THE BEAR'S
LAIR Gaol
time for banks By Martin
Hutchinson
The Barclays Libor debacle,
over which both chief executive Bob Diamond and
chairman Marcus Agius ended up resigning, may be
seen as something of a farce - to lose one top
executive may be an accident, to lose two looks
like carelessness. However, Barclays' trajectory
over the past few decades, while unrewarding for
shareholders, has epitomized the errors of the
financial services industry over the last
generation, errors even more egregious in Britain
than in the United States.
As of 1970 or
so, Barclays was a prominent and successful
organization. It was the largest of the British
"Big 4" clearing banks (commercial banks), with a
large international operation in South Africa and
smaller ones elsewhere, especially in former
colonial markets. It had further increased its
profile by launching the Barclaycard credit card
in 1966 and in the following year
pioneering the world's
first automated teller machine, or ATM, in
Enfield, North London. Its employees had until
1968 included my much-loved great-uncle Cecil, who
rose quite high in its retail operation in the
English Midlands and drove a splendid 1949 Bentley
Mark VI. It was a highly important factor to the
economies in which it did business, highly
profitable and almost risk-free.
Founded
in 1690 with strong Quaker antecedents, Barclays
became a joint-stock bank in 1896, following a
merger. In this respect, however, its ancestry was
not quite as unsullied as it appeared; one of the
banks merged into it in 1896 was the Norwich
Quaker bank of Gurney and Co. An offshoot of that
bank, Overend, Gurney & Co., pioneered the
London bill discounting market and then attempted
to finance with the resulting revolving
three-month money a venture capital portfolio
including the shipyard that built Brunel's
Great Eastern. Inevitably it went
spectacularly bankrupt in 1866, suffering the last
full-scale British bank run until Northern Rock in
2007. David Ward Chapman, financing a lavish
lifestyle with a house at Kensington Gore while
running the bank into ruin through poor or
non-existent risk-management, had his analogues
140 years later, in Barclays and elsewhere.
Like its clearing bank competitors,
Barclays was tempted in the 1960s and 1970s by the
merchant banking business, which appeared to be
dominated in London by much smaller houses, some
of them very sleepy, but was nevertheless growing
exponentially. Initially Barclays' participation
in this business was carried out though Barclays
Bank International; then in 1975 it set up
Barclays Merchant Bank.
The problem with
merchant banking was that Barclays was not very
good at it. In spite of its more or less infinite
access to capital, Barclays Merchant Bank was at
best a second-tier operator. Top management and
control systems transferred across from the parent
bank mixed with staff, many of whom had failed in
traditional merchant banks, either because of lack
of ability or worse, because of their tendency to
cut ethical corners.
When the Big Bang of
banking deregulation happened in 1986, Barclays
bought the broker De Zoete and Bevan and the
jobber (market maker) Wedd Durlacher, but this
made the scale much larger and the cultural
problem worse. Barclays' top management recognized
there was something wrong.
In a March 1987
interview with the Melbourne Age, its retiring
chairman Sir Timothy Bevan (from one of Barclays'
founding Quaker families) said, "I think the best
thing that could happen to the City right now is
if someone goes into the slammer quickly," adding
prophetically "Firm, clear and decisive action by
the authorities is far more effective than too
many complex regulations." Alas, the only City
jail sentence after the 1987 crash was that for
the fringe figure Tony "the Animal" Parnes, in
relation to the Guinness share-trading scandal.
BZW, as the merchant banking arm had been
renamed in 1986, struggled throughout the 1990s,
trading as aggressively as others but with less
success. The risks of investment banking were too
gamey for the Barclays board, and the result was
an inevitable culture clash. Finally, in 1998,
what appeared to be a sensible decision was taken,
and BZW was broken up, with most of the pieces
being sold to Credit Suisse First Boston and only
the debt trading business being retained.
At the same time as it poured resources
into its merchant banking business, Barclays had
been building up a very different business in
investment management. From 1990, it beefed up its
private banking activities, and it bought Wells
Fargo Nikko Investment Advisors in 1996, merging
it into Barclays Global Investors. A pioneer in
exchange-traded funds, Barclays Global Investors
grew to have the largest assets under management
in the world.
Unlike investment banking,
investment management, both directly and through
funds, required little capital and relied heavily
on the reputation of its sponsor. At least in
principle it needed to take few risks, although in
the 2000s Barclays diversified heavily into
"quantitative" hedge funds, which came the
inevitable cropper in 2008. Investment management
was hence an ideal business to combine with
Britain's largest clearing bank, and since
Barclays was able to achieve scale in this
business, it should have been potentially very
lucrative for shareholders.
The clearing
bank/investment management strategy was however
given no time in which to work. Another in a
series of boardroom coups in 1999 removed those
who had sold BZW and built up the investment
management business, and in the 2000s Barclays
again placed its bets on investment banking.
Diamond had been brought on board in 1996
and was responsible for the debt business
remaining after the breakup of BZW. In the
environment of funny money, excess leverage and
generally declining interest rates pervading
internationally after 2000, this business did very
well, while investment management suffered from
the market's relapse after the dot-com bubble
burst.
After Barclays' misguided attempt
to merge with the Dutch bank ABN-Amro in 2007,
Diamond's power within the bank was in the
ascendant. Consequently he bore much of the
responsibility for Barclays' extraordinary twin
decisions of 2008-09: to buy the remnants of
Lehman Brothers on its bankruptcy in September
2008 and to sell Barclays Global Investors to
BlackRock in December 2009.
The result was
a mess, with Barclays' gigantic investment banking
business, with Diamond totally in control,
responsible for 60% of Barclays' profits, and the
residual clearing bank business, still the
second-largest in Britain, purely a milch cow and
capital provider for the investment bank, with no
control of its own destiny.
The Libor
scandal, in which Barclays was fined 290 million
pounds (US$450 million) for providing false
"fixings" on the London interbank offered rate may
thus have been a stroke of luck for Barclays (and
for British taxpayers). It exposed the
incompatibility of the trader/investment banking
culture with the needs of a deposit-taking
commercial bank, without itself causing
catastrophic losses except to Barclays' reputation
and that of the City in general.
The
problem is that traders and conventional bankers
are very different people, and mixing the two
inevitably involves the organization in a level of
risk that is incompatible with a deposit-taking
bank that is a major lender to a nation's small
business. The former trader and current
neuroscientist John Coates in The Hour Between
Dog and Wolf (Penguin Press, 2012)
demonstrates that trading is largely instinctive,
closely connected to athletic ability, and that
trading success is closely correlated with the
testosterone level in the trader concerned - high
testosterone causes greater risk-taking and
greater success, until eventually risk-taking
becomes excessive and large losses occur.
Theoretically, risk managers can prevent
that; in practice the traders make most of the
money and come to dominate decision-making,
resulting in the imposition of risk-management
systems, like value-at-risk, that pretend to
control risk but grossly fail to do so in any kind
of turbulent market.
If Coates is right,
that has enormous implications for banking
regulators. In a "too big to fail" deposit-taking
bank, since traders prevent risk managers from
installing risk management systems that actually
work, either there should be no traders, or all
the bank's traders should be low-testosterone
women, who will not endanger the bank's capital.
After all, unsuccessful traders provide just as
much liquidity as successful ones, but extract
smaller rents from the system.
Either way,
there would seem no need to reward this skilled
but un-cerebral activity any more generously than
society rewards other skilled but physical
activities, such as truck driving or welding.
For Barclays, the implications are clear.
The strategy the bank had for a fleeting period of
about a year in 1998-99 was the correct one.
Retail banking and business lending, the core
activities of the bank, can be carried out
internationally and involve only moderate risk.
Investment management likewise meshes well with
banking activity, provided that the investment
management activities are carried on primarily for
clients, and do not involve high-risk trading.
Trading should be undertaken only when, as
in foreign exchange, it is of moderate risk and
essential to the provision of client services.
Finally, investment banking should be left either
to specialist, much smaller, institutions or to
hedge funds, who can bankrupt themselves and lose
their foolish clients' money without involving the
banking system as a whole.
The universal
bank model works well only in old-fashioned
continental cultures, where trading activity is
minor, pay scales are bureaucratic and competition
is modest. In the world of global banking and
sky-high remuneration, it is a recipe for
disaster, whether in Britain, the United States or
anywhere else. It should be abandoned, either
voluntarily or through regulation.
And as
Sir Timothy Bevan said in 1987, a few jail
sentences, on both sides of the Atlantic, would
wonderfully clean up the business.
Martin Hutchinson is the author
of Great Conservatives (Academica Press,
2005) - details can be found on the website
www.greatconservatives.com - and co-author with
Professor Kevin Dowd of Alchemists of Loss
(Wiley, 2010). Both are now available on
Amazon.com, Great Conservatives only in a
Kindle edition, Alchemists of Loss in both
Kindle and print editions.
(Republished
with permission from PrudentBear.com.
Copyright 2005-12 David W Tice &
Associates.)
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