The banking crisis has in 2009 sparked a wave of recriminations: new guidelines on bankers’ pay from the G20, a bonus crackdown from the Treasury, and from the FSA a string of initiatives including the vetting of senior bank appointments, a statutory banking code, and a radical new focus on consumer outcomes not organisational process.
But are politicians and regulators merely reacting to the last disaster, rather than preventing the next one?
Clues may be found in two of the year’s best books, which in different ways draw profound lessons from the financial meltdown.
In Fool’s Gold, prescient Financial Times journalist Gillian Tett traces the story of the real bankers involved in devising the financial rocket science which eventually blew up.
It started as a simple idea, turning the income from corporate or mortgage loans into bonds to sell to investors in neat slices with different flavours of risk -- “selling an $8 pizza for $10”. But the whizzkids at JP Morgan moved on from mortgage-backed securities to credit derivatives, where the risks of default on corporate loans were offloaded through insurance.
Next came the idea of using special purpose offshore vehicles to do the insuring, receive the premiums from Morgan, and sell on smaller chunks of the risk to the investors in new pizza slices. The killer idea was that for every $1bn of insured loans, only $70m of AAA bonds were to be issued to cover them. “The JP Morgan team reckoned full funding just wasn’t necessary; the number of defaults would be so low that so much capital just wouldn’t ever be needed for covering losses.”
Crucially, after months of argument, the scheme was approved by Moody’s ratings agency. “The team was jubilant, they felt they had stumbled on a financial holy grail. At a stroke they had managed to remove credit risk from the banks’ books on an enormous scale.”
A more sceptical commentator recorded even at the time “they thought they were the smartest guys on the planet”.
Sadly, they were easily smart enough to outflank the financial regulators.
Credit derivatives such as CDOs (collateralised debt obligations), declared Fed chairman Alan Greenspan in 1999, had “undoubtedly improved national productivity growth and standards of living” and required minimum regulation, Tett records. Bill Clinton’s repeal of the Glass-Steagall Act, allowing commercial and investment banking under one roof, drove a new market hunger for scale and daring innovation to achieve it.
But it also drove greed. Over the next decade, the young Turks on Wall Street created a Frankenstein’s monster that was eventually to rampage out of control. The banks began to use sub-prime mortgage debt as the base of the credit derivative pyramid -- turning it into a house of cards -- and then create off-balance sheet Special Investment Vehicles (SIVs) to circumvent the Basel 2 rules and hide their “assets” away from all but market savants.
“Even regulators seemed only vaguely aware of what the banks were really doing,” Tett says. “Financiers had created a vast shadow banking system that was out of the sight of almost
everyone outside the specialist credit world.”
After America’s biggest bank Citigroup unveiled the first big explosion of writedowns at the end of 2007, a senior manager was to admit “perhaps only a dozen people in the bank really understood” where the $43bn of losses had come from.
AIG, the US’s biggest insurer, had to be rescued from ruin a year later. Both had bought into Morgan’s snake oil -- loading their balance sheets with insured risk requiring “no reserves” to cover it.
Morgan survived, and became a byword for conservatism, purely because it appointed a boss, Jamie Dimon, who liked to know what was going on in his bank, and in 2006 decided not to follow the herd into massive mortgage-backed security production. (Goldman Sachs survived because it called the property market in time.) Dimon’s favourite saying, unlike Gordon Brown’s, was “every five years or so something bad happens”.
But would fiercer scrutiny of key appointments at banks have barred from office those chiefs of several other huge Wall Street institutions who were much less questioning? Can it do so in future? And even if the bankers had known their bonuses would be clawed back if today’s profits turned into tomorrow’s losses, would they have done anything differently? The central bankers and regulators, says Tett, were “trapped in vast bureaucratic machines and only equipped to fight the last war”.
Her model grass-roots investigation concludes that the credit bubble may have been stoked by extreme monetary looseness, savings imbalances, and poor regulation, and all must be re-thought, but so too must the culture of finance. “Policymakers bankers and politicians must adopt a more holistic vision of finance. In essence, what is needed is a return to the seemingly dull virtues of prudence, moderation, balance and common sense.”
Exactly the same call comes in Good Value, the book penned by an ordained Church of England minister who also happens to chair one of the world’s biggest banks, HSBC. Stephen Green, also the bank’s chief executive from 2003 to 2006, is arguably a little bland on what happened (“safe to say this will not be the last financial crisis, for all its severity”) and who was to blame (“there has been a marked decline in the sense of trust… which also applies to business more broadly”).
But he is determined to put bankers in context by turning a mirror on society and ourselves.
He grapples with the Faustian bargains we make with our morals, tells how a charity (Futurehope) was started by a banker who gave it all up to serve the poorest, and cites the spread of microfinance in the developing world as a sign of hope.
Green has presided over a bank whose hands are not as clean as he would wish, but in sketching out a blueprint for “integrity in the global bazaar”, he issues an unusual insider’s call for banking leaders to embrace a genuinely holistic view of their responsibilities.
Fool’s Gold, Gillian Tett - Publisher: Little Brown Good Value, Stephen Green- Publisher: Allen Lane
Young Turks on Wall Street created a Frankenstein’s monster that was eventually to rampage out of control
