Bankers Trust Case Study

P&G like several other profitable companies was looking at ways to hedge itself from risk. They were also looking at methods at making small gains, where possible. In case the gains turned to be losses, since they were offset by the small gains. They did this by using plain swaps of fixed for floating rate debt or vice versa. They also used futures, options and currency trades to hedge.

P&G decided to go into high risk complex derivatives through Bankers Trust which was known to be a top player in risk management. P&G had discussed hedging by Bankers Trust using vanilla swaps. It entered into two such contracts. These contracts were floating rate notes in Deutsche marks and dollars. The bets were made on the assumption that the interest rates would fall. P&G further upped the stakes by betting twenty to one in favor of an interest rate fall.

There was the buzz that rates would indeed increase at some point and therefore positions must be cleared before it did happen. In 1994, Greenspan went ahead and did what the market was predicting. He raised rates. P&G lost heavily. Its Chief Financial Officer claimed that they had no knowledge of the intricacies of the contract and were thus unaware of the losses that could be made. Bankers Trust on its part had not clearly detailed the underlying risk inherent in their contracts.

P&G sued BT for $195million. BT claimed that P&G had in place its own panel of experts to do interest rates forecasts and that they had not complained when they made handsome gains. Eventually both the parties settled out of court for a net of $78 million. Bankers Trust also settled with Federal Paper Board Company, Gibson Greetings, Air Products and Chemical, and Procter & Gamble for $93 million.

Bankers Trust contended that P&G could have learnt more about the complex derivatives it was channeling funds into. P&G countered by saying BT should have made them fully cognizant of the risks that were involved in these instruments, since P&G had given their funds in good faith. Since the returns were good P&G had no real reason to go into the details of the contract.

A series of recordings among employees at BT were heard out, in which employees discussed how the contracts that P&G had got into were not unlike a keg of gunpowder waiting to explode.

One of the oft quoted excerpts from those recordings (6500 of them) from Newsweeks archives reads as follows:

“It's Nov. 2, 1993, and two employees of Bankers Trust Co. are discussing a leveraged derivative deal the bank had recently sold to Procter & Gamble Co. ``They would never know. They would never be able to know how much money was taken out of that,'' says one employee, referring to the huge profits the bank stood to make on the transaction. ``Never, no way, no way,'' replies her colleague. ``That's the beauty of Bankers Trust.''”