The US needs a single financial stability regulator, said Tom Ryan, chief executive of the Securities Industry and Financial Markets Association (SIFMA).  In a recent presentation at a Reuters conference, Ryan said that regulatory agency will need better information.
“Regulators are basically rear view people.” They have been operating with data that is three months old. To be effective, they need improved operations and technology and real-time data and information. Regulators can’t see the risks among institutions unless they have the data in real-time.

“We need a regulator who will be a collecting point for all this information.”

Ryan, who was director of the Office of Thrift Supervision (OTS) during the savings & loan cleanup in the early nineties said that the division of responsibilities among regulators contributed to the financial crisis. The OTS thought the sophisticated options-related mortgage products were fine, the Office of the Comptroller of the Currency (OCC) wasn’t sure, while the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve considered them too risky.

“They talked about barring some of these products but never did. Different institutions had regulatory authority and exercised it different fashions. A regulator with overview could have walked in and said ‘No, we need to stop. The complexity is too great.’”

The global financial crisis is not over; we have just entered a quiet period, Ryan added. In his presentation, he outlined key steps to improve financial services. Ryan said that an industry survey which SIFMA commissioned from McKinsey asking how to fix securitization showed that the top priority among investment banks is fixing the way credit rating agencies work.

“If we do not fix securitization we have a massive problem on our hands,” 55% of consumer finance was securitized, he added, and that has now fallen to a fraction of what it was. SIFMA, which had opposed laws requiring originators to retain a portion of their lending now supports 5% retention, he added.

“We are being very reasonable in our approach. We know that things are going to change. We want to help regulators change things in a responsible way. If they are not changed in a responsible way the industry, which is global and the lynch pin to economic development, won’t operate in an effective and efficient fashion.”

Saying Wall Street is ready to cooperate with the government in making improvements, he said the industry had pushed financial engineering to a level of complexity which was unsustainable.

“We admit part of this is our problem and we need to be constructive about fixing it.”

Both the US and the UK need a resolution authority to take care of institutions that are at risk or broken, such as AIG, Lehman Brothers, Fannie Mae and Freddie Mac, Ryan said.

“We are still making it up on the fly. We have conservatorship for Fannie and Freddie; the Fed pushed firms into bankruptcy because there was no resolution authority.”

Letting Lehman fail was clearly a mistake, added Ryan, but he had high praise in general for the way the government agencies handled an unprecedented crisis.

“The government did a helluva job and they had no playbook. They didn’t know how to back up the dump truck filled with money to stabilize the system so panic didn’t infect the financial system. They did it weekend after weekend, and closely coordinated with the EU – mostly the Brits – and the Canadians.”

He expects the US to have a systemic regulator by the end of this year or the beginning of 2010 and Europe to follow sometime after that.

“Politics in Europe are much more complex than in the US. They have a machine that is more press related so they are out front with ideas,* he added. But the complexity of getting something done is much greater where regulations have to be implemented by each nation state.

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What role should derivatives play in a reformed financial services marketplace?

I have yet to see much intelligent discussion on the topic and was really disappointed that the FT, in a full page article, resorted to a simple comment from a market participant and never sought other opinions:

“Forcing OTC products on to exchanges … would result in increased risks and costs for end users,” says Mr Clark of the WMBA, which says British pension funds have saved themselves £40bn recently by hedging with derivatives. Or as Anthony Belchambers, head of the Futures and Options Association, says: “This kind of regulatory pressure will distort free-market competition and restrict product diversity.”

Really? Could they get along without the swaps? How does the $40 billion in alleged savings compare to the global market losses in the last two years, and are they related?

In the meantime, bankers in London are preparing to exploit any transatlantic regulatory gaps. “Only 25 per cent of all OTC trading actually happens in America,” one senior London-based banker says. “So we don’t think what Geithner says is going to change anything for us … and even if [Brussels] does the same, activity will just go to Singapore or Switzerland instead.”

Between Warren Buffet’s description of derivatives as weapons of mass financial destruction and ISDA’s assurances that the world wouldn’t be safe or profitable without them is plenty of scope for deeper evaluation. Where it is apt to come from is the issue.

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Aline van Duyn, writing in the FT over the weekend, says bankers are suffering from the Lake Wobegon effect, something dreamed up by radio talk show host Garrison Keillor who reports from his fictitious Minnesota town “where all the women are strong, all the men are good-looking, and all the children are above average”.

“Well, according to senior regulators, they revealed that banking is also subject to
a “Lake Wobegon” effect.
“Banks are very good at working out models that show potential losses on loans, under many different economic scenarios.
“But, according to regulators, all the banks assume they will make fewer losses than average.”
This has an amusing echo in retail banking. At the BAI Retail Delivery Conference (upgraded a few years ago from a mere Show to a Conference) speakers are apt to note that banks all assume above average growth with completely standard, solidly in-the-box strategies. As a few speakers have pointed out, to grow faster than average, or faster than the economy, a bank needs to take market share from competitors. And this is difficult to accomplish if your products look exactly the same as the stuff offered by the guy down the street. Yet bankers persist in planning for above average growth with completely average products.

She concludes: “Collective delusion has to be stamped out by accepting that average – not better-than-average – is the norm.”

Michael Porter, who spoke at the last BAI conferences which I attended, couldn’t have said it better.

It does remind me of a comment that John Kenneth Galbraith made years ago about U.S. Treasury Secretary C. Douglas Dillon that “nobody ever recovers from being a banker.”

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We’re doing some messing about on Twitter - early days yet, but I’m hoping to join up the dots between some of the houskeeping aspects of this site - forward features, Readers’ Choice Awards entries and so on – to automate some of the more mechanical processes … sorry, I mean “to create an interactive dialogue with the community”.

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 At a SunGard conference in New Orleans a bunch of years ago, an executive from a Chinese bank – it may have been Citic – explained that they were buying Panorama for risk management so they could learn how western banks did risk.

A week or two ago the International Herald Tribune carried a front page story saying Chinese banks were no longer using American firms as mentors. Hmm, wonder why.

The ostensible value of capital markets, as practitioners drone on and one about, is to provide funds to make a society more productive. Although as Carlota Perez notes in her fascinating book “Technological Revolutions and Financial Capital,” during bubbles speculative finance runs the show and after the bubble bursts it is a real struggle for new regulation that will supplant it with production capital. Looks like we are going through that now and so far the status quo – speculative finance, seems to be winning. I’ve been talking to experts in London and New York on what happens to tech infrastructure if banks are broken up by regulators – look for the story in the upcoming issue of Banking Technology (it’s in the investment banking supplement coming out with the June issue next week -Ed.).

Jeffrey Garten, the Yale management prof, wondered in the FT earlier this month if London and New York aren’t likely to be replaced as financial hubs by Shangkong – a new financial center of Shanghai and Hong Kong. China will be the world’s biggest creditor and a shift to creditor status is what helped the US leap ahead of Brtain.

“China lacks the sophistication of Wall Street or the City, but given the mess that complex and opaque securities have caused, a simpler system has its virtues.”
When reading about Chinese leaders who talk about finance, it strike me that they have pretty deep knowledge, while American and British politicians for the most part seem pretty much lost when talking about anything as complex as derivatives. Smart regulators, piles of cash, a fast-growing economy – what more could you want? Oh right, political stability. That could still be a problem for China.

Garten’s conclusion is a little light weight compared to his analysis. He warns against populist moves that would discourage the most talented people from working in finance. The industry needs intelligent regulation, it certainly needs to grapple with the issues of derivatives and how to manage them, and both the US and UK should look at what role they want finance to play in the larger economy and then address how to achieve that.

I’ve reviewed the Perez book recently (see below) – it is compelling reading and offers a lot more prescriptive depth than Garten even approaches.

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Gretchen Morgenson in the NY Times Sunday says they haven’t satisfied the critics.

Let’s not call it a stress test,” said Janet Tavakoli, founder of Tavakoli Structured Finance, a consulting firm in Chicago. “This was a test to try to get a measure of capital adequacy, using broad-brush percentages. I think what they are hoping is that the banks are going to be able to earn their way out of this.”
Under the US government’s so-called adverse scenario, for instance, banks may experience losses of 8.8% over the next two years on first mortgages they hold. A more likely figure, Ms. Tavakoli says, is 10%.

The country is caught in a rate bind.
Christopher Whalen, editor at Institutional Risk Analyst said keeping interest rates in the cellar to revive banks has significant costs, Mr. Whalen said. For example, institutions that have agreed to pay out interest on investments that are higher than prevailing rates — think insurance companies and pension plans — are getting killed. “The Fed can’t do this for much longer,” he said.

I had never heard of Institutional Risk Analysts, but their Web site is pretty interesting — more about them and their views in a bit.

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Technological Revolutions and Financial Capital is a slim (171 pages of text) book with a hefty punch. In it Carlota Perez charts major technological changes over two centuries that drew in massive amounts of speculative capital, created a bubble that then burst, and then continued in a quieter fashion to spread through the world drawing on production capital. She is Visiting Senior Research Fellow at the Judge Business School of the University of Cambridge and is also affiliated with the University of Sussex and a number of other institutions.

She says hers is the first account of bubbles and panics to link technology innovation to capital. Joseph Schumpeter, in his accounts of business cycles, devoted a lot of attention to financial capital, but his followers “strangely” seem to have missed this, she adds.

Her examples of technological innovations are:

• The Industrial Revolution, Britain, 1771
• Age of steam and Railways, Britain, spreading to America, 1829
• Age of Steel, Electricity and Heavy Engineering, USA, Germany, Britain, 1975
• Age of Oil, the Automobile and Mass Production, USA, Germany then Europe, 1908
• Age of Information and Telecommunications, USA, spreading to Europe and Asia, 1971

They move in roughly 50-year segments, similar to Kondratieff long waves, but she brings the technology revolutions into the account, while he is completely economic.

(I looked for the telegraph, which was sometimes mentioned as a world changer bigger than the Internet – she has it with the Age of Railroads, which makes sense because the lines ran along the rails and were often used to coordinate train schedules.)

Each new surge of innovation dramatically lowers cost and has a widespread impact on the economy, society and politics. Until the 1980s, she says, the best form of organization to support mass production was the centralized pyramid, but with the advent of computers and the Internet, that structure appeared rigid and clumsy. And along came Michael Hammer and James Champy with their books on how to re-engineer the corporation.

Configuring institutions around the technology advances often takes a decade or more and is accompanied by a lot of turmoil, she adds.

“The full unfolding of its wealth-creating potential at first has rather chaotic and contradictory social effects; it later will demand a significant institutional re-composition.” The Big Bang, a period of years or decades which she calls Installation, pulls in money through market frenzies. It is often followed by a recession which leads to demands for change – sometimes violent — which in turn leads to a calmer Golden Age she calls Deployment with new regulation, business practices and standards adapted to the new technology. Once a technological surge is widely adopted and spreads out globally from its source, the way is open for the next wave of innovation.

This is a densely written book that will make your head hurt – first from trying to keep pace with how the pieces are tied together and then from slapping yourself on the forehead at how obvious some of it is. Once electricity is adopted and houses have wires, the way is open for all sorts of electrical appliances to be developed and sold. Railways were first designed just tot move coal from mines – then they started moving passengers. The initial impact was to put long distance stagecoaches and inns out of business, although initially they increased the business for horse-drawn carts to carry passengers from terminus to ships. They attracted huge investments and often went bust, especially in America, leaving English investors with substantial losses while creating a network of rail lines for the US.

At any given time, says Perez, many powerful ideas exist, but to produce a wave of change they require the right social and economic conditions. They are most apt to win support of capital when other innovations have been tapped out and are generating simply normal returns; speculative capital, accustomed to the huge returns of an innovative area, is searching for the next big thing. While waiting for the next highly profitable opportunity, financial capital turns to real estate, paintings, pyramid schemes and hostile takeovers.
Financial frenzies are good for innovation, if not necessarily for investors, because they help build out valuable infrastructure. The huge investment in fiber optics led to outsourcing since so much dark fiber was available at prices far below the cost of laying it.

Nor is the investment always good for the home country. Britain’s financial capital supported transcontinental infrastructures like rails, ships, telegraphs, mining and agriculture around the world while neglecting the home markets.

Concluding in 2002 as the world was going into a post bubble recession, she said the time required institutional imagination and quotes Keynes on the Grand Slump of 1930…”there cannot be a real recovery until the idea of lenders and the idea of productive borrowers are brought together again,” which is what Perez means by moving from financial capital to production capital.

IBM’s Irving Wladawsky-Berger notes that her theory was remarkable in understanding the timing of the dotcom crash.
“I first heard Carlota speak shortly after the implosion of the dot-com bubble. I assumed, as did most of those who attended her lecture, that given the dot-com financial crash, we would soon be entering the deployment period. She argued vehemently then, and in subsequent conversations, that the real financial crash had not yet taken place. After a meeting in 2005, where we once more discussed where we were in the cycle, I posted this entry where I wrote that
“Carlota Perez believes that we may not yet have entered the deployment period, as the crash phase doesn’t seem to have resolved itself. She mentions three particular structural tensions that we need still to work out in order to move on: investments continue to be focused on short-term gain, not on long-term production and growth; the social system continues to foster an unstable environment in which the rich get richer and the poor get poorer; and there is too much idle money chasing and inflating assets like housing and not going into expanding the demand needed to soak up all the excess supply being produced.”
“Think how remarkably prescient her words are, especially when you consider the number of top economists who were at the time advocating the notion that the world was now safe from cataclysmic financial crises, because of the ability of derivatives and other new financial instruments to effectively distribute risks.”

In her book she explains that “The tensions between the growth of paper values and real wealth creating capacity, which was partly relieved by the collapse, can only be overcome by strict and decisively enforced regulations to restrain the practices of the casino economy,” she said, while warning that the financial collapse of 2001-2 may not have been spectacular enough to wipe out excess self-confidence.
The massive amounts of low-priced technology demand expansion into new markets such as China and Eastern Europe, she added.
“…the tasks are complex and wide-ranging: designing an adequate and enforceable regulatory framework, devising ways of effective intervention to reshape the demand profile to extend the Information Revolution; and decisively acting on both sides of the world divide to stimulate a truly global economy, expanding wealth generation across the planet.”
Perez encouraged readers to avoid nostalgia and look forward. Her look back with its extensive and detailed links between technological innovation, capital, frenzies, bubbles and recessions lays out a pattern that decision makers can benefit from.
For some more recent commentary by Perez:

Steve Hamm of BusinessWeek caught up with her in 2008 on the issue of immigration
“Capitalism is founded upon the principle of the common good resulting from the private pursuit of profit. Yet, much more often than not, it is governments that have to make sure that the principle works.
“But when governments don’t act intelligently, economic forces hit back hard and brutally. Just as the reluctance to regulate the “free” financial markets brought on the sub-prime crisis and a likely recession, letting the unrestrained markets continue to shape globalization is likely to bring social unrest and an energy and environmental crisis.

Art Kleiner in the Booz & Company publication strategy+business in 2005 got this from her:
“Finance capital has done its job; it’s brought forth the resources to pave the way for the next wave of technology. Along the way, it’s created an environment in which companies like Microsoft, Intel, and Google could emerge and flourish. Now we need to spread out the new paradigm of our era through all the economies of the world, just as in the past.
S+B: We’ve been here before?
Perez: Yes, and more than once. There are historical regularities in the way technological revolutions form and become assimilated into society. You and I both have seen the changes wrought by information technology, and we think it is uniquely momentous. Yet previous technological revolutions made equally momentous changes. When you go back and read contemporary accounts of life in the 1880s and ’90s, you could replace the words steamships and telegraph with computers and Internet and the text would sound completely modern.
The dinosaurs have to be replaced.
“The industrial giants have reached limits to growth and innovation, but most of them still can’t give up their old practices, even when they see the need to. The electric refrigerator and the vacuum cleaner had been truly fantastic innovations, but by the 1970s innovation had devolved down to the electric knife and electric toothbrush. The appliance companies were still producing a lot of money, but they didn’t know how to invest in or design the new types of appliances that semiconductors would make possible.”
“For each technological revolution to flourish, you need a lot of new investment in infrastructure. If you don’t have railroads, who can build locomotives? If you don’t have roads or electricity, how can you sell cars or refrigerators? But if you don’t have enough cars or refrigerators, you can’t justify the roads or power plants. The solution comes through asset inflation.”
What the future demands:
“First, finance needs to be adequately regulated. Every time some forward-looking CEO tries to implement a three-year plan, he gets ousted in three quarters. The finance world still expects the easy profits of the bubble, but what is needed now is long-term investment. If capital gains were taxed more stringently when assets were sold before five years, for example, then more investors would “marry” the companies they own and focus on maximizing longer-term returns. Similar measures for all assets would discourage the current massive deviation of investment money toward housing bubbles and derivatives. And, obviously, regulation of global finance must be enforceable at the global level. Quite a tall order!
“Second, prices have to come into line. During Installation, there is always strong asset inflation (both in equity and in real estate) while incomes and consumption products do not keep pace. This creates a growing imbalance in which the asset-rich get richer and the asset-poor get poorer. When salaries can buy houses again, we will be closer to the golden age.
“Third, as Deployment gets closer, you will see increasingly stable industry structures. Look at the mad price wars of the airline industry; it has a lot of restructuring to do to segment its markets and develop a sustainable set of practices.
“Fourth, there need to be innumerable investments and business innovations to complete the fabric of the new economy. Here’s one small example: Millions of self-employed entrepreneurs work from home with uneven sources of income. Where are the financial instruments to smooth out their money flow so they can work and live without anxiety? For them, that innovation could be the equivalent to installment credit in the 1950s, which made possible the consumer base needed for mass production.
“Finally, I’m not sure we’ve understood the causes of fraudulence at companies like Enron, nor how to avoid them by means other than excessive bureaucratic controls. The key decision makers, in government and business, do not seem ready to make the changes that could get a golden age under way.”
IBM’s Irving Wladawsky-Berger has an appreciation of her, with links, here:

He links to a 10-minute video presentation she made to an audience in Rome. It is well worth watching for its concise explanation of her ideas and her forceful presentation.

She contends that globalization has great potential for providing a better life around the world but it is being better life but it is being resisted by those who are being hurt by it, which calls for imaginative government response in education and individual protection.
“Governments have to become as modern and agile as business firms.” She calls on governments, businesses and NGOs to collaborate for a better world.

In a presentation University College London apparently posted in March 2009, she explains more about the role of governments and finance in developing the future:

“What is needed is the redesign of the financial architecture so that the system will go back to its basic role of reallocating resources, smoothing the flow of money from savers to investors and making its profits by sharing in the wealth it helps create and acquire. Of course, there will always be special instruments that take advantage of imbalances or misjudgments, and that is part of the legitimate workings of the market. But the idea that money can “work” and make you a millionaire in no time and with no risk has to be clearly ruled out if the global economy is to get the full growth and profits benefit from the potential of the current paradigm.
“There are many regulatory directions to follow, but there are two that define whether finance will be constructive or will continue to be decoupled from the real economy, playing its own game. One is transparency, the other is global reach. The need for transparency is obvious. One of the main strengths of the synthetic instruments, hedge funds, default swaps, derivatives and other supposedly sophisticated innovations in recent times was precisely their opacity. Without full information there is no accountability, no protection for investors and no proper supervision or regulation is possible. To achieve effective disclosure rules, only the truly savvy financiers could help define effective disclosure rules -quite a few are willing- and only very determined political will can effectively set and enforce them. “

This is not merely a financial crisis; this is the end of a period. As Stephen Roach puts it: leaders must have “the wisdom and the courage to shift the policy debate away from tactics and toward strategy”.

On the value of industrial policy during the deployment stage:

“Once installation has been achieved, however, there is a vast innovation and growth potential that the economy is ready to tap. Unrestrained markets then become a very blunt and brutal instrument; yet markets guided by policies that implement common visions arrived at through a social consensus orchestrated by modern, well informed, realistic and socially responsible governments are more likely to achieve the best results in these circumstances. “

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In the recent Gartner report: “Social Banking: It’s All About the Money and Customer Focus,” Stessa Cohen and Alistair Newton say banks ought to plan on providing greater transparency to customers, especially around pricing.
Interesting that this comes out about the same time as a BusinessWeek article on the way banks, and mobile phone providers, reserve the right to change contract terms in mid-stream. Sprint was one of the worst offenders in the phone industry, while Chase and Citi seemed to rank near the top in banking.
BusinessWeek: In a November 1997 memo, Duncan MacDonald, then one of Citi’s most senior lawyers, warned against adopting Providian’s strategy of “penalty pricing,” which involved charging consumers who made late payments steep fees and hiking their rates. “I was asked to resign three days later,” he recalls.
Then there’s Chase, which lured borrowers who transferred balances with low rates, then added a $10 monthly fee and doubled the minimum monthly payment, leading one borrower,  featured in the BusinessWeek piece, to start a web site about the topic.

His site links to another, www.chase-sucks.com, which the bank is trying to shut down. It makes for pretty interesting reading, including the emails from the bank’s attorneys.

Quoting from a “Post From An Anonymous Chase Manhattan Bank Employee” (as seen on Chase-Sucks.com), here is what appears to be an explanation of the current reward system at Chase:
The reason the bankers at Chase are so pushy, and recommend specific things are because we make what are called “Personal Value Credits” or PVC’s. That is our commission. We open a checking account: 5 PVCs, we sell a Debit Rewards card: 7 PVCs. Credit cards: 17.5 PVCs. Loans and investments pay the most. Loans are 0.7 PVCs for every $1000, so a $100,000 loan = 70PVCs. This is why customer service is horrible … there is a tremendous amount of pressure for each banker to make at least 1150 PVCs. That is 100% payout  … Chase Bank will do anything, at any cost to acquire their business… Ethical or unethical. It isn’t the banker’s fault. We have our jobs threatened unless we push the products they say, when they say. If we don’t food is taken off of our tables, and we can’t earn commission.!

The bank faces consumer lawsuits in five states and has promised to refund fees under an agreement with NY Attorney General Andrew Cuomo. Of course, it doesn’t admit to doing anything wrong.

Congress is looking at legislation and the banks, naturally, say they need to have all this flexiblity to extend credit to consumers and that any regulation would limit the amount of credit available to people with risky profiles.

And would that be a bad thing?

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If you want to understand the current banking crisis, start with Philip Augar whose latest book about investment banking, Chasing Alpha, covers the crash and its causes. Augar has a doctorate in history, although his recent books don’t mention it.

As I recall from The Death of Gentlemanly Capitalism, he sort of stumbled into banking, and then thrived. He led NatWest’s global equity business and eventually became treasurer of Schroders. So he brings professional research and writing skills along with an insider’s view of the City and Wall Street to his books.

In Chasing Alpha, he depicts a UK and America that had gone money mad: UK household debts soared, Americans piled into houses they couldn’t afford using subprime mortgages with cursory or no credit checks, and New York investment banks acted like giant Hoovers, sucking money out of unsupervised mortgage brokerage operations and bundling it into mortgage-backed securities that they stashed off their balance sheets in Special Investment Vehicles (SIVs) which they “insured” through credit default swaps, all approved by the credit ratings agencies. The net result was to make Bernie Madoff look like an underachiever.

The historical facts make up a critical take on banking, as he recalls city scandals such as Guinness, Blue Arrow, BCCI, Maxell and Polly Peck. Asset managers, meanwhile, seriously underperformed the FTSE. It is a highly unoriginal sin in investment banking to confuse good luck with talent, but the run of exceptionally benign market forces from 1997 to 2007, a good talent pool, and support from New Labour made the City a highly profitable place to work and led bankers to think they fully deserved their stratospheric pay.

In 1996, Gordon Brown pushed back against Tony Blair’s idea to promote a stakeholder economy, as promoted by The Guardian’s Will Hutton.

Blair told an audience in Singapore:“It is surely time to assess how we shift the emphasis in corporate ethos from the company being a mere vehicle for the capital market to be traded, bought and sold as a commodity, towards a vision of the company as a community or partnership in which each employee has a stake.” Brown poured cold water on the notion and New Labour went with the shareholder view, the view which GE’s ex chief executive Jack Welch recently derided in a statement to the FT: “On the face of it, shareholder value is the dumbest idea in the world,” he declared to a stunned world.

Something of a missed opportunity there, perhaps one to revisit in determined next moves in governing the economy.

This wide-ranging account includes a reasoned discussion of private equity and concludes that it plays a relatively small, and relatively benign role in the economy. Here I think he is too kind – Businessweek recently did a piece on the way private equity firms strangled a regional US chain, Mervyns by stripping its assets, sucking out $400 million in cash, renting back the real estate at high rents, and putting 30,000 people out of work, many with no severance and unpaid vacation time. (Admittedly this is partly the result of horribly inadequate labour laws in the US)
He cites Gordon Brown’s Mansion House speech in June 2007, just before becoming Prime Minister, and its by now well known praise for The City. (London has enjoyed one it its most successful years ever, for which I congratulate all of you here on your leadership skills and entrepreneurship” was just part of it). The larger point he makes, one also made by BBC reporter Robert Peston in “Who Runs Britain”, is that New Labour bowed before The City – or at least it did once Brown persuaded Blair that the Stakeholder route would not work. At the same Mansion House event, Bank of England Governor Mervyn King noted that excessive leverage is the common theme of past financial crises. “Are we really so much cleverer than the financiers of the past?” he asked.
Augar notes the leverage used by investment banks
Goldman Sachs 24:1
Morgan Stanley 25:1
Lehman 32:1
Bear Stearns 33:1
This is the sort of leverage more commonly associated with hedge funds than banks.

Great while the market was going up, but when the market turned, it moved fast. In October 2007 Stan O’Neal left Merrill, Chuck Prince at Citi followed in November, and in January Jimmy Cayne was gone from Bear Stearns. Over the same period England was creating and expanding rescue packages for its banks.
The failure was system-wide, Augar concludes. Could the CEO of HBOS have announced that everyone else was wrong and he was scaling back? As at least one senior executive has told journalists, if he had cut back on the leverage he would have been replaced.
While Chasing Alpha has the value and shortcomings of a book produced as the crisis moved along (Augar notes that Sir Fred Goodwin left RBS with no leaving package; apparently his pension hadn’t hit the papers at the time of publication) my favorite of his books is The Greed Merchants, which came out in 2005. Here he records the incredible growth in profitability in the securities industry from 1973 to 2000, four times the growth of corporate profits.

It became accepted practice for employees to take half the revenues of firms which had gone public.

Augar is the only analyst I have read who offers an industry wide view on the reason – he says the securities business is a cartel with a few players who maintain oligopolistic pricing (IPOs fees in the US have stayed at 7 percent persistently) and the high payouts are a way to mask the huge profitability of the firms. (They are almost immune to business-changing lawsuits because all the firms with the depth to handle such a lawsuit work for the Wall Street firms). The firms are among the leading political donors, and the political leaders on both sides of the Atlantic feared to annoy the bankers.

“Washington and Westminster had so much riding on Wall Street and the City that they could not and cannot afford to upset them.”

Investment banks concentrate power and knowledge through an integrated model of trading, sales, research and corporate banking. Augar says the largest banks know more about the world’s economy than any other organizations, because they are plugged into the markets for equities, bonds and commodities and talk constantly with leaders of the largest corporations – just 200 CEOs are regular users of investment banking services and the total number of clients globally, if you include occasional users, is no more than 1,000, he says.

Perhaps most damning is Augar’s conclusion that the US-UK investment banking model is actually bad for the economy. The banks enabled the waves of corporate corruption, such as Enron and Worldcom, in two decades they took more than $150 billion out of capital markets through abnormally high compensation, an amount that could certainly help plug the pension deficits in the two countries, and they have promoted mergers which made sense only in accounting rules while destroying value.

His conclusions? The integrated model has to be broken up – that’s the only way to alleviate the inherent conflict of interest between advising clients and making a proprietary profit on trading. Second, advising clients and then profiting from the mergers and acquisitions leads to conflicts for both banks and CEOs.
CEOs of companies are no match for fast-talking bankers, he says, and the bankers were able to dangle life-changing rewards in front of them in return for deals that actually destroyed value.

Advice should come from fee-charging advisory firms which do not handle deals. Deposit taking institutions should be separated from securities trading, and lending banks should keep the risk on their balance sheets, although he doesn’t specify whether this means keeping the entire loan. Investment banks would become providers of liquidity as pure trading houses.

This might lead to less liquidity and an increase in the cost of capital, although that isn’t certain, he adds, but such as system would be transparent and free of conflict of interest.

“Tinkering with the rules did not work in 2003 and it is doubtful it will make a lasting difference in 2009. Unfortunately, more tinkering is exactly what is being discussed at the time of writing.”
His first book on the City, “The End of Gentlemanly Capitalism,” showed the way clubby and somewhat outdated City firms were taken over by Americans, Swiss and German banks. The Americans in particular brought highly professional management, meritocracy in hiring and promoting, the ability to cross-subsidise London from New York, plus, of course, and the ungodly habit of working through lunch. (It too is an excellent book and easy to read).

All three of his books are valuable for understanding how we got to this point and where we can go from here. Augar has appeared more recently in the Financial Times where he had a recent article saying “It is time to put finance back in its box.”
“Unless governments in America and Britain really open themselves up to new ideas, emerging economies in Asia and mainland Europe, places where alternative economic and corporate governance models do exist, will seize the initiative and redefine the global agenda.”

He recently told Joe Nocera of the New York Times that “…he believes that the regulatory environment helped bring about the “Americanization” of the City of London, and that it was ultimately ruinous. All the big American investment banks raced to London — which they saw as a place to do business not just in Britain but all over the Continent. After the abolition of Glass-Steagall, the commercial banks came roaring in as well.
“Gordon Brown instituted a lot of pro-City policies,” Mr. Augar said. “He cut the capital gains tax. He combined about nine different regulators into the F.S.A.” — the Financial Services Authority — “which adopted something it called ‘proportional regulation.’ ” Mr. Brown himself had a more apt phrase: “light touch regulation,” he called it. In other words, he consciously aligned regulation in Britain with the free-market, deregulatory approach being promoted by Mr. Greenspan and Mr. Rubin.

Nocera, after a quick tour of London talking to finance experts, concludes that Britain faces a bigger problem than the US because financial services has been such a large part of the national economy.

“The country is drowning in debt. Mr. Brown’s Labor government is running large deficits in an effort to stimulate the economy.
“If that, too, sounds like the response of the Obama administration to the financial crisis, it is indeed quite similar. Here’s the big difference. New York is a big city in a big country, and our national banks, as big as they are, are much smaller as a percentage of gross domestic product. London is a big city in a small country, and during the bubble, its banks became truly immense, outsize really, given the size of the country they operated in.”

But Britain can’t regulate alone, he adds.

“…although no one will say this out loud, Britain can’t regulate unilaterally anymore — it is simply too dependent on American institutions. Its regulatory response will be to mimic whatever the Obama administration decides to do.

Nocera also caught up with Martin Wolf the Financial Times who told him
“If regulation is transformed in London it is because of what the U.S. does,.The U.S. will say, ‘You are to follow us.’ We now have no regulatory autonomy.”

Are political leaders in the US, UK or Europe up to the challenge? I doubt it.

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Want to see intelligent risk management in operation? Dial up the World Health Organization press conference April 29 on CNN or some other site and try to recall any recent political or financial press conference with this level of calm, smart presentation of complex information. .
Dr Margaret Chan, director general of the organisation, took questions from a group of reporters representing news outlets from around the globe and answered them directly. The reporters seemed well informed on the issues and asked intelligent questions, which is not always the case in issues of finance and politics.
The sort of stupid grandstanding, which we have come to expect from politicians, was completely absent from the WHO conference where Dr Chan and two colleagues handed off questions to each other with no signs of camera hogging. Gordon Brown, if he could ever recuse himself from hyperactive imitations of a flipping sardine out of water, could learn a few things from watching.

Near the end, a reporter struggled to ask Chan what the WHO was doing to secure its own staff. Once she understood, she explained this is the WHO’s business:  it takes protective measures but it won’t flee from global health problems. And she reminded the reporters, and the world, that people, especially in poor countries, face medical crises such as HIV AIDS and malaria, which are regularly killing far more people than the swine flu.

This presentation – I almost wrote performance but that doesn’t do it justice – was the most impressive I have seen in ages. I stayed with the entire press conference marveling at how well informed public officials and educated reporters can provide valuable information. The followup commentary on CNN was back to normal drivel: they should have rerun the press conference instead.
Once this pandemic is over, could the WHO lend some of its experts to the FSA, SEC and treasury departments around the world?

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