In 1999, I was employed by a British financial services institution. That summer, I was visiting branches around the country as part of an initiative to become more sensitive to the varied needs of our customers and less in thrall to witless and inflexible rules. One of the branches, Liverpool’s Old Street, was in a deeply deprived area, so I was horrified later that day when the branch manager told me their primary sales objective – set by headquarters – was to ensure that a credit card, a ruthless means of generating revenue through locking people into cyclical debt, was sold to each customer. I remember feeling weak-kneed. How could a bank that claimed to focus on fulfilling customer needs set targets that entrench impoverished communities in debt?
Later that year, I asked that very question of a general manager at a company event. The microphone was taken away from me after he declined to answer, so I snatched it back and asked the question again. Still he didn’t answer. After I had grabbed the microphone a third time and demanded a response, my career there came to a fairly abrupt end.
Now the banking world is in shock. Margaret Thatcher’s “Big Bang” of financial sector deregulation, so applauded by the City in the 1980s, led to the coagulation of the financial services industry into the few remaining giants we have now. Retail banks which administer personal bank accounts and lending merged with insurers, then with stockbrokers, and then with investment banks. The resulting institutions had little strategic coherency beyond making money.
Retail banks operate on low-risk models, aiming to make money through the safekeeping of depositors’ cash and utilising that capital to raise further funds while maintaining the capital requirements to disburse money when required. Stockbrokers aim to provide access to markets. And investment banks aim to raise capital for companies through the issuing of securities. They are profoundly different, with different aims, activities, types of employees and cultures, so combining them in one institution causes serious problems. The resulting hybrids are beset by internal contradictions.
Stockbrokers aim to persuade people to buy stocks through them, in part by recommending securities. But investment banks aim to raise capital for specific firms by placing securities for public sale. So how do you prevent the stockbrokers from pumping up the value of the securities that their investment banking colleagues are trying to place? “Chinese Walls” – the ethical barrier between different divisions of a financial or other institution to avoid conflict of interest – say the regulators. But Chinese Walls don’t work.
Take another firm for which I once worked, Merrill Lynch. This benefited from such tactics for years until an enterprising New York District Attorney, Eliot Spitzer, took them to court. During the tech boom, one of Merrill’s analysts, Henry Blodget, an expert on technology companies, would write equity research – essentially buy or sell recommendations – that the bank’s stockbrokers would use to recommend securities to their clients. However, while he was publishing reports saying that certain securities were instant buys, he was also sending internal emails ridiculing what “dogs” they really were.
Meanwhile, there was pressure from the retail banking side, which invariably wants to capture cash deposits and provide servces to businesses for large fees. This is all neatly summed up by one Blodget quote from an internal email explaining why he had been lauding a security: “[InfoSpace] is very important to us from a banking perspective, in addition to our institutional franchise.”
This was not unusual. Analysts are quite frequently used as the vanguard in attempts to capture various types of business from attractive companies and build goodwill towards a future multi-faceted relationship. I saw this often during my time in the City.
In the years since the Big Bang, these practices led to a series of spectacular market failures, with securities vastly overvalued before the market could correct itself. The consequences have been devastating. Both the dot.com crash and the most recent financial collapse are directly traceable to the contradictions that followed the Big Bang in Britain and the repeal of the Glass-Steagall Act in the US, which permitted hybrid financial services companies there.
Labour’s failure to intervene during its 13 years in power was unforgiveable and a prime reason for their 2010 General Election defeat. Without the banking crisis and recession, the party could still be in government.
So what went wrong? Under Labour, the Financial Services Authority was simply not fit for purpose. Bankers I know say duping the FSA is simple – for a number of reasons. The FSA has no systems perspective; it has been too obsessed with small areas and could never see how ridiculous the overall system was becoming. Second, the bankers are usually brighter and more ingenious than the regulators. Third, the regulatory regime almost forces the FSA into believing that Chinese Walls and the eagerness of bankers to comply with the law will work. That has never happened and it probably never will.
Like a gas, a bank will expand to fill whatever regulatory cage is places around it. Like a gas, it will probe the edges for ways out. This happens not because they are evil: rather, banks constitute an amoral natural force. Therefore, regulating them tightly is neither good nor evil, despite what the bankers and their political arm, the Tory Party, would have us believe. It is merely prudence.
When you have an explosive mix of gases, you need to separate them out and put them in appropriate containers. There is no reason for a retail bank to own an investment bank and a stockbroker. Bankers can talk about efficiencies and rationalisation, but all I saw were grotesquely large institutions engaging in self-congratulatory rounds of payouts to senior executives. It is time to start separating out these entities so they can do what they do best free from the temptation to find shortcuts, and regulate them properly.
We should reverse the Big Bang and split up retail banks, stockbrokers and investment banks. This will end the farcical Chinese Walls and allow for a diverse and competitive City that relies on innovation and quality service to differentiate it from its competitors, not on who can come up with the most elaborate ruse to evade the rules.
There should be an investigation into retail banking and the changes that have happened over the past two or three decades since the old Midland Bank became the first to eliminate account management fees. Since then, banks have been forced to create revenues through the cross-sale of insurance products, fees on overdrafts and other, often fatuous charges. This has created the situation where the poorest are deliberately mired in debt and charged each year for the privilege, subsidising the accounts of the wealthy. If the financial institutions are unwilling to change, especially after the Office of Fair Trading’s decision against them last year on overdraft fees, there must be legislation to change them. The culture of indifference must end.
Aggressive intervention in the financial advisory services is necessary. These have become a laughing stock. We should consider radical solutions, including increasing the liability of advisors for their clients’ losses.
Over the past 20 years, we have permitted the creation of a financial sector that is both too big to fail and too big to succeed, and is riven by internal contradictions. We are right to blame the banks for the return to boom and bust after Gordon Brown’s prudent macroeconomic management as Chancellor.
A financial sector as large as ours, failing so frequently and so dramatically, is sure to take the whole economy with it when it crashes. But it is in great part the last Labour Government’s fault for not having intervened. Even having seen the symptoms, Labour was comfortable to sit back and be intensely relaxed about the financial sector. This was a huge failure – in part, the result of a lack of commercial acumen and understanding at the highest levels of the party.
If we are to regain the trust of the electorate, we must apply the same dogged understanding of problems, radicalism of solutions and pragmatism of implementation that is at Labour’s grassroots to the monumental sickness at the heart of the British economy.
Imran Ahmed is a Labour activist in Hammersmith and a former strategist in the financial services industry