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January 03, 2005

The Terror of Finance: The Man Who Broke Britain

Posted by Elaine Sternberg

The Man Who Broke Britain
Directed by Gabriel Range
BBC2, 9th December 2004

Finance is a favoured target of those who dislike or distrust business. The Man Who Broke Britain, a 90 minute drama documentary screened by BBC2 on 9th December 2004, displayed the fantasies of one such group - the BBC - about another... Islamic terrorists. Ostensibly about the dangers of financial terrorism, this meretricious programme ignored risks that are real and dangerous, to focus instead on less plausible but ideologically-defined perils.

According to the BBC's own publication, Radio Times, this mockumentary was commissioned by the BBC Public Affairs Unit, and was "designed to reveal the fragility of financial trading systems". To achieve this end, it presented a series of faked interviews with, amongst others, the Prime Minister and Chancellor of the Exchequer. They purported to explain how one man had "sabotaged" the world's financial systems, causing the downfall first of his own investment bank employer, then the international banking system, and finally the economy of Britain.

Most of the programme consisted of an extended red herring about a Saudi national trading derivatives in the City. At the very end, however, it emerged that the villain was instead his English boss. The boss had modified contracts intended to protect the financial position of their employer, the fictional Sun First Credit Bank ('SFCB'): he added a clause that rendered the protection null and void in the unlikely event that oil prices exceeded $75 per barrel. And he did so, we were told, because such contracts were cheaper; the boss expected the savings to increase his personal bonus. The programme drew the conventional anti-business conclusion: financial greed was the cause of the catastrophe, and more government regulation was needed to control it.

That conclusion is, however, both false generally, and unsupported by the contents of the film. First, the programme did not, and could not, show any relation between either financial sabotage or financial terrorism and greed, because no financial sabotage or financial terrorism was depicted in the film. Sabotage is a deliberate act of destruction. But the programme never suggested that the errant boss had sought to undermine either his employer or the financial system. Indeed, his plan to achieve greater riches would only have worked had the bank, and the banking system, continued to operate normally; the calamitous effects of the altered contracts were wholly unintended. The one genuine act of sabotage portrayed by the programme was the bombing of Saudi oilfields by Islamic terrorists. But though that was genuine terrorism, neither the target nor the motivation was financial. So the programme wasn't about financial sabotage or financial terrorism at all, and a fortiori not about their causes.

The programme also did not demonstrate that derivatives were "financial weapons of mass destruction", despite repeatedly describing them as such. It is worth remembering that a weapon is an instrument used or designed to inflict bodily harm. Even if the definition is extended to non-physical bodies, derivatives do not qualify as weapons. Although their effects can be harmful, harm is not intrinsic either to their design or their primary use.

Even when problems do arise from the use of derivatives, it is the particular uses, and not the derivatives themselves, that are at fault. Powerful though they may be, even computer-assisted derivatives are mere inanimate instruments, tools. The effects that tools produce reflect their natures: knives and spanners have different capacities. But tools' effects also depend crucially on the ways in which they are used. A knife used as cutlery is not a weapon; a spanner used to brain a burglar is one. On their own, derivatives can no more cause financial disasters than credit cards can cause debt.

Nevertheless, endorsing Warren Buffet's misleading description, the programme suggested that derivatives were to be feared, both because of their complexity and their tendency to increase linkages between financial institutions. Even in the film, however, the cause of the global economic collapse wasn't a complex derivative: it was a contractual clause so simple that, we were told, it was discovered, understood and questioned by a junior lawyer working in the bank's back office.

Knowing that linkages between financial institutions can transmit problems, prudent institutions take steps to limit their exposures... to any one obligor, any one kind of instrument, and any one kind of transaction. Prudent institutions, like prudent individuals, also scrupulously avoid engaging in transactions that they do not understand. That prudence is a virtue does not, however, mean that all risk can or should be avoided: risk taking and speculation can both be constructive. Different risk/reward profiles can be accommodated if potential counterparties - including depositors, if any - exercise the elementary precaution of caveat emptor.

Unfortunately, much financial regulation discourages such basic care. Deposit insurance provides a positive incentive to disregard the level of risk; compliance with onerous money laundering regulations diverts resources from genuine risk assessment. The moral hazards of regulation are one of the real dangers ignored by The Man Who Broke Britain. Governments are far too rigid and slow to keep pace with rapidly evolving financial markets; in attempting to prevent mischief, governments are more likely to produce it, and to impede legitimate, productive activity.

The programme also failed to identify the proper lessons to be drawn from the Barings disaster. The only parallel between the fictional situation and Barings' was that of bad management. Whereas Barings' main activity was traditional UK corporate finance, the fictional institution was supposed to have derivatives trading as its core activity. Whereas Nick Leeson had an undisclosed county court judgement registered against him, the fictional Saudi trader had a blameless record and a PhD in financial econometrics. In both cases, however, it would seem that the banks' senior management were unaware of or unwilling to control what was happening in their own organisations. And sadly, shockingly bad management is not uncommon in the financial services industry. Not only are managements sometimes astonishingly ignorant of how their own businesses work, but that ignorance is sometimes wilful. Managements refrain from inquiring too closely for fear of what they might discover... and have to manage.

What is needed, however, is not more government regulation, but greater commitment to organisational purposes. In business corporations, the money that managements lose is not their own: it ultimately belongs to the shareholders and creditors, and has been entrusted to the corporation to fund the maximisation of owner value. Boards have a fiduciary responsibility to pursue that corporate objective, and to appoint managers who will achieve it. If they use corporate resources to pursue any other end - be it power and prestige or personal aggrandisement, social justice or sustainable development -they have violated their fiduciary responsibilities and should be held to account.

Commitment to organisational purposes includes heeding information that is critical to achieving them. It may be information about exigent opportunities. Or it may be information that is critical of the organisation: for an organisation to stay on course, it must know when and how it deviates from it. Managers and directors should therefore be routinely confronted with, not shielded from, uncomfortable facts. Whistle blowers should be valued as trouble-shooters, not dismissed as trouble-makers. When conscientious employees who raise concerns are encouraged to leave, organisations lose an important early warning system.

Getting the right information is particularly crucial when hiring and promoting... especially when 'sleepers' might pose a danger of terrorism; all candidates should be carefully vetted, for their attitudes to risk and the corporate objectives, as well as for criminal records. The references obtained need to be both checked and understood; too often one or both elements are neglected. Constant vigilance is necessary to keep organisations to their proper purposes, and to avert the genuine dangers posed to the world's economy by inappropriate regulation and cyber terrorism.

But vigilance is also necessary to prevent terrorism from being used as an excuse. The Man Who Broke Britain illustrated the vested interests that both media and government have in scare-mongering. Fear helps the mass media to boost sales; seeming tough on terrorism gives governments an excuse to increase their powers. Fear itself can be a danger. But it is one we must resist. As Thomas Jefferson rightly observed, "A society that will trade a little order for a little freedom will lose both, and deserve neither".
Elaine Sternberg 2005

Dr Elaine Sternberg is the author of Just Business: Business Ethics in Action, Oxford University Press, 2000.

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