Alex Crossman
Above: Adair Turner’s interview in the September issue of Prospect hit the headlines and caused a furore in the City
The City takes too big a share of our economy and is bloated by doubtful profits from dubious activities. Not the allegations of placard-wielding demonstrators but of Adair Turner, chairman of the Financial Services Authority (Prospect, September), and of Lloyd Blankfein, chief executive of Goldman Sachs (to a German banking conference in September), respectively. Suspicion inevitably accrues both to an embattled regulator talking tough and an emollient investment banker. And neither Turner nor Blankfein seems comfortable in their role as Jeremiah. But is either right? Is the City too big?
Britain faces an estimated bill of £130bn for shoring up its banking system, a higher proportion of GDP than any other country. This alone should put the issue of the “right” size of the finance sector on the agenda. Unfortunately, the question yields no easy answer. There is no consensus on a relevant measurement, or even on whether the statistics—especially those in Britain’s national accounts—are reliable. Britain has a historic comparative advantage in finance, so one would expect it to have a relatively larger finance sector than some other countries. No one thinks it odd that Germany has a big car industry.
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Tom Streithorst
City limits: the sector must shrink
The outcry at proposals recently floated by FSA chief Lord Turner in Prospect suggests that the City knows they would be effective. The City does not fear “regulation”; regulations can always be circumvented. But a Tobin tax, an infinitesimal levy on all financial transactions, would squash the profitability of much of the short-term trading which swells investment bank profits without doing anything to create value in the real economy.
For the past 30 years, the economics profession has been in the grip of a dangerous delusion, namely that all financial transactions are intrinsically beneficial, in that they create “deeper, more liquid markets.” The credit freeze that began on 9th August 2007 tells us that this liquidity is more apparent than real, that in moments of danger, when markets really need liquidity, it just evaporates. Without the liquidity “fig leaf,” the rationale of social and economic benefits for much trading activity becomes impossible to maintain.
The current financial crisis gives us a chance to return to an earlier understanding of the purpose and function of financial markets. Finance exists in order to most efficiently transform societal savings into productive investment. It is a deal between the present and the future; forgoing consumption now in order to invest in capital goods which will spur productivity, thus allowing greater consumption at a later date.
The explosion in the size and profitability of the financial sector since the early 1980s has almost nothing to do with the creation of capital goods. Real investment as a share of GDP has declined even as financial sector profits have gone through the roof. Arbitrage, intra-day trades, short term purely financial self-referential transactions, which do nothing to create real investment and do nothing for the real economy, would all be priced out of business by a Tobin tax.
The financial sector has grown too big. It needs to shrink. The Tobin tax will do that, without hurting the rest of us. That’s why the bankers are getting apoplectic in the Financial Times. Finance needs to stop being a parasite on the real economy and once again return to its traditional role of creating capital goods and so increasing worker productivity. That is how finance can make all of us richer.
David Goodhart
As the 2009-10 political season splutters into life there is no bigger question facing this country than the future shape of our most important industry: financial services. In this month’s interview with Britain’s top financial regulator Adair Turner, a respected group of experts talks about the swollen size and excessive profits of high finance using language that would, until recently, have been heard only on the wilder reaches of the left. Turner himself even backs a global Tobin tax on financial transactions, something normally sneered at in the Anglo-Saxon world. Yet the crisis—in Britain at least—has not benefited the left. Instead it seems to have prompted a fresh bout of political cross-dressing with the Tories raging against their own City backers and Labour cursing the fat cats but unable to do anything constructive about them—a further coda to its slow death.
Notwithstanding Turner’s bold words, his Financial Services Authority has lately been under fire not for its radicalism but rather its feebleness in the face of a revived bonus culture. And there does seem to be a case to answer. There is now a broad consensus that big City bonuses are both morally dubious and contributed to the crisis through encouraging excessive risk. Yet, just one year on from the fall of Lehman, here they are again, this time partly underwritten by the taxpayer. Government ministers (in private) and George Osborne, the shadow chancellor, blame the FSA. But this is not fair: the FSA doesn’t have the legal authority to cap pay or bonuses. The government does have the authority.
Parliament could pass a law banning pay above, say, £500,000 a year in the City—but the law would either be side-stepped or financial firms would leave London. More practically, why isn’t the government using its powers as a shareholder in Royal Bank of Scotland and Lloyds (and as a provider of state guarantees to private banks like Barclays) to enforce better behaviour? It must be possible to apply some sort of check on bonuses without sinking the City. The deeper problem, as Turner points out, is that bonuses are a symptom of the super-profits earned by wholesale financial firms. What is required in the longer run is more vigilance from big investors (pension funds and so on), global agreements that constrain the market power of financial insiders in the world’s biggest industry, and perhaps even a shift in the moral climate (see Amitai Etzioni’s reflections on transcending consumerism).
Welcome to Anne McElvoy, our new British politics columnist. And we have redesigned our website and made it more user friendly—after reading Kamran Nazeer’s true story of a haunting you might want to visit his article online and offer him some advice.
Chris Hughes
The London stock market has been trading at a ten-month high. The best traders are signing multimillion pound contracts. Sealed bids have returned to the top end of the housing market. A year after the collapse of Lehman Brothers on 14th September 2008, the City feels like it is returning to normal.
But the City looks very different. The crisis was well underway when Lehman went bust but the firm’s collapse introduced an intense period of turmoil. British taxpayers have over the past year spent £50bn on shares in British banks and put at least a further £500bn into supporting the financial system.
Lehman’s collapse froze the western financial system. If the authorities were willing to allow the failure of Lehman, a large company close to the centre of the financial world, any bank might be allowed to topple. Trust between banks evaporated. “Overnight dollar Libor”—the rate at which banks lend to each other—rose from 2.15 per cent to 6.44 per cent. Money-market funds, on which many banks rely for cash, cut back the duration for which they would lend.
Much of Lehman’s actual business was stabilised quickly. Barclays, the British high-street lender with ambitions to build a global investment bank, bought the core US operation out of bankruptcy. Nomura, the Japanese bank with similar global pretensions, bought the European and Asian parts out of administration. Lavish bonuses were offered to keep staff from leaving. Ironically, Lehman became a safe place to work.
But if Lehman’s demise was good for Barclays, it was disastrous for HBOS, owner of Halifax and Bank of Scotland. HBOS relied on tricksy money-market funding. Its shares plunged as much as 69 per cent in the three days after Lehman’s collapse. In an unprecedented move, the Financial Services Authority (FSA) issued a statement saying the bank had sufficient cash and capital, and banned speculators from practices that could put downward pressure on financial shares.
But the watchdog’s action only increased the panic. A Northern Rock-style run was prevented only by a leak to the BBC that HBOS faced a takeover by Lloyds TSB. Lloyds had long coveted such a deal but was blocked by competition law. Now it had the government’s blessing for a merger. The hasty deal later cost Lloyds chairman Victor Blank his job.
On the other side of the Atlantic, the waning Bush administration was struggling to get its Troubled Asset Relief Programme—a $700bn plan for buying up bad debt from banks— through congress. American International Group, the world’s largest insurer, was rescued from the brink of collapse.
October: Financial Armageddon seemed imminent. Confidence in Britain’s banks continued to ebb away. On 8th October, the British government took action, agreeing to provide up to £50bn of capital, £200bn of short-term funding and guarantees on £250bn of British bank debt. It was a year since the difficulties at Northern Rock. Back then, the Bank of England had censoriously explained that central banks did not try to keep banks from collapsing. But desperation softens many principles. And there was still the hope that the confidence fostered by the explicit declaration of state support might render actual support unnecessary.
By the time markets closed on Friday 10th, shares in Britain’s banks had fallen sharply again. Monday brought the watershed moment in Britain’s financial crisis. The government said it was sinking £37bn into Royal Bank of Scotland, owner of NatWest, and the soon-to-be-merged Lloyds and HBOS. It was a humiliation for RBS’s empire-building chief executive, Fred Goodwin. Two of Britain’s biggest banks were now de facto nationalised and full nationalisation of the entire sector seemed possible.
Even so, the crisis at this point remained financial. The real economy looked relatively healthy. The MSCI World Index of stocks rallied nearly 21 per cent in the last weeks of October.
But another chapter of the crisis was yet to come.
November: Citigroup, once the world’s largest bank, went into in a “death spiral” as equity and then debt investors withdrew support, feeding off each other’s fear. Fresh losses were emerging at Merrill Lynch, the investment bank bought by Bank of America while Lehman was sinking. Barclays, intent on resisting government intervention, raised capital from middle eastern investors.
Each day brought news of job cuts at the big-name investment banks in London’s Square Mile and Canary Wharf—Citi, Merrill, UBS, Morgan Stanley, Credit Suisse, even the “crisis winner,” Goldman Sachs. Entire firms were disappearing. Dresdner Kleinwort was radically shrunk following the takeover of Dresdner Bank by German peer Commerzbank.
Hedge funds, which use borrowed money to multiply their bets, were suffering too. Toscafund, run by one of the City’s most respected money managers, Martin Hughes, made an emotional written appeal to its investors not to pull money out. And private equity companies were staring at portfolios full of debt-ridden companies approaching negative equity.
January 2009: The new year brought a fresh collapse in confidence when British bank stocks plummeted in the last half hour of trading on Friday 16th, hours after the FSA lifted the trading curbs introduced when HBOS was in freefall. Yet again, the government scrambled over a weekend to finalise a second banking bailout. On Monday, the government said it would insure banks against future losses—a radical step-up in the taxpayers’ exposure, later set at a possible £585bn. It also committed to cover any losses on a new £50bn initiative to get credit flowing.
The mounting public costs were now making the crisis a political issue. The media whipped up public outrage with revelations that RBS might pay bonuses in spite of coming under state control.
February: The treasury select committee began show trials of Britain’s banking chieftains. The directors’ scripted apologies were perhaps a necessary step but for some, they weren’t enough: Fred Goodwin’s Edinburgh home was vandalised a few days later, one of surprisingly few acts of violence in the crisis.
In the City, some older bankers privately voiced shame that bonuses were being paid at all. But many investment bankers were still quick to trot out age-old justifications: “We’ll go offshore otherwise,” and “I wasn’t the one who lost money.”
March: Global stocks hit their crisis trough on Monday 9th, with some indices at 12-year lows. With hindsight, this point—almost six months on from the collapse of Lehman—looks like the nadir.
By now, the extreme weakness of the markets was taking its toll elsewhere. Insurers’ assets had been pummelled. Legal & General, Britain’s fourth largest insurer, cut its dividend for the first time in living memory. Shares in rival Aviva fell 36 per cent during a single trading session.
And the financial crisis had become an economic crisis. Economists were forecasting that Britain would suffer the deepest recession in decades. The Bank of England started its policy of “quantitative easing,” or printing money.
April: An absence of further bad news—in particular, the continued survival of Citi—helped to restore calm. By the time world leaders met in London for the G20 summit on 2nd April, there was talk of “green shoots” in the markets.
The results season was starting to show that the market turmoil wasn’t all bad for the banks. The City had a new buzzword: “flow businesses.” This referred to high-volume trading in areas such as currencies, commodities and government and corporate bonds. While all markets had been whipsawed in late 2008, these businesses were staging a rapid recovery.
Indeed, the crisis was creating favourable conditions for those banks still standing. Huge government deficits created by bank bailouts and economic stimulus had led to a surge in government debt issuance. Companies were tapping the global markets for cash because banks were reluctant to lend. The activity was frenetic and the profits available were being spread around fewer institutions. It is hard to imagine a better demonstration of why investment banking is so often called a merry-go-round.
As world leaders agreed a new blueprint for financial regulation—and protesters hurled rocks at an RBS branch in the heart of the City—bankers bandied around a new acronym: BAB, “Bonuses are back.” Those favourable market conditions continued into the summer. Barclays’ investment banking division made £188,000 per employee in the first half of 2009 (it employs 21,900 people).
August: The City is making money again. But it has also witnessed creative destruction and corporate concentration. Britain’s voice among global regulators has lost much of its former authority. That may explain the newfound confidence in European attempts to regulate private equity and hedge funds, a big business for the City.
The new regulatory framework has yet to be written. But while the FSA softened some proposals to curb bankers’ pay, new regulation is set to increase banks’ cost of doing business and dampen super-profits and bonuses. The flipside is that these costs also raise barriers to entry—and will help sustain the tighter oligopoly that the City has become.
Tom Streithorst
Lehman Investment Bankers Protest
Never waste a good crisis. So says Rahm Emanuel, Obama’s right hand man. Sorry Rahm but it looks like we already have. At least, that’s what this banker told me, and with the return of big bonuses by firms recently bailed out by government, I fear he’s right.
A few weeks ago, after a scintillating lecture about Credit Derivative Swaps (yeah I know, I’m a sad, sad, boring man), I was sipping a cocktail at the bar of the Frontline Club, standing next to two bankers. In my friendly American way, I started chatting with them. In my irritating American way, I let them know what I thought of their profession, ranting that investment bankers have become parasites, that finance no longer serves the needs of the real economy, that the financial tail is wagging the productive economy dog. One of them, a short prim man in an expensive suit, turned away with a snort muttering something about how risk management has been around since ancient Egypt and is the hallmark of civilisation (I thought it was fresh bread or maybe fermented grapes) and but the taller one was amused enough to continue our conversation…. Read more »
CityBoy
The lobster test
There are numerous gauges of economic health – whether you prefer to look at retail prices, consumer prices, industrial production, gross domestic product or business confidence the list, it seems, is almost endless. And with today’s news of the return of City bonuses and bank profits we might also see the return of lavish lifestyles.
For those of us on the periphery of the financial services industry itself, however, there is a much more direct way of measuring sentiment – the lobster test.
Corporate hospitality is as much a feature of the business as the 12-hour days and the pin-striped suits. Whether it’s champagne and cucumber sandwiches in a box at Lord’s or fine wines and nouvelle cuisine at the Connaught Hotel, Mayfair, being wined and dined is very much the axel grease of the industry during the good times.
It was all the more noticeable, therefore, when despite bullish statements of business as usual the freebies dried up last year.
I’m sure it was in part a response to the pressures of public scrutiny – it would never do to be caught swilling champers while you’re sacking the back office workers – but unspoken significance of it was a creeping belief that the days of excess might really be over.
And it wasn’t just the bankers. PR companies, which fed like ticks on the excesses of the industry at its pomp, suddenly went silent as attention turned from public posturing to simple survival.
This week, sitting over a seafood and saffron risotto in the heart of the city while my host worked his way around a lobster’s blushing carcass, it was starkly demonstrated to me that those ‘good ol’ days’ might not be as gone as we’d imagined.
Lo and behold back at the office the phone has started ringing again with PRs positively bristling with new and exciting ideas to pass on over a glass of Sauvignon Blanc. Read more »
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