Fail-Safe or Safe-Fail?

Are computer systems the problem?

A little over a year ago Knight Capital–a small broker with a large trading presence—suffered a computer glitch which cost it almost $500 million dollars, wiping out its capital and destroying the company. Newly-installed computer code didn’t interface well with legacy systems: overdrawing some accounts by billions and setting massive short positions in others. In the course of 45 minutes, the firm was gone.

By contrast, it took months for Bruno Iksil, the famed London Whale, to accumulate oversized derivative positions that ultimately generated over $5 billion in losses for JP Morgan—about a quarter of a year’s earnings. Part of the reason he could establish such a large position was because entire spreadsheets were manually copied from one computer to another, and a coding error in a single cell cascaded through the system.

IT systems fail all the time; they just usually don’t make headlines. That’s because they’re essentially an art-form, with equal parts planning, experience, and coding skill. If any piece is missing, the system will crash. Major failures this year include airlines, phones, banks, and—right now—health-care.

Failure happens. The key is to make sure initial failures are small–and to have enough capital to cover the large ones.

Douglas R. Tengdin, CFA

Chief Investment Officer

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