In the Gaps: House of Cards

When Diane looked up from her analysis, she was certain of one thing: her calculations had to be wrong. A 21-year-old architecture major at Princeton, Diane had chosen the Citicorp Center (now called 601 Lexington), one of the most famous new buildings in America, as the focus of her senior capstone project. Diane wanted to understand and reproduce how the tower’s innovative design and structural engineering handled its load.

William was one of the most admired structural engineers in America, trained at Harvard and MIT. He had just given New York City a 59-story engineering marvel. The entire tower was suspended above the street on four columns set, unusually, at the center of each face.

The Citicorp Center was also the first skyrise to employ a tuned mass damper. This 400-ton concrete block installed at the tower’s crown floated frictionlessly on oil; electric actuators sensed the building’s motion in the wind and shifted the block opposite the tower’s sway. The tower’s design and the damper’s effectiveness were engineered to withstand hurricane-force winds from each side in compliance with New York City building code standards and structural engineering conventions of the day.

Diane was curious about the design’s performance against wind striking a corner rather than a side. Her calculations suggested that a relatively modest quartering wind was sufficient to topple the entire structure… which couldn’t be right. Diane raised her concern to a junior engineer at William’s firm. He reassured her that the building was indeed safe from quartering winds. In light of that reassurance and William’s reputation as a structural engineer, Diane deferred to the experts and assumed the error was hers.

Meanwhile, Diane’s question about diagonal winds landed on William’s desk. To his credit, he ran her wind scenario himself. His calculations were even more alarming because he knew something Diane did not: to reduce cost, the building’s load-bearing braces had been fastened using bolts rather than welds, materially increasing the building’s vulnerability to a diagonal wind. He also knew that the building’s mass damper ran on electricity with no generator back-up. Should power be lost in a storm, the damper would not operate.

Almost immediately, William began making phone calls to his lawyers and insurer. Soon, a small group formed that included independent experts, a brand new mayor (Ed Koch), and the head of the welder’s union. No one else outside of this group, including the public and employees of Citibank, was informed.

Quietly, secretly, emergency repair crews welded steel plates onto the building joints by night. Even as repairs were underway, a fierce hurricane (Ella) was heading toward the east coast and threatened to turn toward the city. Fearing the worst, city officials and the Red Cross began drafting an evacuation plan for a ten-block radius around the tower.

To the utter relief of everyone involved, Ella unexpectedly turned sharply out to sea, averting catastrophe. The nighttime repairs to the building’s joints were quietly completed later that year. The building’s resiliency to wind from all directions was ultimately rendered even stronger than had been originally contemplated.

The whole incident stayed buried for nearly 20 years. Diane was standing in her living room holding her baby when she happened to turn her TV channel to a documentary about the averted crisis, naming her as the student who had identified a risk that all the experts had missed. Diane nearly dropped her son upon realizing that she had been right all along.

More and more these days we have been feeling like Diane. Some new financing and new structure shows up on our deal pipeline. We dive in to get a closer look. We soon find ourselves scratching our heads, wondering what we are missing, because to our eyes it takes such little wind from the “wrong” direction to turn clever into calamitous.

“...to our eyes it takes such little wind from the “wrong” direction to turn clever into calamitous.”

We need a lot more Dianes out there. We need more investment professionals looking at risk along different axes than what convention or protocol might normally dictate. We need more credit investors willing to ask questions, explore scenarios, and stress factors or variables that fall outside rating agency criteria, transaction models and historical precedent.

In this edition of In the Gaps, the team explores a different kind of structural integrity and its association with a relatively loaded term: financial engineering. What appears structurally sound under one set of scenarios might present significant vulnerability along a different axis of risk.

How does one identify and differentiate structural integrity from vulnerability, creative solutions from shenanigans? Both extremes are present in today’s market and perhaps to the greatest degree we’ve seen since the years before the Global Financial Crisis.

We are big fans of using structures to improve risk and align interests; it is Lesson #4 on our Top 15 Lessons Learned (see page 29). Structural complexity itself is not the issue. What history has taught investors is that sometimes structural complexity and financial engineering are not used to improve risk, but to hide it.

“...sometimes structural complexity and financial engineering are not used to improve risk, but to hide it.”

Our Charity Spotlight this edition is Great Ormond Street Hospital (GOSH). This 174-year-old, U.K.-based organization goes beyond what government funding provides to seriously ill children and their families. The GOSH teams care for more than 78,000 children annually with an emphasis on children battling cancer. This is a very special organization making a huge impact. Please take a moment to learn more about GOSH on page 26.

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