Wunch of bankers

It has been a bad week for the erstwhile great and good of the banking industry in both the UK and the US. On both sides of the Atlantic, senior bankers have been publicly flagellated by politicians for their perceived sins, while in the UK a former banker turned regulator has been forced to resign over suggestions that he fired a whistleblower.

Two executives from each of HBOS and RBS, now partly nationalised, appeared before a House of Commons committee in London at the start of several days of hearings into the financial crisis. All four made extensive use of the words "apologise" and "sorry", but failed to convince the assembled MPs (or, I daresay, most of the public) that they were truly contrite. All four seemed to be dismayed that things had gone so horribly wrong, but rejected any suggestion that it might have been their fault. To borrow from the US children's author Lemony Snicket, they appeared to see it all as "a series of unfortunate events".

This really doesn't wash. Most elements of a bank run themselves on a day-to-day basis, yet it's unlikely that any of the Gang of Four could actually do the job of a teller or a branch manager. Sir Fred Goodwin and his ilk are paid serious money to look at the big picture -- building a sound franchise, protecting the bank's capital and earning long-term profits for shareholders. The gung-ho push for growth at both HBOS and RBS in the early part of this decade was incompatible with these goals. If Sir Fred and his pals couldn't see that, they were unequivocally to blame for what happened next.

Media commentators on the four men's testimony have expressed frustration that it still seems unclear why they allowed these bad things to happen to their good banks. I've written before about the confluence of factors that made the crisis possible: cheap credit, the explosion of derivatives and so on. But there is still a story to be told about why those in charge failed to prevent it.

Banks are competitive institutions and senior bankers are competitive people, but there's a clear tendency towards groupthink. It's a standing joke in the industry that no Japanese bank will try something new unless all its competitors join in, but the same is true of bankers everywhere. If one bank seems to be making pots of money in a new business, the rest will pile in. The inevitable consequence is a series of bubbles, sometimes in more than one product at a time, like the unholy trinity of REITs, tanker loans and LDC lending that plagued the industry three decades ago.

The tendency to move as a herd is enhanced by the fact that bank directors are drawn from a narrow pool of senior business types. They all know each other, and when they meet at Glyndebourne or the Hamptons, they inevitably brag about their institutions' latest wheezes. In no time, senior management back at head office is getting an ear-bashing about how they're missing the boat. This may sound far-fetched or even childish, but I've actually seen it happen repeatedly though the years, usually with unfortunate results.

The current financial crisis reflected groupthink on a global scale, but with one new twist. This time, the most senior people at the world's major banks simply did not understand the details of the products they were taking on. Instead they allowed themselves to be talked into taking unquantifiable risks by hugely qualified but totally inexperienced specialists, secure in the knowledge that almost all of their major competitors were doing the same thing.

There were exceptions. I once heard a senior investment banker declare that he'd never seen a derivative he didn't like. Fortunately for that bank's shareholders, the CEO had never seen a derivative he fully understood, and stayed away from the riskier parts of the business. However, it takes real courage for a senior banker to admit he doesn't understand something when all his competitors seem to be making out like bandits.

While the MPs and their opposite numbers in Washington were tryingto get to the bottom of all this, a senior UK regulator abruptly quit. Sir James Crosby, second in command at the main UK industry regulator, the FSA, had previously been CEO at HBOS, which was recently forced into a merger with Lloyds TSB. A former executive of HBOS is alleging that he warned Crosby as long ago as 2002 that the bank was growing too quickly -- and was fired for his trouble. Crosby denies this, but the FSA has admitted that it too had expressed concerns about HBOS's business model while Crosby was still in charge. One can only imagine the expressions of horror at FSA headquarters when the Government forced Crosby on them.

One interesting aspect of this is that the FSA relies very much on whistleblowers to help it do its job. The regular money laundering training to which all bankers in the UK are subjected stresses the absolute duty of each employee to inform compliance officers if they have any concerns about how their firm is being run. Failure to do so is treated by the FSA as equivalent to covering up a crime. If Crosby really did fire a whistleblower, his presence at the very top of the FSA would constitute a remarkable lapse on the part of the Government.