The Dogs that didn’t Bark (1)

 

Throughout all the financial crisis, attention has been centred on one aspect -- the culpability of the bankers and the problem posed by the bonus culture in banking.

 

But there are at least three other areas that need attention if the same mistakes are not to be made again: the role of the non-executive directors and, particularly, the chairmen of banks; the role of ratings agencies; and the role of the auditors. None of the dogs barked. Guard dogs that don't bark are completely worthless. 

The Walker Report, issued yesterday (16/07/09) may go some way to shifting attention to the first of these three groups. Initial “reaction” from the banks – in fact more accurately, off-the-cuff responses from high-bonus earners  stirred up by the diligent reporters of the FT --  suggest that Walker’s review little possibility of being implemented, while Gordon Brown remains in thrall to the City.

But action has got to be taken in this country -- as it apparently is in the USA -- to make sure that the credit ratings agencies held to account.

At the beginning of the noughties they altered the way that they charged for their services shifting the burden to the businesses being rated and giving the ratings information away to their previous customers. This put them in a clear conflict of interest  since they were now taking fees from people who would wish to receive th best possible rating rather than impartial assessment.  They  either failed to recognise this conflict or else recognised it and failed to do anything about it. Consequently everything got rated highly regardless of the true  underlying risk.

The FSA should review the activities of Moody's; D&B; S&P and the other ratings agencies to make sure that they behave properly and observe their duties to the end customer who relies on the integrity of their information

The other issues of the auditors -- the other dogs who didn't bark -- is less easily addressed. All the big four are guilty of giving clean bills of health to banks who within months were found to be riddled from top to bottom with toxic assets There are some senior people in the accounting profession who need to be held to account. To be continued……

Start Worrying -- It's Business As Usual for the Banks

On Wednesday evening (1st july 2009) Jeremy Paxman devoted most of his BBC2 Newsnight programme to new reports of bonus payments in the financial sector. He had heavyweight guests: Nobel prize winner Joseph Stiglitz; Liberal Treasury spokesman Vince Cable; Sir Brian Pitman, ex-chairman of LLoyds TSB; and Paul Myners (Lord Myners), Financial Services Secretary to the Treasury. Gillian Tett of the FT, this year's Financial Journalist of the Year and award-winning author also played a walk-on part

Paxman's story led with the news that for the City the recession is over; "Bonuses are Back" and the good times are rolling again. Goldman Sachs has reportedly set aside £600m in bonuses for its staff and 430-plus Barclays managers will share over £732m in bonuses.

Now, neither of these two financial institutions talk government rescue money, so they are free agents as to how they remunerate their staff. But these bonuses are being paid within a few months of the near-collapse of the financial foundations of the Western world when the change in the culture was supposed to be shifting to long-term horizons matching bonuses with certain returns and was supposed (if it was going to work at all) to apply to all banks -- either by diktat or by osmosis.

Presumably neither Sir Brian nor Lord Myners are fools -- their positions in life would suggest that they can assess evidence; make rational and reasoned judgments and add up to twenty without taking their shoes and socks off. So why did they persist in insisting -- in the face of a billion pounds worth of bonus evidence -- that the bonus culture of the City had changed? Why aren't they devoting their energies to changing that culture with concrete actions rather than singing lullabies to send us to sleep -- again? and if they aren't fools or knaves or liars -- what do they presume we are?

The Sorcerer's Apprentice

Think of the chiefs of the large banks like a character from Mickey Mouse. Yes, i know it's hard -- but try.

Think particularly of Fantasia -- and the Sorcerer's Apprentice sequence, where Mickey dresses up in the magician's cloak (much too big for him), consults the book of spells and proceeds to get the brooms to carry water backwards and forwards to clean the floor of the magicians house. Hold that image in your mind while you read the rest of this note.

As the immediacy of the crisis recedes, so more time for reflection brings increasingly complex solutions to the financial mess we find ourselves in.

Originally the proposed distinction seemed to be between 'good banks' and -- somewhat unoriginal, this -- 'bad banks'. Good banks would be what was left after all the financial pus was cleaned out of the wound and bad banks was where all the icky stuff would go. The Swedes more or less invented the structure years ago during their last banking crisis, (in comparison to the Japanese who kept everything bundled together and ended up with 'zombie' banks). Ordinarily banks want to retain and attract customers; that sort of bank would be the good banks. By contrast the purpose of the bad banks would be to get rid of their customers by gradually working out the loans, with minimal losses of value; running the two different sorts of bank requires different sets of managerial skills.

A development of the good bank/bad bank idea was to revive the structure brought about by the American Glass-Steagall Act of 1933 (repealed by one W Clinton in 1999) which prohibited American banks from undertaking both commercial and investment banking. The thinking behind this was that it was the investment banks which got us into this mess so if we can them separate from the High Street retail banks, then we shan't have any more runs on banks, which so frightened the horses, and the financial regulators can contain the effects of whatever self-harm the bankers do to the bankers themselves, rather than precipitating the whole world to the brink of financial catastrophe.

Recently, however, the debate has got more complex. Some commentators have pointed out that it wasn't just the investment banks (the complex ones) that got us into trouble. it was in fact the High Street (simple) arms of the banks playing around with things that they didn't know the power of -- a bit like the Sorcerer's Apprentice.

So the argument from these supposedly more sophisticated commentators is that we shouldn't try to separate the banks into simple and complex or good and bad , because that wasn't the root of the problem.

Regardless of whether it was or was not, what the recommendations of the simple bank proponents ignores is this. The money that the investment banks play around with is mostly based on pension funds, insurance funds, corporate treasury money and municipal treasury. In other words all the really big money that matters for the long run. So regulating the paltry High Street funds tightly and letting the Sorcerer's Apprentices continue to play with the long-term wealth of the economy doesn't really seem like too sophisticated a solution, does it?.

Rather than give Mickey Mouse the book of spells to play with in any part of the banking structure and try to proof the rest of the structure against him, we ought to make sure that all the structure is as Mickey Mouse-proof as we can get it in the first place.