News

Summer Storms

August 16 2019

In An Italian Education, Tim Parks describes the wonderfully languorous routine of an Italian summer: the shutting down of all but essential services in hot, humid cities, leaving them to tourists, the departure for the coast, the gathering of the extended family, the early mornings to enjoy an espresso outside when the day is cool, the encampment at the same spot on the beach amongst the ombrelloni, neatly and beautifully laid out, the careful attention to one’s toilette, la bella figura being quite as important when little is worn as at every other time, lunch followed by siesta, the late afternoon passeggiata before the evening’s entertainment. Day in, day out, the rythym is much the same, punctuated by religious festivals: Sant’ Andrea in Amalfi in late June, for instance, or Ferragosto everywhere. Then the gentle return home in September, with weekend visits to the coast for those lucky enough to live nearby. It is a time to breathe, relax, close off the pressing problems of life, which can – for now – wait.

Yet summer has often been when horrible crises and unexpected events have impolitely intruded into this idyll. Often these have been financial ones. Consider:-

  1. 1992: 16 September – Black Wednesday – strictly not the summer but the short-selling of currencies with the ERM, not just sterling but also the lira, had been happening in the months leading up to the day when, despite interest rates being raised briefly to 15%, sterling was forced out of the ERM, with losses of ca. £3.3. billion. How humiliating for this to happen when Britain held the Presidency of the EU and not long after its Prime Minister had, somewhat hubristically, suggested in a TV interview that the pound would one day be as strong as the Deutschmark and might replace it as the ERM’s anchor currency. Oh dear.
  2. 1997: the Asian financial crisis – starting in July with capital flight as the Thai currency was floated, spreading to other Asian countries and Japan and resulting in IMF support to the troubled region. A portent of trouble ahead.
  3. 1998: a Russian financial crisis – in August when Russia devalued its currency and defaulted on its debt. One of the high-profile victims was Long-Term Capital Management, a hedge fund set up by ex-Salomon Brothers traders and boasting two Economics Nobel prize winners on its Board. Their claim to fame was having devised a brilliant new way of valuing derivatives. Despite such brainpower, LCTM managed to lose $4.6 billion in less than 4 months that summer, was bailed out by the Federal Reserve and closed 18 months later. Alas, the two obvious lessons to be learnt: (1) when clever people talk about “a new paradigm” in finance, it is time to put your money under the mattress; and (2) there is a sort of stupidity that only clever people are capable of – was not learnt by anyone important at the time. Hence…..
  4. 2007: the financial crisis – starting with a French bank, in August, blocking withdrawals from two of its funds because it no longer knew what they were worth (a sign they were probably worthless) and leading, via increasing worries amongst policymakers, central banks, regulators and others about the state of the financial system, to the UK’s first bank run in over a century as Northern Rock depositors decided the mattress was indeed safer. The signs had been there for some time but had been ignored. In July, Citigroup’s CEO, a lawyer-turned-banker, gave his own inimitable account of the Greater Fool theory – not realising the fool was him – when he said: “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.” Whoever thought that putting lawyers in charge of a bank would be a good idea? They turned out to be every bit as bad as bankers at running them. The crisis went on and on and on. We are now in the interregnum between that one and the next.
  5. 2010-2012: the European sovereign debt crisis – this was a summer perennial at one point and, indeed, seemed to pop up on a regular basis during these years. In May 2010 it was Greece’s turn to dismay the markets with its request for  a €110 billion loan, the austerity package put together to justify this dismaying Greek voters even more and leading to protests, riots, social unrest and Parliamentary shenanigans over the summer and into late autumn.  A bailout was agreed but in June 2012 the crisis erupted once more with the possibility of a forced Grexit from the euro. Yet another bailout-cum-austerity package was eventually agreed. It was not the last the world would hear of Greece, though. Ireland too went through some pain, though this was – as are most matters Irish – related to land and the colossal sums Irish banks lost when the property boom went bust. Money had to be borrowed to keep the banks afloat; the costs became too painful; a bailout was obtained in August 2010 and in July 2011 the interest rate payable on this was reduced by the IMF. The European Commission announced a reduction in the interest rate on its loan to Ireland on 14 September 2011. The cognoscenti may remember that also on that day a Swiss bank announced that one of its traders had managed to lose $2.3 billion in a fraudulent and catastrophic misreading of the markets that summer. The following summer in 2012 (while that trader prepared for his trial) Spain, too, became a concern eventually obtaining a €100 billion bailout following banking losses caused by their unsustainable property boom.
  6. June – August 2015: Greece and the Euro – Yes. Again. A charismatic politician comes to power vowing to renegotiate terms with the EU, to end his country’s humiliation and even gets his electorate to support his showdown. It is all of no avail. He is forced to back down. His party is split. Terms are agreed – or rather dictated by the powerful neighbour. There is no more talk of boldness. The politician hangs onto power being finally ejected four years later by someone promising boring economic competence. Perhaps Greece, having provided a template for democracy , is providing another one.
  7. Summer 2019: Britain – our PM tells the EU, which has said for months that negotiations for Britain’s withdrawal for the EU (27 years after its eviction from the ERM – was that when the journey to Brexit started?) are at an end, that he will not negotiate with them unless they give him what he asks for first. The EU is now trying to understand what sort of a threat it is to say that you will not do something which the other party has also said they do not want to do. Meanwhile, the pound has declined against a basket of currencies at just the moment when holidaymakers are buying their foreign currency, English summer weather proving as unreliable as ever.

It is now mid-August. Perhaps this year it will be a quiet calm summer. Financially speaking anyway. Not long to find out.

 

Photo by Nellia Kurme on Unsplash

 

Back to Basics

July 30 2019

Ever since the financial crisis started there has been a plethora of explanations about why traders and bankers behaved as they did.  Some have been purely descriptive: what happened and when, allowing us to marvel at the folly of it all, at least in hindsight.  At the time these clever financiers were praised by pretty much everyone from Chancellors down. There were very few pointing out at the time that the Emperor had no clothes.

But increasingly there have been attempts to use the insights gleaned from other disciplines to explain why what happened in the way it did. The latest neuroscientific findings were used to describe the biology of boom and bust (The Hour Between Dog and Wolf, for instance). Behavioural economics has had its say, as has nudge theory. Rather than nudging people to behave well, all the payment and reward incentives nudged financiers into doing what suited them financially irrespective of the effect on the customer and no matter what the expressed good intentions of the firm were. Goodness! Whoever could have predicted that, without a theory to explain it.

Psychologists have had their say, of course, though only a cynic might wonder about how much actual knowledge about the realities of life in the financial sector they have. No matter: all could opine merrily on the importance of culture in finance and on all the wonderful insights that these disciplines could bring to those seeking to manage and regulate the financial sector.

And now the anthropologists have got in on the act, as in this article by Gillian Tett. In it she points out how anthropologists have tried to analyse the cultural patterns, the rituals and symbols, even the words people use in finance to understand what was going on under the surface. In truth, the insights brought by anthropologists (at least as described here) are pretty obvious rather than thought-provoking; the article does not need them to be worth reading.

What is interesting, though, is how commentators on finance and perhaps also regulators are, perhaps unconsciously, making the same mistake as many of those traders and bankers. They are over-complicating, coming up with all sorts of theories and hypotheses apparently grounded in science or other social studies, described and interpreted by experts, using technical language to describe common human behaviours. Just as too many traders developed over-complicated products which they only half-understood and managers kidded themselves into believing that they had found a foolproof solution to valuation or risk management or any of the other difficult tasks they had, so there is a risk of developing overly complex explanations for why so many people behaved so stupidly or worse. The risk is that the more complex the explanation, the more people feel that it is all too difficult really to do anything about it or that this is something best left to the culture specialists, psychologists and other “ologists“.

Keep it simple might be the motto. In the end, by whatever means the conclusions are reached, what everyone in finance needs to remember is this:-

  1. Trust is at the heart of finance.
  2. Everyone in a financial institution is, in one way or another, managing risk.  There is no such thing as a risk-free product or institution.  Or, indeed, individual.  Understanding the risk you are running and managing it properly is what every bank, every employee in a bank, every customer of a bank, every shareholder in a bank, every investor in a financial product and every regulator of a bank is doing.  Or ought to be doing.
  3. Understanding properly is hard work.  There is no magic bullet, algorithm, theory, process, spreadsheet, AI or killer piece of management information which will do it for you. Thinking is often required.
  4. There is no way of eliminating risk.  Mitigating and minimising it: yes.  Eliminating it: no.  If anyone says otherwise (and much of the financial crisis was caused as a result of clever people thinking they had done just this and learning, painfully, that they hadn’t) they’re a charlatan or worse.
  5. Human beings, even clever ones (particularly them, it sometimes seems) do not behave rationally around money. Money and emotions are bosom pals. As any decent novelist or lawyer dealing with divorces or wills will tell you.  The “animal spirits” Keynes described do not just apply to market participants but to all of us.
  6. Managing people, understanding them, motivating them, inspiring and leading them, teaching them, setting them a good example, setting them high expectations and making it clear what the boundaries are, what behaviour will not be accepted, what crosses the line, helping them get past their frailties, working effectively with them is hard work, the hardest work anyone ever has to do.  And by far the most valuable – and rewarding.
  7. Finance is there to serve others, not itself.  It is a means to an end and the moment it (and the people in it) start thinking of themselves as indispensable, as set apart from the society they are part of, as entitled to special consideration and immunity from challenge is the moment when hubris sets in.  Nemesis will surely follow.

 

Photo by Lesly Derksen on Unsplash

Ask Not For Whom The Bell Tolls

January 21 2019

The best single essay on financial misbehaviour was written not by a journalist, academic or former trader, but by a novelist and 25 years ago: The Deficit Millionaires by Julian Barnes, that most pointillist and French of English writers.  It is about Lloyds of London, the huge losses it suffered in the early 1990’s and how trusting Names slowly realised that their faith in a long-standing and well-established institution was utterly misplaced.  Lloyds had been around for ever.  It was part of the City’s furniture.  And it was insurance, after all.  How boring is that. How could anything possibly go wrong?

Well, with exquisite care and sympathy and the precision of a surgeon’s scalpel, Barnes shows us how.  And the story is a surprisingly familiar one.

  • A novel but complicated instrument designed to reduce risk but instead increasing it – the London Market Excess, or the spiral of reinsurance.  “Making a turn” – in the spiral – “was the easiest way to make money” one underwriter said.”
  • Greed – “If you are making a good living, if you have self-regulation, if you are outside exchange control, it’s human nature to get greedier and greedier and greedier”.
  • The market’s rapid expansion in a short period of time.  There was a near-ten-fold increase in the number of Names in 14 years, most of them trusting amateurs and all looking for insurance to underwrite.
  • A lack of due diligence, a suspension of critical faculties, a lack of scepticism coupled with an all too human willingness to believe in the promises of a no risk investment, all wrapped up in a flattering appeal to vanity.
  • A  deeply cynical – and possibly fraudulent – approach by the professionals to those who joined (“If God had not meant them to be sheared, he would not have made them sheep.”) 
  • Relaxation of the rules and lax monitoring of those that existed.
  • The undisclosed conflicts of interest – recruiters were paid a fee for each Name who joined.
  • A lack of transparency – it was Lloyds insiders rather than external members who got onto the best managed, low risk and least spivvy syndicates, justified by the then Chief Executive thus – “In any activity, the professionals will know more than the others.”
  • The breakdown of trust – what Barnes describes as the “tickle of fraud“, the realisation that the belief in “an honourable society, operating on trust, on shared values” was a chimera.  Or as one Name put it more bluntly, “You know, trust, honour, and then to find in such an august body a bunch of craven crooks”.
  • The realisation, far too late, that private warnings were given about some of the risks and unacceptable/criminal behaviour but these were ignored or not shared with those who ought to have been told.
  • The turning of blind eyes to unacceptable/negligent and/or criminal behaviour by a remarkable cast of shameless rogues during the 1980’s, even when the latter were the subject of legal action.
  • The failed institution’s repeated insistence that any problems were only the result of that well-worn old favourite: one or two rotten apples, despite one of those rotten apples being a Chairman of Lloyds.
  • The determined focus by new management only on its new procedures and processes and business plans for the future in the hope that a veil would be cast over the past, without any unseemly digging into it.
  • The eventual realisation by the institution that, as its deputy Chairman, put it, for the previous twenty years it had lacked “total integrity” and “strong government“.

Even the modern new building housing the salvaged and totemic Lutine Bell and built by a famous “name” architect is part of the story.

Barnes eloquently shows how an institution believed to be “the highest name of honesty“, seen as part of a certain sort of honourable Englishness, around for three hundred and five years, a stalwart of the City, selling its services around the world, as venerable as the Bank of England and thought to be as safe, came to be seen, harshly but accurately, as “a cesspit of dishonesty“.

If only this had been published more widely than in a US publication and, later, a book of essays.  If only we had paid more attention.  If only we had learnt the lessons that were there to be learnt.

Everything that went wrong in the run up to the near collapse of the Lloyds insurance market happened again two decades later and led to the financial crash 10 years ago, even with the benefit of external regulation and control.  Indeed, pretty much the same things happened in the lead in to most financial scandals going back hundreds of years.

And, human nature being what it is, it’s a pretty safe bet that a version of all or some of these will happen the next time, may indeed be happening now.  The same behaviours will once again come under the spotlight when the the next scandal becomes known, with its inevitable backing chorus.  

Why didn’t anyone see?  

Why did no-one ask the obvious questions?  

Why did no-one listen to the warnings?  

Why, oh why didn’t anyone act?

As Parliament’s Intelligence and Security Committee put it in a different context“it has been striking how some the issues which arose in [2005 and 2013] have also been seen as having been a factor in 2017.  We have previously made recommendations in these areas, yet they do not appear to have been acted on.”

Scepticism.  Curiosity.  Asking tough questions.  Learning lessons from previous events.  Their absence is a regular feature of many incidents of misconduct, many crises, both large and small.

But ultimately, in finance, as in other sectors, it is those old-fashioned concepts – trustworthiness, integrity, honourable dealing – which remain as essential in 2019, and years to come, as they have always been.

 

Photo by Boris Stefanik on Unsplash