Will Hutton traces the banking crisis back to the Big Bang
Will Hutton
The Guardian, Saturday 2 May 2009
Article history
Chasing Alpha: How Reckless Growth and Unchecked Ambition Ruined the City's Golden Decadeby Philip Augar272pp, Bodley Head, £20
Fool's Gold: How an Ingenious Tribe of Bankers Rewrote the Rules of Finance, Made a Fortune and Survived a Catastropheby Gillian Tett352pp, Little, Brown, £18.99
Meltdown: The End of the Age of Greedby Paul Mason192pp, Verso, £7.99
The Crash of 2008 and What It Means: The New Paradigm for Financial Marketsby George Soros288pp, Public Affairs, £9.99
Gordon Brown will not think it, but in the politics of credit crunch he is a lucky man. His speech at the Mansion House on Wednesday 20 June 2007, days before he took office as prime minister, is one of the greatest political and economic misjudgments among postwar politicians. Yet very few have read or even recollect it. But then his political opponents, outbidding him at the time in their slavish praise of the City, have even more embarrassing quotes on the record. They are hardly in a position to attack him.
"This is an era that history will record as a new golden age for the City of London," Brown intoned. "I want to thank all of you for what you are achieving." Just weeks later the financial catastrophe burst, creating the "great recession" and leaving the UK taxpayer with a one-sided exposure of £1.3 trillion in loans, investments, cash injections and guarantees to the banking system, of which over £100bn may be lost for ever. Brown went on to hymn the City's "creativity and ingenuity" that had enabled it to become a new world leader. In language so purple it could make a cardinal blush, he praised London's invention of "the most modern instruments of finance" - the very instruments that were to bring it and the western banking system down.
Invoking Adam Smith, Brown declaimed: "The message London's success sends out to the whole British economy is that we will succeed if, like London, we think globally ... and nurture the skills of the future, advance with light-touch regulation, a competitive tax environment and flexibility." He even managed to boast that, after financial and accounting scandals in the US such as those that brought down Enron and WorldCom, which led the American government to introduce new regulatory reforms, "many who advised me, including not a few newspapers, favoured a regulatory crackdown. I believe we were right not to go down that road."
The boastfulness, the wholesale endorsement of the philosophy that was to bring the world to the economic edge and the sheer ignorance are painful to read - tribute to the way the bankers completely pulled the wool over the eyes of the political and regulatory establishment in one of the greatest heists the world has witnessed. The IMF now calculates that there are $4.1 trillion of losses in the world financial system, less than half of which has been formally written off. Without massive government support, the scale of the banking collapse that would have followed such losses would have induced a global depression. Even as it is, world trade will this year decline by 9%. Alistair Darling's budget has already passed into legend as the most depressing since the war. The credit-crunch-ravaged, post-recession British economy will be unable to shoulder the size of the current British state. In the most challenging decade since 1945, a way has to be found of shrinking its size while still finding new ways to grow and alleviate mass unemployment.
It is a disaster, or, as BBC Newsnight's Paul Mason would have it, a financial Krakatoa. It is the economic and financial story of our times, and he, the Financial Times journalist Gillian Tett and financial author Philip Augar have all been inspired to write "crash" books. Each is gripping and revelatory, with sometimes breathtaking quotes or new facts, and each adds a different dimension to our understanding of the crisis. Their subtitles tell of greed, recklessness and catastrophe - and all three writers are as good as their promise. What has happened to finance and the financial system since London's Big Bang in 1986 is an astounding story of ideology, greed and lack of restraint - sanctioned by our politicians who, like Brown, marvelled at the apparent results without beginning to understand how they were achieved. Moreover, they built regulatory systems to suit the bankers' interests. You might have hoped that politicians of the left would have been savvier and more suspicious of the bankers' claims. One of the tragedies of New Labour is that the party leadership bought the story so completely - Brown becoming as much of a zealot for free-market financial innovation as the free-market fundamentalist neocon Alan Greenspan, whose knighthood he organised.
The books leave no doubt that it is the bankers and their greed who were the authors of the crisis. True, there were dollars spilling out of Asia and the Gulf in huge volumes in the 2000s, and low interest rates created an appetite for taking risks. But bankers seized the opportunity to lend unprecedented amounts on ever smaller amounts of capital, with the risk apparently abolished by the invention of new financial instruments and tradeable insurance contracts. This is Tett's original contribution. Her blow-by-blow story of how these were developed during the 1980s and 90s, and the motivations of those who did it, is an impressive piece of detective work. She pulls back the curtain on a closed, unaccountable world of finance - a "silo in its own right detached from society". My only cavil is that I wish she could have got as much access to top British bankers as she got to American ones, and in particular those in JP Morgan: her locus is too much New York.
That is made good by Philip Augar, a former investment banker who has made it his mission to reveal the systemic and destructive way that British finance works. He understands both the people and the processes - and Chasing Alpha is his best book yet. He even devotes a chapter to Brown's Mansion House speech. Together, he and Tett make it clear beyond peradventure that it was the structure of the financial system that created the havoc, and that it was firmly embedded in the intertwined London and New York markets from the 1980s onwards. Similar-scale dollar surpluses in the 1970s did not create such financial problems; but that was before the Thatcherite and neoconservative revolutions.
In 1933 Senators Glass and Steagall, prompted by Roosevelt, had sponsored the Glass-Steagall Act, prohibiting investment bankers betting deposits on the buying and selling of tradeable financial securities that can create huge losses. Banking and investment banking should be separate. For 50 years the act kept American banking honest. But after Mrs Thatcher decided in 1986 that banks could own stockbrokers and market-making stock jobbers in her new anything-could-go casino City of London - the "Big Bang" - American banks complained to the US central bank, the Federal Reserve, that they could do things in London not possible in New York. Paul Mason explains how in 1987 the Fed relaxed Glass-Steagall to allow 5% of a bank's deposits to be used for investment banking, further relaxed to 25% in 1996. The act's abolition in 1999, which opened the floodgates for today's financial catastrophe, was inevitable - even if it cost the banks $300m in lobbying fees.
Tett shows how the regulators rolled over in another core area. In the late 1990s they accepted the banks' argument that their alchemy in creating collateralised debt obligations (bundling up income-generating assets of varying quality into one security) and then insuring against the risk of default (credit default swaps) both merited the triple A credit scores the credit agencies were awarding and, crucially, needed less capital to stand behind them. By 2000 the stage was set for what was to follow: investment banks having balance sheets 30 times or more larger than their core capital, refinancing as much as a quarter of their trillions of dollars of liabilities every day from the so-called wholesale money markets, and lending/investing in a range of highly risky financial instruments. The system could not insure against its own systemic failure. It was an edifice built on sand: $1 trillion of sub-prime debt had been bundled into various categories of structured, tradeable debt; when American house prices began to crumble in 2007, the whole interlinked pyramid came crashing down.
Mason's first three chapters are a page-turning account of September and October of last year, when it did look as though the American and British financial systems were about to collapse - the fateful weekend in September when Lehman Brothers went bust and America's top insurance company AIG only survived courtesy of an $80bn loan, and later, in early October, when Britain's RBS and HBOS were hours away from implosion. Mason, I think correctly, emphasises the highly risky way some British commercial, and other, mortgage lenders had become reliant on the money markets to support their lending, so that RBS and HBOS were in an analogous position to the US investment banks Lehman and Bear Stearns, both of whom went bust. At the root of the crisis were the interaction of money market-financed balance sheets, too much consequential borrowing and the new "weapons of mass financial destruction".
Mason is refreshingly clear-eyed about the operation of today's finance-driven capitalism - and angry. It wasn't only that the banks and insurance companies campaigned to have the law changed to serve their interests with such disastrous results. Sometimes, as with AIG, they began to transgress the law. AIG admitted in 2005 that it had faked $500m of transactions to fool the auditors, and "misclassified" another $3bn to inflate its profits. I have no doubt that there are more instances that may never come to light. Britain has insured £585bn of bank loans. It is hard to believe that every penny of bad debt on such a scale was just honest misjudgment. Do we believe that the British were angels and the only frauds American?
George Soros, successful hedge fund entrepreneur and famous beneficiary of the pound's expulsion from the European Exchange Rate Mechanism, has been trying for decades to explain that the axioms of free-market economics do not apply to the financial markets. Brown and Greenspan were always wrong to believe that free financial markets would tend to optimal outcomes. Rather, markets feed on themselves, so that financial values have a permanent tendency to swing between boom and bust - they are never rational. The crash of 2008, Soros explains, was an accident waiting to happen. Recovery will require regulation that compels banks to carry more capital and lend more judiciously. But until the international financial system is fairer to the less-developed countries on "the periphery", the core of the world economy will always be at risk of being flooded by hot money fleeing from that risky periphery.
This quartet of books indict modern finance. They cannot be read without wishing for something different. Yet even now I am not sure that the politicians and officials get it. The support for British banks is disgracefully one-sided. The taxpayer will lose at least £50bn, if not £100bn, but there has been no concomitant willingness on the part of the bankers to restructure their business model - or accept that their pensions, bonuses and pay should be seriously qualified. They want to get back to the glory days, and if once in every 30 or 40 years the rest of us suffer recessions and a £100bn bill while they make personal fortunes - so be it. It is not a fair bargain. These books set out why, and how it could be changed. Read all of them.
• Will Hutton is executive vice-chair of the Work Foundation
Will Hutton
The Guardian, Saturday 2 May 2009
Article history
Chasing Alpha: How Reckless Growth and Unchecked Ambition Ruined the City's Golden Decadeby Philip Augar272pp, Bodley Head, £20
Fool's Gold: How an Ingenious Tribe of Bankers Rewrote the Rules of Finance, Made a Fortune and Survived a Catastropheby Gillian Tett352pp, Little, Brown, £18.99
Meltdown: The End of the Age of Greedby Paul Mason192pp, Verso, £7.99
The Crash of 2008 and What It Means: The New Paradigm for Financial Marketsby George Soros288pp, Public Affairs, £9.99
Gordon Brown will not think it, but in the politics of credit crunch he is a lucky man. His speech at the Mansion House on Wednesday 20 June 2007, days before he took office as prime minister, is one of the greatest political and economic misjudgments among postwar politicians. Yet very few have read or even recollect it. But then his political opponents, outbidding him at the time in their slavish praise of the City, have even more embarrassing quotes on the record. They are hardly in a position to attack him.
"This is an era that history will record as a new golden age for the City of London," Brown intoned. "I want to thank all of you for what you are achieving." Just weeks later the financial catastrophe burst, creating the "great recession" and leaving the UK taxpayer with a one-sided exposure of £1.3 trillion in loans, investments, cash injections and guarantees to the banking system, of which over £100bn may be lost for ever. Brown went on to hymn the City's "creativity and ingenuity" that had enabled it to become a new world leader. In language so purple it could make a cardinal blush, he praised London's invention of "the most modern instruments of finance" - the very instruments that were to bring it and the western banking system down.
Invoking Adam Smith, Brown declaimed: "The message London's success sends out to the whole British economy is that we will succeed if, like London, we think globally ... and nurture the skills of the future, advance with light-touch regulation, a competitive tax environment and flexibility." He even managed to boast that, after financial and accounting scandals in the US such as those that brought down Enron and WorldCom, which led the American government to introduce new regulatory reforms, "many who advised me, including not a few newspapers, favoured a regulatory crackdown. I believe we were right not to go down that road."
The boastfulness, the wholesale endorsement of the philosophy that was to bring the world to the economic edge and the sheer ignorance are painful to read - tribute to the way the bankers completely pulled the wool over the eyes of the political and regulatory establishment in one of the greatest heists the world has witnessed. The IMF now calculates that there are $4.1 trillion of losses in the world financial system, less than half of which has been formally written off. Without massive government support, the scale of the banking collapse that would have followed such losses would have induced a global depression. Even as it is, world trade will this year decline by 9%. Alistair Darling's budget has already passed into legend as the most depressing since the war. The credit-crunch-ravaged, post-recession British economy will be unable to shoulder the size of the current British state. In the most challenging decade since 1945, a way has to be found of shrinking its size while still finding new ways to grow and alleviate mass unemployment.
It is a disaster, or, as BBC Newsnight's Paul Mason would have it, a financial Krakatoa. It is the economic and financial story of our times, and he, the Financial Times journalist Gillian Tett and financial author Philip Augar have all been inspired to write "crash" books. Each is gripping and revelatory, with sometimes breathtaking quotes or new facts, and each adds a different dimension to our understanding of the crisis. Their subtitles tell of greed, recklessness and catastrophe - and all three writers are as good as their promise. What has happened to finance and the financial system since London's Big Bang in 1986 is an astounding story of ideology, greed and lack of restraint - sanctioned by our politicians who, like Brown, marvelled at the apparent results without beginning to understand how they were achieved. Moreover, they built regulatory systems to suit the bankers' interests. You might have hoped that politicians of the left would have been savvier and more suspicious of the bankers' claims. One of the tragedies of New Labour is that the party leadership bought the story so completely - Brown becoming as much of a zealot for free-market financial innovation as the free-market fundamentalist neocon Alan Greenspan, whose knighthood he organised.
The books leave no doubt that it is the bankers and their greed who were the authors of the crisis. True, there were dollars spilling out of Asia and the Gulf in huge volumes in the 2000s, and low interest rates created an appetite for taking risks. But bankers seized the opportunity to lend unprecedented amounts on ever smaller amounts of capital, with the risk apparently abolished by the invention of new financial instruments and tradeable insurance contracts. This is Tett's original contribution. Her blow-by-blow story of how these were developed during the 1980s and 90s, and the motivations of those who did it, is an impressive piece of detective work. She pulls back the curtain on a closed, unaccountable world of finance - a "silo in its own right detached from society". My only cavil is that I wish she could have got as much access to top British bankers as she got to American ones, and in particular those in JP Morgan: her locus is too much New York.
That is made good by Philip Augar, a former investment banker who has made it his mission to reveal the systemic and destructive way that British finance works. He understands both the people and the processes - and Chasing Alpha is his best book yet. He even devotes a chapter to Brown's Mansion House speech. Together, he and Tett make it clear beyond peradventure that it was the structure of the financial system that created the havoc, and that it was firmly embedded in the intertwined London and New York markets from the 1980s onwards. Similar-scale dollar surpluses in the 1970s did not create such financial problems; but that was before the Thatcherite and neoconservative revolutions.
In 1933 Senators Glass and Steagall, prompted by Roosevelt, had sponsored the Glass-Steagall Act, prohibiting investment bankers betting deposits on the buying and selling of tradeable financial securities that can create huge losses. Banking and investment banking should be separate. For 50 years the act kept American banking honest. But after Mrs Thatcher decided in 1986 that banks could own stockbrokers and market-making stock jobbers in her new anything-could-go casino City of London - the "Big Bang" - American banks complained to the US central bank, the Federal Reserve, that they could do things in London not possible in New York. Paul Mason explains how in 1987 the Fed relaxed Glass-Steagall to allow 5% of a bank's deposits to be used for investment banking, further relaxed to 25% in 1996. The act's abolition in 1999, which opened the floodgates for today's financial catastrophe, was inevitable - even if it cost the banks $300m in lobbying fees.
Tett shows how the regulators rolled over in another core area. In the late 1990s they accepted the banks' argument that their alchemy in creating collateralised debt obligations (bundling up income-generating assets of varying quality into one security) and then insuring against the risk of default (credit default swaps) both merited the triple A credit scores the credit agencies were awarding and, crucially, needed less capital to stand behind them. By 2000 the stage was set for what was to follow: investment banks having balance sheets 30 times or more larger than their core capital, refinancing as much as a quarter of their trillions of dollars of liabilities every day from the so-called wholesale money markets, and lending/investing in a range of highly risky financial instruments. The system could not insure against its own systemic failure. It was an edifice built on sand: $1 trillion of sub-prime debt had been bundled into various categories of structured, tradeable debt; when American house prices began to crumble in 2007, the whole interlinked pyramid came crashing down.
Mason's first three chapters are a page-turning account of September and October of last year, when it did look as though the American and British financial systems were about to collapse - the fateful weekend in September when Lehman Brothers went bust and America's top insurance company AIG only survived courtesy of an $80bn loan, and later, in early October, when Britain's RBS and HBOS were hours away from implosion. Mason, I think correctly, emphasises the highly risky way some British commercial, and other, mortgage lenders had become reliant on the money markets to support their lending, so that RBS and HBOS were in an analogous position to the US investment banks Lehman and Bear Stearns, both of whom went bust. At the root of the crisis were the interaction of money market-financed balance sheets, too much consequential borrowing and the new "weapons of mass financial destruction".
Mason is refreshingly clear-eyed about the operation of today's finance-driven capitalism - and angry. It wasn't only that the banks and insurance companies campaigned to have the law changed to serve their interests with such disastrous results. Sometimes, as with AIG, they began to transgress the law. AIG admitted in 2005 that it had faked $500m of transactions to fool the auditors, and "misclassified" another $3bn to inflate its profits. I have no doubt that there are more instances that may never come to light. Britain has insured £585bn of bank loans. It is hard to believe that every penny of bad debt on such a scale was just honest misjudgment. Do we believe that the British were angels and the only frauds American?
George Soros, successful hedge fund entrepreneur and famous beneficiary of the pound's expulsion from the European Exchange Rate Mechanism, has been trying for decades to explain that the axioms of free-market economics do not apply to the financial markets. Brown and Greenspan were always wrong to believe that free financial markets would tend to optimal outcomes. Rather, markets feed on themselves, so that financial values have a permanent tendency to swing between boom and bust - they are never rational. The crash of 2008, Soros explains, was an accident waiting to happen. Recovery will require regulation that compels banks to carry more capital and lend more judiciously. But until the international financial system is fairer to the less-developed countries on "the periphery", the core of the world economy will always be at risk of being flooded by hot money fleeing from that risky periphery.
This quartet of books indict modern finance. They cannot be read without wishing for something different. Yet even now I am not sure that the politicians and officials get it. The support for British banks is disgracefully one-sided. The taxpayer will lose at least £50bn, if not £100bn, but there has been no concomitant willingness on the part of the bankers to restructure their business model - or accept that their pensions, bonuses and pay should be seriously qualified. They want to get back to the glory days, and if once in every 30 or 40 years the rest of us suffer recessions and a £100bn bill while they make personal fortunes - so be it. It is not a fair bargain. These books set out why, and how it could be changed. Read all of them.
• Will Hutton is executive vice-chair of the Work Foundation
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