City column: Questions the City failed to ask
3 Nov 08
Warning signs – even some warning words – preceded the crash but the financial community, its regulators, and the media ignored them
by Angus McCrone
“O wad some power the giftie gie us, to see oursels as ithers see us,” wrote Robert Burns in To A Louse.
The words were aimed at individuals, but in recent times they apply well to a collective – the City of London. The lesson of the 2008 financial crisis is surely that the City failed to look critically at itself, or to heed what outsiders saw when they looked.
Banks, insurance companies and investment houses employ many of the best brains in the workforce. So where were the voices from within, to question the wisdom of the strategies being adopted in the mid-2000s or the incentive regime that paid out monster bonuses?
With hindsight, the actions of the banks look extraordinary. In 2006 and 2007, HBOS spent £1.5 billion buying back 147m of its own shares, at an average of £10.02 each. By October 2008, a few months after an emergency rights issue, the shares were around £1 and the company’s future depended on a takeover bid from Lloyds TSB.
Insiders at most financial institutions seemed blind to the risks of new, complex credit products and funding structures. Early last autumn, a high-flier at one of the largest investment banks informed me that the credit squeeze would pass quickly because all that needed to happen was for the banks to take their off-balance-sheet vehicles back on to the balance sheet and to own up to the resulting write-offs. Out of politeness, I will not say what happened to the individual concerned, or his firm.
Investors were little better. Institutions, hedge funds and analysts put pressure on banks to leverage themselves more aggressively, to carry out takeover bids – such as the €71.1 billion (£55.5 billion) move by Royal Bank of Scotland, Fortis and Santander for ABN Amro – warning them that otherwise they would become targets themselves.
The public looked at the City and most took the view that its workers were not worth the telephone-number salaries they were being paid. People also questioned why their post was full of offers for cut-price credit cards.
They were right to be sceptical, but they were let down by those who were supposed to guard their financial interests.
I will start with the US Federal Reserve. Under Alan Greenspan, it decided that it was not its job to prevent asset bubbles, only to help clear up afterwards. So it did not even try to prick the credit bubble, increasing interest rates only in tiny, quarter-point steps in the middle of the decade.
Then there was the US Treasury, which let Lehman Brothers, the fourth largest investment bank, go bust on 15 September. This flew in the face of the 1930s lesson that governments should not allow major banks to default, and it triggered a storm of counterparty losses on complex trades that aggravated the ensuing market crisis.
What about our own watchdogs? From my conversations with the Bank of England in 2005 and 2006, I know that it was queasy. Governor Mervyn King warned in June 2004 that house prices were “well above what most people would regard as sustainable in the longer term”.
The Bank was also worried – rightly – about the exponential growth of credit derivatives, the contracting-out of debt risk from banks to others.
In its April 2007 Financial Stability Report, the Bank began its summary with the unfortunate words “The UK financial system remains highly resilient”, but inside there is that queasiness – on page 8, it says: “Levels of risk premia have led to concerns among market contacts that assets are being ‘priced for perfection’.”
However the Bank did not have the courage of its convictions. It failed to call loudly
for higher bank reserve ratios or more prudent mortgage lending rules.
The Government was a victim of hubris. It talked the talk in its early years about sound money and “an end to boom and bust”, and arrogantly jettisoned both ideas in 2003/07. As for the Financial Services Authority, it failed to smell a rat in the dependence of the banks it was supervising on wholesale funding, or to demand that
its remit be extended to cover buy-to-let schemes.
And what of the media? They did their best to stoke the bubble with wall-to-wall coverage of how to make a living from property, and of “opportunities” everywhere from flats in Leeds to apartments in Bulgaria.
There was a black cloud on the horizon. A few journalists and politicians sensed it, even if they did not see it clearly. But the City was not in a mood to look.