The origins of the banking greed culture

A lot of people have asked me in recent days how we ever got into this incredibly damaging state of affairs, where apparently well-educated and purportedly sensible men and women began to run the banking sector like it was a high-stakes poker game for a bunch of private high-rollers!

If you ask these former ‘Masters of the Universe’ whether they have read the writings of Edwin Sutherland, Gilbert Geiss, Robert Merton, Austin Turk, or more recently and perhaps more potently, Barry Rider, Michael Levi, Michael Clarke, Tom Naylor, or even my own very small contributions to the literature, you will find universal ignorance.

Much as one would like to put the blame on their bullying personalities, inflated-egos and indefensible arrogance, that is not enough. That is almost too easy, and makes the problem sound almost pathologic.

It is not just these things, but it is also a monumental failure to learn the lessons of history and to be able to deconstruct lessons from our past. Those of us who have been in the game long enough have seen this all before. This is part of the problem for the regulators and their staff. Most of them are so young, they have never experienced this kind of situation before and so do not know how to handle the fall-out.

Well, for the ignorant and uninformed, here is my take on the origins of this crazy, bizarre, money-go-round, where if you want to make a mess of an industry, hire a management consultant, but if you really want to damage it beyond repair, then just choose the CEO of a major name bank, and watch its assets tank!

Back in the 1970’s and 1980’s most businesses, both in the USA and the UK operated on a fairly sensible basis of commercial conduct. Most of them recognized that they existed in a form of mutually supporting interlinked relationship with their workforce, and that their lives and well-being were mutually sustainable. I am looking at a macro picture here, I do not intend to focus on small, individual disputes or disagreements at individual factories or works premises. In fact, it needed politicians to begin to really screw things up, but that came later, and is a story for another time.

Towns and cities very often supported one or two major industrial entities, and the local works very often became the employer-of-choice for the town. These businesses owned premises, they had an order book, they produced finished products and they hoped to make reasonable and realistic profits, both to pay sensible dividends and grow their business. They had careful relationships with their banks, who knew their business, understood the annual fluctuations of their order and sales books, and who had money loaned to the business on sound commercial terms to provide liquidity in the hard times.

Then, in the late 1970’s and early 1980’s a group of aggressive businessmen on both sides of the Atlantic began to take a close look at the way in which these businesses were structured, and they quickly realized that their asset value, when broken up, did not meet, in any way, their share value, and that most companies’ shares where grossly undervalued. They were not interested in the companies’ social relationship with their work-force, and they were not concerned about the long-term effect on unemployment on working-class communities, they merely wanted to strip the valuable assets out of the companies for their own benefit, and leave the dross behind.

Thus began the era, first of the ‘asset strippers, quickly followed by the piratical arbitrageurs or ‘arbs’. Given immense acquisition power by the use of a financial derivative instrument created in the US by a financial genius Lew Ranieri, the ‘junk bond’ became the offensive weapon in the hands of the Corporate Raiders, as they marched into battle, singing their anthem of releasing ‘shareholder value’.

Thus was spawned by great myth of ‘shareholder value’. It was a lie from the very start because the most aggressive activities were being brought by men who had only very recently acquired a few shares in a potential target company, as a justification for their actions. From early beginnings, the corporate raids multiplied, spinning off a new business which became called the ‘Mergers and Acquisitions’ industry. Suddenly, all the big law firms, merchant banks, accountanting businesses, ‘investigating consultants’, everyone wanted to pile into the M&A business, because it was a multi, multi billion dollar business, and the simple mathematics of the business model meant that the loser paid the bills.

It was literally a no-lose situation, and lawyers and merchant bankers grew incredibly rich on the back of M&A. Vast sums of money were spent on attacking and defending corporate takeovers, it was enough merely to hear a rumour that a particular raider was taking a look at a particular company, for the share price to climb exponentially. Company directors literally fell over themselves to account for every penny of cash and every asset owned by their business, so that their share price more accurately reflected their asset value. It didn’t make their businesses any more efficient or profitable, but it was a means of keeping the business going and out of the hands of the asset strippers.

What it did was to make business more short-term, demanding ever-greater revenue delivery in a shorter and shorter time-span. It stripped business of investment capital and dried up liquidity in the form of capital assets.

Such a febrile atmosphere naturally spawned its own derivative activities, and predicated the rise in insider trading, as gamblers, speculators and insiders gorged themselves on the stock of these companies.

It took the prosecution of Dennis Levine, Ivan Boesky and Michael Milken in the US in the late 1980’s to drive the stake through the heart of the great monster that had been spawned by the arbs, nurtured by greed, and other people’s money, and which had ruined huge swathes of the commercial landscape, particularly in the USA.

The monster might have been laid low, but the short-term culture of the business environment had taken hold with a vengeance. US management found that stock analysts and Wall Street commentators were not going to relax their obsessions with the delivery of shareholder value, and they continued to focus their attention on the revenue streams that each quoted company was producing. It only took a single quarter’s figures to reflect a dip in revenues, for the Wall Street scribblers to issue dire warnings about the company’s profitability, and for the share price to take a southbound trip.

This conduct had a seriously deleterious effect upon the value of the shares and the share options which most US companies now insisted their staff and executives hold, part as a means of encouraging ever greater commitment, and part as a means of paying the ever-growing bonuses which these businesses were beginning to demand.

Having grown used to the bonus culture which had developed during the decade of M&A greed, the employees of the businesses were unwilling to give it up, and they were very often funded, partly in cash, and partly in corporate paper.

Thus everyone had a vested interest in ensuring that the share-price remained buoyant and that revenue streams were maintained, because otherwise, their share and option values took a hit!

This unhealthy atmosphere expanded, and expanded again. Banks and other businesses began to rely more upon the level of bonuses they were paying, than the basic salaries that their staff were taking home. The bonus became the means of ‘keeping score’, and it became an annual ritual where bonus compensation in millions of pounds or dollars became the norm.

The continued need to maintain the share price, both in the name of the myth of shareholder value, and more, to maintain the value of the bonus payment, became the only focus of the banks and institutions. Any business stream that could be manipulated to demonstrate vast profits and huge revenue flows became the ‘holy grail’, and thus the sub-prime mortgage business and its concomitant securitization processes, which seemed to be a stream of revenue without end, became the obsession of every banker, and every financial driver.

So, now you know how the present situation was brought about!

Bernard Baruch, a Nobel Prize winning economist writing about the Wall Street Crash in 1929 said;

‘…At a time of dizzily rising prices, it behoves us to remember that one and one equals two. If we had remembered that simple formula, I believe that much of the present crisis could have been averted…’

Shame that ‘Fred the Shred’ and his fellow partners-in-shame hadn’t read Baruch either!