Nick Leeson – King of the Rational Emotional Decision Makers

Nick Leeson is a working class lad made good. Then made bad. Then made good again. His story is famous the world over. He is the man who brought down an entire bank. Exactly how this was allowed to happen is of course a Black Swan in itself but it did and the fallout was immense, not least for Leeson himself who ended up in a Singapore jail for several years before laudably coming back with a vengeance and writing a book about his recovery and the effect that stress can have and how to beat it.

The exact details of what happened in 1995 are obviously complicated but essentially the principle is exactly as the world understands it: by the end of 1992, the amount concealed in the error account was £2m, but the end of £1994 it was £208m and by 23 Feb 1995 Leeson fled the country leaving a note saying “I’m sorry” and an account which held £827m in losses. Essentially, Leeson had got caught in a spiral of loss partly due to his decision to use a system to try and correct what began as fairly modest errors.

The system – known as the Martingale system – is known to gamblers and traders the world over and must be the cause of more unhappy nights in Vegas than any other. Essentially, it says if you lose your first bet (of, let’s say $1) you simply double it on the next spin, or hand, and if you lose that, simply double it again and so on and so on until you, eventually win, as you eventually must. The inherent problem with the system is that in theory it works perfectly. At some point within an infinite period of time, however, the monkey on the typewriter will bash out the works of Shakespeare or at least a sonnet or two! What the laws of probability don’t say, however, is WHEN! Which means that an infinite bankroll is required to make the system work in practice, something that even Warren Buffet doesn’t have. And neither did Barings Bank!

But here’s the question: why – when he was £100 million pounds down, did Leeson – an apparently intelligent, determined young man keep going? Why not throw in the towel, concede defeat and do the time that he was ultimately sentenced to do? Why push the envelope until the point of no return and potentially destroy everything for everyone in the process.

The answer lies in the meanings or values that Leeson placed on the different possible outcomes of the potential opportunities available to him.

The only thing that meant anything at all to him at that point was just breaking even. Reducing the losses to £70 or £40 million meant nothing. He was still going to lose his job and almost certainly go to jail in this eventuality. Increasing the losses to £200, £300 even £400 or £500 million was not going to worsen the situation for him really. He had got to a stage where the downside remained the same and the meaning of the upside (his possible reward) was everything. Effectively doubling through and breaking even meant safety, it meant freedom, it meant employment, it meant an end to the stress which eventually gave him cancer. It meant getting the life he loved back.

In this way Nick Leeson was no different to the millions of gamblers who step inside the billion dollar casinos in Las Vegas or Sun City or Mayfair or anywhere around the world. Largely otherwise intelligent, rational people make decisions for an evening which deep down they know will cost them money. People who play slot machines, for the most part, know deep down that the house will win in the long run. I’m not saying that there aren’t people in those places who become convinced that they are “hot” or that they have a “system”.

For Nick Leeson, whatever the probability of the downside, the meaning he placed on losing even more money was minimal. The only thing which meant anything at all to him was breaking even. This was immoral, certainly, given the consequences of his actions for thousands of people but rationally… well, rationally it made sense! Given a similar lack of moral fibre any one of us might well do the same in the same situation.

Certainly given a different situation which, for example, forced us to make a decision to do something which might kill us but which might also very well save the life of our child, which mother or father would not take this course of action? Naturally, this is a hypothetical situation with no detail at all and the first thing you would want to know would be the probabilities involved – but we’ve already covered that. The point is that the meaning we place on the possible upside as a parent would far outweigh the potential downside. Somewhat morbidly, in order to more closely simulate Nick Leeson’s emotional calculation we would probably have to assume that we were likely to die in either event – a factor which would make the ultimate decision a no-brainer.

The situation that Leeson found himself in was very different to going into a casino with £50 (or even £50 million like Kerry Packer did) that you’re happy and prepared to lose. It’s more akin to the position that the poor sap who has heard about the Martingale system finds himself in after maxing out two credit cards in a desperate bid to win back that first $10 after a statistically freakish but eminently possible 10 spin losing run (1024 -1 against). Now, we are anything but happy. We are anything but prepared. But in much the same way, if for very different reasons, there is very little additional pain we can experience. It’s not just our credit cards that are maxed. So are our pain levels. And the only way is up.

Posted 02:47pm by Caspar and filed in Decision Making, Risk

Taking Risks on Life’s Journey

The first thing to understand about betting on a roulette table is that when you bet red, at the simplest level, the casino is betting black. And neither is more likely than the other. Indeed, according to some people’s definitions of the word, casinos are “gambling” in the same way that their punters are.

They’re not, of course, which is why most people use the word “gambling” incorrectly and why we need to calibrate our terms when we talk about this complicated but fascinating subject. Every time the wheel is spun, however, uncertainty reigns and nobody but nobody can tell you with any certainty what the result is going to be. It is the visibility of uncertainty in a casino – as opposed to its often invisible nature in life – that makes it such a wonderful little laboratory in which to study the way people that people react to it.

As a young man I never took drugs, bungee-jumped or even placed a bet. Activities associated with risk just never appealed to me. Then, aged 26, – quite out of the blue – I quit my job as a reasonably successful writer for film and television to become a professional poker player.

This was long before poker became the multi-billion dollar industry that it is today. In 1999 poker was the preserve of a few eccentrics and iconoclasts who had either never known any other “career” or who had dropped out of one because it wasn’t offering them the thrills they dreamed of as a child. I guess I fell into the latter category.

With hindsight, it was the best career move I ever made. I learnt more from three years in Las Vegas than any other single formative experience. Playing poker for 10 hours a day 6 days a week for three years certainly taught me a thing or two about risk and just how little most people understand it.

Most people assume that – as a professional poker player – I was a gambler but the fact is that “gambling” is the act of placing a bet where you have the worst of it. In the long term, if you “gamble” you will lose money. Playing poker professionally is not about gambling but taking a series of “calculated risks” with the aim of making a healthy long-term profit at the end of the day.

Isn’t that the aim in business too? What poker players call “bets” business people call “investments” but the uncertainty is still there. We live in an increasingly uncertain business world where it is impossible to guarantee the outcome of anything.

In my seminars I demonstrate how to bet on the roll of a die and make money – even though you lose five times out of six – and explain why professional sports bettors aren’t looking for the horse most likely to win. The implications of that often changes the way people view risk forever.

Operating a business in the knowledge that you will be profitable in the long run, even though some of your investments will fail, is something that the best companies in the world have known for many years: companies like 3M, HP, and Google have created cultures that encourage risk taking and accept failure as a necessary part of their calculations. They don’t sweat the short term any more than a casino manager sweats when someone wins a lot on roulette in one evening: they know that the house will bust them in the end, just as the great company knows that great ideas will always be produced by a healthy culture of innovation and adaptation.

After three years in Vegas I came home to England and effectively became an entrepreneur. I know that I could not possibly have done this without the knowledge and skills that poker gave me and it is a pleasure for me to foster discussions around this whole area with people in business today.

Posted 12:27pm by Caspar and filed in Risk, Uncertainty