Insanity at the heart of banking Barings has crashed. The surprise is that a bigger institution has not yet done so, says James Buchan

I would be surprised if Mr Leeson knew the nature of the markets on which he staked his life

THERE are moments in the life of the City, when the gorgeous trappings of high finance - the pin-stripes and the vowels and polished shoes, the marble and glass, the secret language, the women dressed in Westwood dangling their exhausted children after midnight, and all that money money money - fall away to reveal an insane disorder: a thing of crowds and panic and fugitives and terrified nights in remote Malaysian resorts, and manly tears trickling on to the blue baize tables of Threadneedle Street.

The failure of Barings last weekend is not just any such moment. "This is," says David Kynaston, a historian of the modern City, "the greatest City story ever. I've seen some pretty strange things in my researches, but nothing like this, remotely." It is an opportunity for a bemused and excluded public to look right into the heart of the City - if it has the nerve.

The fault, we are now told by the Baring family, arose in the most bare- faced fraud by Nick Leeson, the 28-year-old head of a small trading operation in Singapore known as Barings Futures, and the unbelievable incompetence of his nominal superiors. The Baring family desperately needs to prove fraud to absolve this generation of responsibility for the destruction of 232 years of history. Other bankers say those Barings were always twits: look at 1890, the last time that Barings went to the Bank of England for rescue. That the Barings prospered as bankers longer than the Medici, the Fugger, the Rothschilds and the Morgans and therefore must also have had something up top is conveniently forgotten.

All these people are prisoners of a theory that arose in the 16th century but was precisely formulated in the 18th: that commerce at this level is a technically rational activity not subject to ethical rules. If something goes wrong, according to the theory, it is the reckless straying into this province of ethical categories - philanthropy (the Barings), embezzlement (Mr Leeson) - or human error, which is now known as "failure of internal controls".

Yet the Lloyd's insurance market was not undermined by fraud: the most egregious crooks were booted out from Lime Street at the beginning of the 1980s. Nor even by much mismanagement. It was disrupted by a series of acts of God.

The most imaginative - financier of our epoch, Michael Milken, was jailed in 1990 for technical infringements of the US securities laws that, taken individually, would barely have merited a reprimand from the New York Stock Exchange. Financial crime is not defined from ethical considerations: it is just conduct that costs money. That is why the courts have such trouble with it and why their punishments are often technically unjust. Similarly, incompetence is action or inaction that loses money. All judgements are by hindsight.

Against this theory of finance, I would counterpose another: that the operations of the City are profoundly, irreparably irrational. Or, put another way, the banks are bombs just waiting to explode.

Modern banks, whether of the lending or investment type (and these distinctions don't really mean much now) are fundamentally unstable not because bankers are stupid or mad, but because the business is so unprofitable. Competition has weakened the basic business: lending for the high street banks and, for the City firms, advice, security, fund management and trade finance. Just to earn a return, they have to deploy an immense volume of money on the markets, most of it borrowed. Even so, the high street banks earn less on their capital than supermarkets. Bank profits may look excessive to a public that is exasperated by the cost of accounts, but even £1bn in profit is a mere raindrop in the £166bn ocean that Barclays, for example, employs in the business.

To keep themselves in the style to which they are accustomed, bankers have taken to speculation. They are not frightened because their owners are protected by limited liability and their depositors are, to a varying degree, guaranteed against loss by the state. In the US, the Federal government insures deposits up to $100,000 while, in this country, the Bank of England is expected to stand ready to pick up a bank when it stumbles.

To enjoy returns from speculation, the banks need very high risks. Elaborate gambling instruments have been devised to provide them, such as the contracts on the Tokyo stock market index to which Mr Leeson was so devoted. Some of these instruments were originally devised to protect farmers or producers of other sorts from fluctuations in product prices - the TV news, hopelessly at sea all week, showed charming pictures of orange groves - but they have now lost any connection with productive activity and merely exist to provide banks with the spectacular risks they crave. These instruments add a further twist to the gearing of the balance sheet: a tiny sliver of owners' capital can confront an almost unimaginable loss. The surprise is not that Barings failed last weekend, but that a bigger bank has not.

This risk multiplies itself in every direction, as in a room lined with mirrors. Because an individual trader can have a winning streak - as gamblers do - the bank becomes hostage to that individual because all the bankers depend on him or her for their pay and bonuses. Drexel Burnham Lambert could never control Mr Milken because it never earned a cent that wasn't carried by him: when he went to prison, the firm vanished overnight as if it had never been. As far as I can tell, Mr Leeson earned a third of Barings' reported profits in the first half of last year. "The loss of his services to a competitor," said a management audit last year, "would speed the erosion of Baring Futures' profitability greatly". In short, don't offend the boy! (A trader's life, an almost military compound of terror, elation and unbelievable drudgery, appeals only to young people.)

Because bankers measure their self-worth in money, and pay themselves a lot of it, they think they're fine fellows and don't need to explain themselves. But, as a general rule, a class that ceases to make itself understood eventually ceases to understand itself. The internal Barings documents published last week, a mixture of management clich and outright nonsense, show the bankers simply did not have the English to describe (and therefore understand) the Singapore enterprise. I would be surprised if Mr Leeson remotely understood the nature of the contracts and markets on which he had staked his life.

For much of the 19th century, my family were small bankers in the town of Peebles in Scotland. In 1878, the City of Glasgow Bank failed, ruining all its correspondents in southern Scotland. It took six years of misjudgement and phoney balance sheets to destroy the City of Glasgow; it took Mr Leeson under three weeks to kill Barings. Entire banks are now bet on a few moments in the life of an ignorant individual.

It is bad form to suggest a major bank will fail. But they do, every now and then; and, because they owe money to other banks, these fail, too; loans dry up, there is a depression in trade followed by trade wars, sometimes even killing wars. This is history and even ING of Amsterdam, which wants to buy the Barings carcass, cannot abolish history. The Bank of England tried to rescue Barings last weekend and failed. The Governor, Eddie George, makes out this was all policy, pour encourager les autres. The events of last week - the calm in the markets, the purely instrumental reforms, the squabbling over the corpse - reveal that the others do not want to be encouraged. The bankers I spoke to all said that speculation in derivative financial instruments could not be controlled. The question "Why do you engage in a business you cannot control?" evoked well-remunerated sighs. To paraphrase: the world banking system is rushing towards a precipice and the UK financial services sector must be the first or among the first over. A big bank must fail so that competition is reduced and the basic businesses restored to profit. They just pray it's not their house that fails, or at least not until after bonus time. At the heart of a supposedly rational enterprise is prayer.

What can the rest of us do? Even if you seek out a bank with a reputation for prudence - say, First Wachovia in Winston-Salem, NC, or the Yorkshire Bank in Leeds - they will still put out surplus money to earn interest at other banks and thus will be liable to contagion. So we, too, must pray.

My favourite building in the world is on the street known as the Bowery in New York City, just at that point where the sodden boozers and the crack-heads give place to shuffling Chinese great-grandmothers. The building has a stolid portico, a dome, a pediment, a wrought-iron grille and an inscription in handsome Federal lettering: The Bowery Savings Bank. It is a relic of a buried era, the one before deposit insurance or lenders- of-last-resort, when the essential franchise of banking was safety: that is, that the money you deposited one night would still be there at the start of business next morning. You can pray that when the crisis comes, which might be sooner rather than later, your bank will be like that building, still standing, solid and bizarre, among the raving destitutes.

Special report and Your Money, Business pages 1, 2, 3 and 9