Wednesday, 11 February 2009

Bankers: Apologies Fake, Stupidity Genuine

It’s easy to diagnose greed and assorted wickedness from the Select Committee hearings – for example, the whole outrageous Paul Moore / James Crosby saga that, as CU says, will rightly run and run. (CU UPDATE: Crosby has resigned from the FSA this morning)

But I want to highlight another aspect – the circle-jerk phenomenon where everyone is, err … drinking each other’s whisky and gets completely carried away. Hornby says he invested his bonus ££ in HBOS shares (and has thereby lost a packet), and Goodwin avers he never sold an RBS share.

This exactly mirrors the behaviour of almost all the senior Enron execs, most of whose personal wealth was in Enron stock, and similarly sank with the ship. The notable exceptions were head trader Lou Pai, who (uniquely) insisted on being paid cash bonuses: and the actual criminal mastermind Andy Fastow, whose ill-gotten gains were invested in … municipal bonds (well, he knew the score better than anyone). Which kinda suggests that the rest were not calculating crooks, but were swept along in the excitement of the whole adventure. Ditto Hornby and Goodwin, by the same token.

This is doubly remarkable, because as any banker (and Enron exec) should know, the first paradigm of risk management is Diversification (the other two are Hedging and Insurance, BTW): indeed, in RM circles diversification is known as the only free lunch. These guys were so caught up in what they were doing, they ignored first principles, even in their own personal decision-making. They weren't just being reckless with shareholders' wealth, but with their own as well. That’s how intoxicating the game becomes.

And this is why we need regulators that are permanently ready to intervene. And this is why politicians who instruct regulators to turn a blind eye (Brown, Blair, this means you) are utterly, utterly culpable.
-------------
Footnote: a couple of interesting comments from the Grauniad’s Dan Roberts in their live coverage, one perceptive, the other unbelievably crass:

McKillop and Goodwin have so much gravitas about them that you can almost see how they managed to con us all out of billions of pounds

They've now wasted best part of half an hour on an arcane row about a supposed whistleblower at HBOS. I wish we could get back to the meat

ND

new footnote: Alex (comments) points to an alternative account of how Lou Pai made off with his Enron dosh

19 comments:

Mark Wadsworth said...

The sob story that they invested their own money in their own bank shares either testifies to their immense stupidity, or it's a Big Fat Lie.

I wouldn't mind losing £5 million on my shares if I'd received £10 million in cash as well.

Richard Beddard said...

I couldn't agree more. Though you might say the same of everybody including customers, politicians, regulators, and much of the media. Stupidity (otherwise known as short-termism), it appears, is our default behaviour!

dearieme said...

They kept shares in Bank of Bust. OK: did they get their wives to short them, then? It's time for Inspector Knacker.

The Great Simpleton said...

(less haste, more speed!)
Interesting that they are expected to apologise for their stupidity to those who believed boom and bust had been abolished and that house prices could only go up.

There must be a saying along the lines of "the blind leading the blind" for this situation.

roym said...

what an excellent post.

"And this is why we need regulators that are permanently ready to intervene."

will the FSA be up next? leading onto...

"And this is why politicians who instruct regulators to turn a blind eye"

joining the dots as it were?

is it possible to put together a synthesis of dictats from the treasury to the FSA? Im sure plenty must have been said behind closed doors, but will there be another whistleblower? who would they go to though? can we get this from FOI etc?
Without going back on myself though, someone must have lobbied for hands off regulation?

Anonymous said...

Good point, Dearieme!

Roym. Joining the dots indeed.

Nick.
You seeing things yet?

Sebastian Weetabix said...

I am astonished anyone could be that thick, never mind the "Masters of the Universe". Whenever I've had share options I've flogged them at the first opportunity. I suppose on the plus side we can now assume they aren't the cynical scumbags we thought; they really did believe their own shit.

As a humble engineer & curious visitor to this excellent blog, I begin to wonder (present company excepted) if the smartest people in the city are the tarts in the lapdance bars taking the actual cash.

Nick Drew said...

Mark, dearieme - no prisoners, eh ?

RB - thanks; yes, the human condition, but predictably so, therefore (when the stakes are high and the potential damage intolerable) to be protected against

GS - yes, perhaps we should have a little competition (my muse having deserted me temporarily)

anon - I see all sorts of things ... but as indicated in the post, not all are conspiracies (even if some are !)

Nick Drew said...

roym - thanks to you, too. We definitely need a few more whistleblowers, and I said ages ago it's to be expected that some more emerge, given how many disgruntled folks there must be, with little to lose.

This said, it is quite astonishing how little has come out on Enron (and I recognise that quite a bit has - but trust me, there's more)

Lobbying for hands-off ? Oh yes: see a famous 2006 speech by Blair slamming the FSA for its interfering ways (sic !) - so someone had clearly got at him. Back to Enron again: they openly (and successfully) lobbied for the CFTC not to be given jursidiction over energy trading (whereas it does regulate all other US commodity trading). they used a Senator called Phil Gramm for this, whose wife Wendy was *ahem* a Director of, err, Enron ...

(Anon - you listening to this ??)

SW - it can seem odd, but at the same time I feel it's kinda understandable. Part of it is a type of herd loyalty (you get this very strongly in US co's where it's almost a loyalty test to sink your entire 401K suicidally into the company you work for)

Sebastian Weetabix said...

ND: once upon a time when I worked in the USA I heard it said of a co-worker that he "wasn't really committed" because he refused to fill his 401K up with company shares. At the time I thought I was listening to an aberrantly stupid middle manager; I didn't realise that was a common perspective on that side of the water.

Alex said...

According to Eavis/McLean's The Smartest Guys in the Room, Lou Pai actually kept all the share options he ever received throughout his career, but cashed out the lot for around $400 million (about the same as Enron's operating cashflow less trades with self and prepays for 2000) in early 2001 as he prepared to leave the company (partly, to finance his divorce and remarriage to Melanie the stripper and her horse-flesh habit).

Rather than shunning the company stock, he did what most of the others *thought* they were doing - riding the scam all the way up and ejecting before the crash - but he actually went through with it and pulled the cord.

It's pretty much the normal failure mode for any really big fraud that the fraudster eventually forgets it's a fraud. When it's still going up, it takes a lot of balls to say "enough, already, I'm off" and jump clear. Ken Lay, at the same time, was diversifying...but by borrowing against his Enron stock.

Nick Drew said...

Alex - thanks, have added a footnote on Pai. Lay, as you say, was attempting a diversification strategy as the stock went south through 2001 (encouraging staff to keep piling in all the while !)

DorsetDipper said...

I'm with James Crosby on this.

1. The risk manager warned that borrowers would not be able to pay. The independent check did not agree, and in fact the borrowers do appear to be able to pay a sufficient amount.

2. HBOS's problem was the wholesale market funding. I have not read that the risk Department warned of this. If they did not, then James Crosby was let down by his risk department barking up the wrong tree.

3. "The regulator warned HBOS repeatedly." Now there's a big big problem with regulators and other police functions giving warnings. Given they have the power to arrest, then a warning is a tacit approval, because they haven't arrested the culprit or stopped the action.

4. "The regulator should have intervened". So, hands up everyone who two years ago thought that what the economy needed was more government regulation? One in the corner? Oh just scratching your nose ...

Unsworth said...

@ Dorset Dipper

But surely intervention is not an extension of statutory powers, is it? It's merely enforcement of existing powers. And the fault was that the regulator simply didn't have the nous or courage to properly take on the banks.

The banks were/are doing exactly what they were geared up to do. The regulator wasn't - and probably isn't.

Nick Drew said...

DD, Unsworth - good debate. On my reading, Moore (the RM) warned of several others things besides just that "borrowers would not be able to pay" (his paper here). I can't infer whether the funding risk was one for him: others have suggested this would have been a (corporate) Treasury matter, not for his 'regulatory risk' dept.

Crosby's sin is to have fired an RM who was bringing unwelcome challenge to the deal-makers' activities, a classic risk situation. Best practice on this is clear (I could give chapter and verse): RM should indeed report independently (as Moore seems to have been advocating - although to be fair to HBOS his reporting line to the CFO would generally be viewed as OK, had the CFO been backing him up !); should be given clear and visible support from the very top in the organisation; should have the authority and resources to be effective.

Crosby's subsequent appointment of someone with (a) a dealmaking background and (b) apparently no formal RM experience, also looks bloody odd (or, bloody convenient for the dealmakers). For anyone who has experienced these types of tensions in an organisation the story is all too familiar.

I've given my views on craven regulators (and shocking govt !). For the record, I and others have been pressing for proper enforcement of existing regulations for a lot longer than 2 years - including in blogs & comments.

We know what dealmakers are like (it's their job). Governance, regulation and legislation must be framed - and enforced - accordingly.

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