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

February 28 2019

One of the financial sector’s characteristics is a short memory.  After about 5-7 years memories, particularly of tough times, begin to fade. New joiners bring their enthusiasm and keenness to do new deals, develop new structures, explore new possibilities. Blockchains, ever more complex algorithms, AI, new paradigms: all are being created and expanded. The future’s exciting. So the surfeit of scandals which came to light following the financial crisis a decade ago are beginning to sound like stories from a forgotten age, interesting but no longer really relevant to now, let alone the bright new future.

And then, from the other side of the world, comes this – a searing report (a Royal Commission, no less) into misbehaviour in Australian banks, to remind us, once again, that – in the words of an official with the US’s Financial Crimes Enforcement Network back in 2013 – “large amounts of money sometimes bring out the worst in people.”

(As an Australian might put it: “You don’t say!”)

The report followed a year-long public inquiry into the culture and practices within Australian banking and revealed shocking, widespread and systemic examples of the sort of misbehaviour with which we have become so familiar.

• Rewards for misconduct: the focus of all the institutions, whether banks, mortgage brokers, insurance firms, intermediaries was on selling, as much as possible for as high a fee as possible, regardless whether this was in the customer’s best interests.  In some cases, non-existent services were provided to dead people for years.
• It will come as no surprise that this arose from badly skewed incentives. Or greed, of both the individuals and the institutions, as the Report says, bluntly and refreshingly.  
• Firms abused their superior knowledge to mislead and defraud customers.  Conflicts of interest were ignored.  Individuals did what they could not what they should.
• When customers complained, staff were trained to lie to them, even when compensation was paid; deliberate actions were conveniently and misleadingly described as an “administrative error”.
• Firms lied to and misled regulators, often for years on end.  Nor were these the actions of junior staff but of senior management who felt no compunction about noting down in internal correspondence how to keep information from regulators and prevent any proper scrutiny of their actions.
• Regulators were weak and did not hold those who misbehaved to account, even when they became aware of them.

500 pages set out in blistering detail a sorry tale of greed, fraud, lies, poor leadership, contempt for customers and a systematically rotten culture.  The usual action is, of course, now being taken: resignations, new leadership, building a good culture, training, new legislation, enforcement, litigation and so forth. 

Two points in particular are worth noting:

1. These scandals did not happen in investment banking but in retail institutions, those dealing every day with ordinary consumers, the very people who need trustworthy and reliable financial services, who had a right to trust their providers and who were so badly let down.
2. The banking sector in Australia is one of the most profitable in the world: 2.9% of Australia’s GDP.  Compare this to the US share of 1.2% and 0.9% in the UK.  The pre-tax profits of Australia’s banks are 6^thin the world even though it is only the world’s 13^th largest economy and its population only 25 million.  Little wonder that they thought they could do no wrong.

When sectors / institutions start thinking of themselves as indispensable (“look at our profits, our tax revenues”), when finance forgets that it is a service industry, there to serve others not itself, when banking is seen as a product to be sold rather than as a long-term relationship to be nurtured, then hubris and the sorts of behaviours seen in Australia, as well as elsewhere, will happen.  

The Australian report is a salutary reminder that the old stories still have much to teach us.  

Photo by Jamie Davies on Unsplash

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