Banking practices changed little since crash

When Lehman Brothers went bust, images of staff carrying boxes out of offices in New York, London and Tokyo seemed to represent an unforgettable public humiliation for bankers. Action was taken to shore up the system, but key figures at the heart of the financial rescue in 2008 reveal that the risk of another meltdown is still very real

By Larry Elliott and Jill Treanor  /  The Observer

Wed, Sep 18, 2013 - Page 9

Seventy-five years before the trillion-dollar bankruptcy of Lehman Brothers in 2008, then-US president Franklin Roosevelt had used his 1933 inauguration speech — in the depths of the Great Depression — to declare that the “money changers have fled from their high seats in the temple of our civilization.”

“We may now restore that temple to the ancient truths. The measure of the restoration lies in the extent to which we apply social values more noble than mere monetary profit,” he added.

In 2008, in the aftermath of the Lehman collapse, the words of the New Deal president were often quoted by those keen to rein in the excesses of Wall Street and the City, London’s financial district. After Lehman there was no shortage of ideas on ways of restoring the temple, including breaking up the big banks into retail and investment arms, as they had been in the US under the Glass-Steagall Act of 1933.

The reformers were not confined to the Occupy Wall Street movement protesters who set up camps on Wall Street and by St Paul’s cathedral, in central London. Paul Volcker, the former chairman of the US Federal Reserve, supported moves to prevent banks engaging in speculative trading that did not benefit their customers, while in the UK the coalition government backed plans to force banks to ringfence high street operations from their investment banking activities.

The aim was to eradicate what Lord Adair Turner, when he was chairman of the Financial Services Authority, the quasi-judicial body responsible for the regulation of the financial services industry in the UK, had called the “socially useless” parts of the City and rein in the risk-taking that might one day require another taxpayer bailout.

Five years on from the tumultuous collapse of Lehman — which prompted a near meltdown of the global financial system — Turner admits the socially useless activity he was concerned about has been only temporarily restrained. Indeed, to the public, the perception is that the City has got away lightly, especially compared with what happened to those blamed for the 1978-1979 winter of discontent.

Five years after that winter, when the trade unions were deemed to have taken Britain to the brink of economic chaos, the government of then-prime minister Margaret Thatcher had taken a series of steps to tame organized labor. However, capitalism’s winter of discontent in 2008-2009 led to no such seismic shift. Just six months after the mayhem caused by Lehman’s collapse — which quickly led to the rescue of HBOS by Lloyds, the bailout of Bradford & Bingley and the near-demise of the Royal Bank of Scotland (RBS) — an industry that loves acronyms had created a new one: BAB, standing for “bonuses are back.”

Five years on, the view of former City minister Lord Paul Myners is that not a lot has changed.

“The banks are still too big, too interconnected and too undercapitalized,” he said.

He is not alone in fearing that too little has changed to prevent another crisis and that lessons have not been learned. Turner, too, fears that history could repeat itself and Alistair Darling, British finance minister at the time of the bailouts, agrees: “As long as people think they can make money out of nothing, it will happen again.”

That is not to say there have not been changes. The Lehman crisis and the subsequent economic crisis led to a change in the political order and, in May 2010, to the first coalition government in the UK since World War II. Bankers’ heads rolled: Fred Goodwin, former CEO of RBS — now plain Mr after being stripped of his knighthood last year — was the first to go, paying the price for the October 2008 bailout. The top bosses at HBOS were not far behind and shortly afterward those of Lloyds and Barclays were gone.

The regulatory system discredited by the crisis has also been overhauled: the Financial Services Authority watchdog was shut down and replaced with a new Prudential Regulation Authority inside the Bank of England and a Financial Conduct Authority in the former offices of the City regulator.

However, this is not enough for some. Myners sees the regulatory changes as largely cosmetic. He said he never believed the regulatory architecture was to blame for the banking crisis and adds that these changes are “quite modest.”

Modest they may be, but they are causing confusion. The debate about the structure of the banking industry and the amount of capital banks should hold is still raging.

The British government is still trying to decide whether RBS — bailed out with £45 billion (US$71.6 billion) of taxpayers’ money in 2008 and 2009 — should be broken up. And there’s still no clear answer on how much capital banks should be required to hold, although a level was set in an international agreement known as the Third Basel Accord (Basel III), hammered out in Switzerland and scheduled to be introduced from this year.

Turner, who has in the past said that banks’ capital ratio should be higher (Basel is aiming at a minimum 7 percent by 2019; more for big firms), now thinks former Bank of England governor Lord Mervyn King was correct in his obsession with this issue. “[King] was always a capital hawk, saying banks needed a lot more capital,” Turner said. “In retrospect, he was right... If I was a benevolent dictator of a greenfield global economy, free to make decisions without worrying about either international negotiations or transition difficulties, I would go for much higher capital ratios even than Basel III.”

Sir John Vickers, who led the coalition government’s review into the future of banking and came up with the idea of ring fencing, last week called for capital ratios of 20 percent — four times the amount of capital RBS was holding when it nearly collapsed and more than double that required under international rules.

Debate is still raging about how to measure that capital. The focus has shifted from a straightforward capital ratio — which allows banks to use their own models to measure the risks they run — to a leverage ratio, where banks are not allowed to make judgments about whether some assets are riskier than others. At the moment, that ratio is set at 3 percent.

The debate has blown up a into row between the regulators and the banks, the latter arguing that being forced to hold more capital means they lend less to businesses and households. Using the leverage ratio has forced Barclays into a £5.8 billion cash call — the prospectus for which is due this week. This sum is less than the bank needed to find to escape a government bailout in 2008, but is still one of the largest ever by a UK bank.

Myners and others, however, reckon that even this leverage requirement is too low. “A 3 percent leverage ratio is still very thin, yet the banks have been able to convince the media that it will cause them to reduce their lending [if it is any higher],” Myners said. He reckons that a mere 3 percent capital requirement (which enables a bank to lend more than 30 times as much as the capital it holds) is “simply planning for failure.”

Darling laments that the international call to action made in the immediate aftermath of the crisis has lost urgency as memories of the panic fades. Darling said: “My biggest regret is that the collective will that was there in 2008-09 had disappeared by 2010.”

Since the crisis, the reputation of bankers has been damaged even further by a range of scandals such as those over mis-sold payment protection insurance in the UK, the repossessions that followed the US sub-prime mortgage bond debacle and the rigging of Libor rate.

Douglas Flint, chairman of HSBC — which was itself hit with a £1.2 billion fine for breaching money laundering rules in the US — said the problems are more deep-seated: “The focus has been on capital because we can measure it. However, the real issue is about culture.”

Attempts to change that culture focused on the bonus system. When the crisis hit, the finger was pointed directly at bankers’ bonuses, which had encouraged a culture of risk-taking: bankers stood to earn huge potential rewards, but with no penalty for making losses and no threat of losing payments if deals went bad years later.

The City regulator was one of the first in Europe to stop all-cash bonuses and demand that a proportion be paid in shares and spread over three years — the rationale being that this will make bankers think more carefully about their long-term actions.

Even so, in the first official audit of City pay, published in 2010, the regulator revealed that more than 2,800 top financial staff had been paid more than £1 million in the year after the bailouts.

Since then, data published by the European Banking Authority has shown that more than 2,400 bankers were paid more than 1 million euros in 2011. Data from the Office for National Statistics, which collects and publishes statistics related to the economy, population and society of England and Wales, shows that bonuses in the finance and insurance sector are heading back towards levels seen during the 2006-2007 boom, when they reached close to £20 billion. And in the year to April this year, some £14 billion was paid out in bonuses in the financial sector.

However, another way to change banking culture is to change the ways banks operate. The Vickers proposals currently weaving their way through parliament require a ringfence to be erected between high street banks and “casino” investment banks. HSBC’s Flint said this will show exactly where the risks lie. Bank of England deputy governor Andrew Bailey welcomes the ringfence plan but adds: “It’s not the answer on its own.”

While the Vickers proposals were more radical than many had expected after the May 2010 election, they are moderate compared with the Glass-Steagall reforms of the post-Depression era in the US, where full separation between investment banks and high street banks was mandatory — a reform that lasted until 1999, when lobbying by investment banks saw it swept away.

Yet even people who were directly involved in bailing out the banks have argued against such separation. Darling points out that a ringfence would not have stopped the collapses of Northern Rock or HBOS — “bog-standard high street banks that got into trouble.”

Many now fear that more trouble is brewing. “We would be naive to say we could not have another crisis in the next 10 years or so,” Myners said.

Darling does not set a timeframe for a further crisis, but fears it will come. “People will forget,” the former chancellor said. “Once the people who were there in 2008 have left [their jobs], the banks will lose their institutional memory.”

Senior Bank of England director Andy Haldane is also concerned about a forgetful City. In a speech this month he said: “Financial crises underscore the importance of a policymaker with institutional memory. This reduces the risk of disaster myopia, of ignoring worrying dots on distant horizons, of being information-rich yet attention-poor, of forgetting fat tails. To misquote Mark Twain, although crises do not repeat themselves, they do rhyme.”

Areas of concern now include the shadowy, unregulated banking sector in China and the weak lenders in the eurozone, many of which are still being kept afloat by the European Central Bank. “In Europe there is complete failure to deal with the banks apart from on a piecemeal basis,” Darling said.

He points out that much of the money was lost because of good old-fashioned lending errors rather than “fancy footwork.” This means there is reason to fear such mistakes could be repeating themselves — in, for example, the schemes created by British Chancellor of the Exchequer George Osborne to get the UK’s housing market moving. As much as he insisted last week that he was not creating a housing bubble, a record number of people are now employed in the estate agency business, house builders are once again reporting queues to snap up new homes and prices are rising at their fastest rate since the 2006 peak.

Business secretary Vince Cable last week said Osborne should consider postponing the next stage of Help to Buy, a British government-backed initiative set up to help home-hunters purchase a property with as little as a 5 percent deposit.

Darling is not impressed either

“The risk is putting more in people’s pockets to chase the housing stock that’s there. I am worried that will create another housing bubble where people think houses are worth more than they are,” he said.

Turner puts its more bluntly.

“The cure for this hangover, it seems, is the hair of the dog that bit us,” he said.