The Barclays LIBOR debacle, in which both chief executive Bob Diamond and chairman Marcus Agius ended by resigning, may be seen as something of a farce – to lose one top executive may be an accident, to lose two looks like carelessness. However Barclays’ trajectory over the last few decades, while unrewarding for shareholders, has epitomized the errors of the financial services industry over the last generation, errors even more egregious in Britain than in the United States.
As of 1970 or so, Barclays was a prominent and successful organization. It was the largest of the British “Big 4” clearing banks (commercial banks), with a large international operation in South Africa and smaller ones elsewhere, especially in former colonial markets. It had recently further increased its profile by launching the Barclaycard credit card in 1966 and in the following year pioneering the world’s first ATM, in Enfield, North London. Its employees had until 1968 included my much-loved Great-Uncle Cecil, who rose quite high in its retail operation in the English Midlands and drove a splendid 1949 Bentley Mark VI. It was a highly important factor to the economies in which it did business, highly profitable and almost risk-free.
With strong Quaker antecedents, founded in 1690, Barclays had become a joint-stock bank in 1896, following a merger. In this respect however its ancestry was not quite as unsullied as it appeared; one of the banks merged into it in 1896 was the Norwich Quaker bank of Gurney and Co. An offshoot of that bank, Overend, Gurney & Co., pioneered the London bill discounting market and then attempted to finance with the resulting revolving three-month money a venture capital portfolio including the shipyard that built Brunel’s “Great Eastern.” Inevitably it went spectacularly bankrupt in 1866, suffering the last full-scale British bank run until Northern Rock in 2007. David Ward Chapman, financing a lavish lifestyle with a house at Kensington Gore while running the bank into ruin through poor or non-existent risk-management, had his analogues 140 years later, in Barclays and elsewhere.
Like its clearing bank competitors, Barclays was tempted in the 1960s and 1970s by the merchant banking business, which appeared to be dominated in London by much smaller houses, some of them very sleepy, but was nevertheless growing exponentially. Initially Barclays’ participation in this business was carried out though Barclays Bank International, then in 1975 it set up Barclays Merchant Bank.
The problem with merchant banking was that Barclays was not very good at it. In spite of its more or less infinite access to capital, Barclays Merchant Bank was at best a second-tier operator. Top management and control systems transferred across from the parent bank mixed with staff, many of whom had failed in traditional merchant banks, either because of lack of ability or worse, because of their tendency to cut ethical corners.
When Big Bang happened in 1986, Barclays bought the broker De Zoete and Bevan and the jobber (market maker) Wedd Durlacher, but this made the scale much larger and the cultural problem worse. Barclays’ top management recognized there was something wrong. In a March 1987 interview with the Melbourne Age its retiring chairman Sir Timothy Bevan (from one of Barclays’ founding Quaker families) said “I think the best thing that could happen to the City right now is if someone goes into the slammer quickly,” adding prophetically “Firm, clear and decisive action by the authorities is far more effective than too many complex regulations.” Alas, the only City jail sentence after the 1987 crash was that for the fringe figure Tony “the Animal” Parnes, in relation to the Guinness scandal.
BZW, as the merchant banking arm had been renamed in 1986, struggled throughout the 1990s, trading as aggressively as others but with less success. The risks of investment banking were too gamey for the Barclays board, and the result was an inevitable culture clash. Finally in 1998 what appeared to be a sensible decision was taken, and BZW was broken up, with most of the pieces being sold to Credit Suisse First Boston and only the debt trading business being retained.
At the same time as it poured resources into its merchant banking business, Barclays had been building up a very different business in investment management. From 1990, it beefed up its private banking activities, and it bought Wells Fargo Nikko Investment Advisors in 1996, merging it into Barclays Global Investors. A pioneer in exchange traded funds, Barclays Global Investors grew to have the largest assets under management in the world. Unlike investment banking, investment management, both directly and through funds, required little capital and relied heavily on the reputation of its sponsor. At least in principle it needed to take few risks, although in the 2000s Barclays diversified heavily into “quantitative” hedge funds, which came the inevitable cropper in 2008. Investment management was hence an ideal business to combine with Britain’s largest clearing bank, and since Barclays was able to achieve scale in this business, it should have been potentially very lucrative for shareholders.
The clearing bank/investment management strategy was however given no time in which to work. Another in a series of boardroom coups in 1999 removed those who had sold BZW and built up the investment management business, and in the 2000s Barclays again placed its bets on investment banking.
Diamond had been brought on board in 1996 and was responsible for the debt business remaining after the breakup of BZW. In the environment of funny money, excess leverage and generally declining interest rates pervading internationally after 2000, this business did very well, while investment management suffered from the market’s relapse after the dot-com bubble burst. After Barclays’ misguided attempt to merge with the Dutch bank ABN-Amro in 2007, Diamond’s power within the bank was in the ascendant. Consequently he bore much of the responsibility for Barclays’ extraordinary twin decisions of 2008-09: to buy the remnants of Lehman Brothers on its bankruptcy in September 2008, and to sell Barclays Global Investors to BlackRock in December 2009.
The result was a mess, with Barclays’ gigantic investment banking business, with Diamond totally in control, responsible for 60% of Barclays’ profits, and the residual clearing bank business, still the second largest in Britain, purely a milch cow and capital provider for the investment bank, with no control of its own destiny. The LIBOR scandal, in which Barclays was fined 290 million pounds for providing false LIBOR “fixings” may thus have been a stroke of luck for Barclays (and for British taxpayers.) It exposed the incompatibility of the trader/investment banking culture with the needs of a deposit-taking commercial bank, without itself causing catastrophic losses except to Barclays’ reputation and that of the City in general.
The problem is that traders and conventional bankers are very different people, and mixing the two inevitably involves the organization in a level of risk that is incompatible with a deposit-taking bank that is a major lender to a nation’s small business. The former trader and current neuroscientist John Coates in “The Hour between Dog and Wolf” (Penguin Press, 2012) demonstrates that trading is largely instinctive, closely connected to athletic ability, and that trading success is closely correlated with the testosterone level in the trader concerned – high testosterone causes greater risk-taking and greater success, until eventually risk-taking becomes excessive and large losses occur. Theoretically risk managers can prevent that; in practice the traders make most of the money and come to dominate decision-making, resulting in the imposition of risk-management systems like Value-at-Risk, that pretend to control risk but grossly fail to do so in any kind of turbulent market.
If Coates is right, that has enormous implications for banking regulators. In a “too big to fail” deposit-taking bank, since traders prevent risk managers from installing risk management systems that actually work, either there should be no traders, or all the bank’s traders should be low-testosterone women, who will not endanger the bank’s capital. After all, unsuccessful traders provide just as much liquidity as successful ones, but extract smaller rents from the system. Either way, there would seem no need to reward this skilled but un-cerebral activity any more generously than society rewards other skilled but physical activities, such as truck driving or welding.
For Barclays, the implications are clear. The strategy that the bank had for a fleeting period of about a year in 1998-99 was the correct one. Retail banking and business lending, the core activities of the bank, can be carried out internationally and involve only moderate risk. Investment management likewise meshes well with banking activity, provided that the investment management activities are carried on primarily for clients, and do not involve high-risk trading. Trading should be undertaken only when as in foreign exchange it is of moderate risk and essential to the provision of client services. Finally, investment banking should be left either to specialist much smaller institutions or to hedge funds, who can bankrupt themselves and lose their foolish clients’ money without involving the banking system as a whole.
The universal bank model works well only in old-fashioned continental cultures, where trading activity is minor, pay scales are bureaucratic and competition is modest. In the world of global banking and sky-high remuneration, it is a recipe for disaster, whether in Britain, the United States or anywhere else. It should be abandoned, either voluntarily or through regulation.
And as Sir Timothy Bevan said in 1987, a few jail sentences, on both sides of the Atlantic, would wonderfully clean up the business.
-0-
(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)