁷

But Bankers Trust's management dismissed the rumors and began working on the most important task of the year: awarding bonuses. In January 1988, the prevailing worry among managers at Bankers Trust was not the riskiness or legitimacy of Krieger's trading; instead, it was
how much he should receive as a year-end bonus. Bankers typically spend much of January debating bonus-related issues, and it was difficult to do business with—or even speak to—a trader during this time. The only topic most traders will discuss in January is their “number.”

A common trading commission at the time was in the range of five percent, so that a trader who generated $10 million in profits might receive a $500,000 bonus. In fact, five percent was precisely the promise Bankers Trust had made, according to Krieger. But five percent of Krieger's profits would have been $15 million, and no Bankers Trust employee had ever received anything approaching such a huge bonus. Charlie Sanford wanted to reward risk-taking, but not excessive risk-taking. Paying Krieger $15 million might set a dangerous precedent.

Moreover, Krieger's boss, Jay Pomrenze, did not support awarding Krieger $15 million. Pomrenze and Krieger were close friends (Pomrenze even came to Krieger's house for Krieger's daughter's naming), and Pomrenze said he thought Krieger was “the most powerful trader he'd ever seen.” But Pomrenze was reportedly “really, really nervous” about Krieger's huge trading positions.
³⁸
There was no guarantee Krieger could repeat his trading profits. If anything, other traders had caught on to his strategies. Krieger's profits might have been due to simple luck, and even if his trading profits were due entirely to skill, the markets would be more competitive next year. Why give Krieger a windfall this year if he wasn't going to repeat his performance?

There also was concern that Krieger was not a “team player.” When Krieger placed a billion-dollar trade, he moved the market. Some employees felt that Krieger did not keep them informed about these moves. They claimed they lost money when Krieger's trades caused currencies they were trading to rise or fall. In reality, many of the traders also had been profiting from Krieger's strategies, because they were involved indirectly in the trades. But their profits had been middling compared to Krieger's.

Even if Krieger had made $300 million for the bank, $15 million was simply too much money, given the circumstances. Management decided to pay Krieger $3 million, a very substantial bonus during a very poor year on Wall Street.

The $3 million bonus was seven times the amount Bankers Trust had guaranteed Krieger the previous year, twenty times his bonus at Salomon three years earlier, and 60,000 times his bonus at O'Connor the year before that. It was even double the bonus of the bank's chairman, Charlie Sanford. However you sliced it, Krieger would be paid big money in 1987,
more than just about anyone working on Wall Street, and much more than he ever had received before. It was decided that Jay Pomrenze would tell Krieger his “number” in late January. Krieger was told, “You're only 30 years old, you don't need any more than this.” Krieger didn't say a word in response.

It is hard to imagine that the son of an accountant—a man who four years before had received a bonus check for $500—would be disappointed by a $3 million paycheck. But Wall Street traders are hard to imagine; besides, Krieger insisted he had been promised more. On February 23, 1998, he resigned, saying the bonus was too small relative to his profits for the year.
³⁹

Krieger claimed Bankers Trust should have paid him a bonus in the range of $15 million. “I was very, very disappointed with the bonus on principle, rather than the actual amount. It was more money than I ever thought I'd need, but it wasn't fair.”
⁴⁰
Krieger said he was tired of working 120-hour weeks. He had been ignoring his family and badly needed a vacation. He spent a few weeks “pairing off” his trades, so that Bankers Trust would not be exposed to any currency risk associated with his positions, which already were up more than $50 million for 1988. Then he left for the Caribbean.

Currency-options traders were shocked, and trading in currency options nearly halted for a few hours after Krieger resigned. Again, rumors swirled about Krieger's resignation, including word that Bankers Trust had incurred huge losses in currency options, perhaps as much as $100 million. A spokesman denied the rumors, but the denial only fed speculation about what had happened at Bankers Trust.

Krieger experienced his first fifteen minutes of fame, complete with front-page coverage in the
Wall Street Journal.
But the markets quickly settled down, and traders soon forgot about him.

 

 

M
eanwhile, back at Bankers Trust, the nightmare was just beginning, with the startling revelation that makes Krieger the unwitting “patient zero” of the virus that has spread through the financial markets during the past two decades.

Bankers Trust had issued its January 20, 1988, press release, announcing a profit for the year, a little too hastily. Bank managers typically receive end-of-the-year reports on the value of the bank's trading positions, just as individual investors do for their own investments. Like most banks,
Bankers Trust initially relied on its traders to evaluate the profits or losses in their own portfolios. Krieger simply used his own computer spreadsheet to do this, because Bankers Trust did not have any systems for traders to use. Every day, financial-control teams—sometimes called the
back office
—used their own spreadsheets to
mark to market
the value of the trades. At the end of the year, the back office marked to market all of the traders' positions, and these
marks
were the basis for reporting annual results.

Unfortunately, Bankers Trust had announced its profit before the back office control teams had finished checking the values of Krieger's trades. There was no reason to think the values Bankers Trust had assigned to Krieger's trades would be inaccurate. But as the control teams continued their work, it appeared that Krieger had not made as much money as the managers initially had thought.

In order to mark an options trade, the back office personnel typically input an estimate of what a particular trade was worth, based on computer models, publicly available information, and quotes from competing banks. The goal in marking to market these positions was to reflect as accurately as possible the market value of each trade.

The key factor in determining the value of options—as the Black-Scholes model showed—was the volatility of the underlying currency. For example, if the New Zealand kiwi had been fluctuating greatly on a daily basis, kiwi options would be very valuable, because there was a good chance the right to buy or sell kiwis at a specified rate would be valuable. But if the kiwi had been stable, kiwi options wouldn't be worth much.