Keeping to his word!

In a recent speech towards the end of 2008, David Cameron made a hard-hitting speech, in which the Conservative leader complained that misconduct in the City was often punished by regulatory sanctions when criminal sanctions would be more appropriate.

“…Bankers and financiers whose misconduct contributed to the credit crunch should be prosecuted…”, he said and he accused Gordon Brown of showing "…a failure of moral leadership…" for supposedly not urging the authorities to adopt a robust approach to financial wrongdoing.

The FSA and the Association of Chief Police Officers (ACPO) have both acknowledged that there is there is some evidence that laws were broken in the City in the run up to the credit crunch, but David Cameron observed that the Financial Services Authority had only brought four cases to trial in the last 12 months.

Faced with the growing realization that the Western world’s banking industry sector is facing the greatest financial crisis since 1929, David Cameron’s words strike a note which while chiming harmoniously in the minds of most non-financial sector workers, will strike a very discordant note in the minds of the professional banking community.

His greatest challenge will be whether he and his team can find the methods and systems needed to impose this as-yet generally untried standard of crime prevention on a sector of the community whose senior executives have long since thought themselves to be a ‘protected species’, (as one banking executive once said to me at a City dinner)!

Will Hutton, writing in the Guardian puts it this way.

“…For 30 years, greedy, callow, ignorant financiers, supported by no less callow politicians from all the political parties, have proclaimed the wonders of financial innovation and how proud we all should be of the City of London. The price tag for their behavior is an economic calamity. We should never have bought such snake oil. The consolation in these dark times is that we never will again…”

This particular section of the financial community long believed themselves to be immune from the ordinary rules of engagement which have applied to the rest of us, believing, as they did that the Government had swallowed the big lie which they had been peddling for so long, that UK plc was better off under a regulatory regime with a ‘light touch’, and as long as politicians did not ask too many embarrassing questions about the provenance of the money being generated and which they were happy to keep siphoning up, believing, albeit wrongly, that this was proof that their own economic policies were working well. All too late have they realized that they too have been conned by the City, and their much vaunted and boasted economic success has been nothing more than luck (well that’s what Tony Blair now believes)!

It was generally accepted throughout the financial milieu that there were institutions who were literally ‘too big to fail’, and this comforted the derivatives-stretched banks and latter-day peddlers of snake-oil economics who felt able to continue with their improvident lending practices and their debt-packaging arrangements, secure in the belief that if the wheels fell off, well something would be done to ensure that the pieces did not all become completely unglued.
Well, that belief stopped the day that Lehman Brothers found out that no-one was coming to their rescue, and suddenly, these proponents of unbridled free-market capitalism (well hitherto free for them, their bonuses and their pension plans), had to learn that the deregulated free market environment they had been demanding for so long, had a price as well as a profit.

It was the realization that they could get away with the lightest kind of compliance response to market regulatory demands that sowed the seeds of this destruction inside the banking sector. Those of us who have worked with the regulatory sector have long since realized that whatever compliance requirements that were being adopted, were the most superficial, the most shallow and the most uninformed possible.

Capital adequacy requirements soon became a meaningless gesture as incentives in the Basle Accord, pushed lending off the balance sheet, as a means of evading the capital requirements imposed by the Basel Committee. As a recent IMF report has stated, the Basel treatment of securitization exposures such as asset-backed securities and credit-derivatives produces ‘strong incentives for moving even low-risk assets off the balance sheet and inadequate capital treatment for securitization of high-risk assets’. (IMF Publications Vol. 45, 2008).

On a personnel level, people being employed within the compliance sector, (particularly the anti-money laundering sector with its vital focus on the ‘know your customer’ requirements) soon began to be very carefully recruited from within a very specific market sector. Anyone trying to apply for a senior post within the banking environment knew that they were unlikely to be approved or appointed if they did not already have previous banking experience.
This no-doubt apparently prudent pre-requisite was not, as might first be thought, because the industry had such complex practice requirements that only a trained former banker would possess them, well, not in so many terms anyway.

I was reliably informed by a senior recruitment director of a niche head-hunting firm that banks wanted to employ such people for two specific reasons. The first was for ‘benchmarking purposes’, so that bank B, having employed a senior man from bank A, would not be required to employ any more systems or controls than those employed in bank A. Secondly, anyone who had long-term experience of the banking sector would instinctively know which questions were not to be asked, which corners were not to be explored, which skeletons were best left in which closets, all of which would save unnecessary embarrassment to the board of the bank concerned.
In other words, in most big institutions, compliance with regulations became a ‘fits where it touches’ operation, and was almost exclusively driven by process. As long as such an institution had a written process or procedure to deal with any given situation, then that would be sufficient. Whether they really employed anyone who had the skill or who would be willing to look beyond the written word was neither here nor there. It was encouraged, in any event, by the ‘light touch’ response of the regulator, whose visits were as much of a box-ticking exercise, as anything else, and as long as the right answers were being delivered, it didn’t need to great a degree of enforced oversight to be employed, so both sides could retire, unhurt.

Such a regulatory response has now been opened up to scrutiny. 10 months ago the Treasury Select Committee concluded that there had been a “substantial failure of regulation’’ at the Financial Services Authority. The committee’s verdict on the FSA’s role in the collapse of Northern Rock was damning: “The failure of Northern Rock, while a failure of its own board, was also a failure of its regulator.”

John McFall M.P, the committee chairman, went even further following publication of the report:

“The FSA appears to have systematically failed in its duty and this contributed significantly to the risks to the public purse that have followed.’’

FSA chairman Lord Turner admitted that the system had failed; “Bluntly we have been trying to do regulation on the cheap,” he claimed.

With these admissions of failure so starkly expressed, it will be interesting to see what David Cameron and his team can implement to ensure that those who would subvert our financial system will be suitably and appropriately punished.

Ironically, a short term of imprisonment would be an ideal punishment for those who engage in criminal acts within the financial sector such as insider dealing, market manipulation, market abuse, etc. In many respects we imprison too many people in the UK, for a variety of activities which are not appropriate for custodial sentences. However, City crimes are examples of egregious conduct which are carried out knowingly, deliberately and with full knowledge of the consequences, and in many cases, are committed by those who owe a duty of trust. Such actions call for an immediate sentence of imprisonment.

It would have a salient effect. A main board director who consistently failed to implement required anti-money laundering compliance programmes in his bank, and who was prosecuted for breach of the Money Laundering Regulations, would become headline news. Even if he were sentenced to only 6 weeks imprisonment, the impact of his sentence would spread through the financial sector like wildfire, and would immediately ensure an opening of the purse strings to implement a complete root and branch review of compliance procedures across the board.

The reason lies not in the length of the sentence, but in the fact of the conviction for a criminal offence. Once criminalized in this way, this man would never work in the City again, because he would be perceived to have become ‘a criminal’ which would have the effect of placing him on the same social level as the teenage ‘hoody’ burglar, the benefit cheat and the drug dealer, a social labeling from which he could never hope to recover.

The City itself knows this, and it explains why it lobbies so hard for differential treatment for its white-collar criminals. Regulatory intervention, while expensive and embarrassing, is merely little more than an inconvenience. It carries no social stigma.

So, it is up to David Cameron to put as much research into this ambition as possible to establish what is possible and how it can be achieved.

“…But it will be poetic injustice if Gordon Brown eventually claims the credit for "saving the British banking system" (with taxpayers' money), given that the roots of the problem lie in the inadequate regulatory regime that he put in place…”

Nicholas Crafts - Professor of Economic History at the University of Warwick