The Bear’s Lair: The road not taken for British finance

Jacob, Lord Rothschild, who died this week at 87, was mourned mostly as a philanthropist, his 1980s venture with Charterhouse J. Rothschild lost in the mists of time. That is a pity, because Rothschild’s vision should have been the way forward for British finance after the foolish 1986 Financial Services Act had destroyed its traditional structure. Today’s City of London is a mere shell of battling foreign-owned trading-floor behemoths, vulnerable to every whim of its globalist masters. This loss is incalculable; it is also not clear why it happened.

Jacob Rothschild’s family bank originated as a collection of partnerships in five financial centers, London, Frankfurt, Paris, Vienna and Naples, controlled by the five sons of the Frankfurt coin dealer and banker Mayer Amschel Rothschild (1744-1812). Its growth beyond a modest size was led by its highly capable London partner Nathan Meyer Rothschild (1777-1836), who organized an effective way to provide gold for Wellington’s armies fighting the Peninsular War in Portugal. Then he was lucky enough to be a large subscriber of a £27 million bond issue carried out by Britain’s greatest Chancellor of the Exchequer Nicholas Vansittart on June 14 1815, four days before Waterloo – the family banks’ holdings of the 10% paid (thus leveraged) “Omnium” bonds proved an excellent investment over the next three years and grew the family’s capital base to become, between the five banks, larger than all the family’s competitors.

With this enlarged capital, the Rothschilds got into the business of arranging bond issues for the various countries of Europe, including quite minor German principalities. Before this time, only Britain had issued public debt on a consistent basis, without defaulting on it since 1672 – the famous ‘Consols’ perpetual 3% bonds had been devised by another Jewish financier, Sampson Gideon (1699-1762) in 1751. By requiring that state bond issues be authorized by a representative body, a principle he established with an 1818 issue for Prussia, Nathan Rothschild both regularized bond issuance (Kings died, but representative bodies could bind their successors) and ensured that the Rothschilds would dominate it.

The peak of Rothschild influence came in the last years of the “old regime” from 1830 to 1848, during which the firm dominated European bond issuance, although not that of the United States, where the house never had more than a representative – this turned out to be lucky in the short-term, given the default rate of U.S. states in 1837-43. The legend of total Rothschild dominance over the global financial system dates from this period – in France, Belgium Austria and most of Germany Rothschilds was by far the dominant financial power, as well as being at least equal first with Barings in London. James de Rothschild’s (1792-1868) relationship with Louis Philippe and Salomon von Rothschild’s (1774-1855) with Klemens von Metternich were both very close, closer than any state relationships Rothschilds held in later years, except possibly Lionel Rothschild’s (1808-79) personal relationship with Benjamin Disraeli, used to finance the British purchase of Suez Canal shares in 1875.

The 1848 revolutions shook Rothschilds badly, because they negated the firm’s then unique advantage of a multinational partnership – revolutions occurred in four of the five countries where Rothschilds had banks, with only Britain exempt, and the prices of state bonds were correspondingly depressed. Both the Vienna and the Paris houses came close to bankruptcy, and with the death of the remaining brothers, Naples (closed in 1861) and later Frankfurt went into decline.

In the remaining centers, Rothschilds was subjected to much more aggressive competition than before 1848, while its relationship with Bismarck, Napoleon III and Franz Josef’s ministers were nothing like as close as with their predecessors – also the lack of a U.S. house became progressively more important. Some influence was preserved through the establishment of large commercial banks in which Rothschilds had a shareholding – notably Austria’s Creditanstalt in 1855—but after 1860 Rothschilds was no longer dominant in size among European banks.

Moreover, Rothschilds never did much with emerging industry; only in the railroad sector was it active, and even there it attempted to get government guarantees on debt. Consequently, while Rothschilds continued to grow and individual Rothschilds remained important, depending on their ability the group’s relative importance in global finance continued to decline. The legend of Rothschild dominance remained, but the reality became less imposing.

Coming now to modern times, the British merchant banks from around 1970 had a major problem: they were undersized. Decades of exchange controls restricting their international business and inflation sapping their domestic capital base had made them far too small to take on
the risks associated with the trading businesses that were just beginning to dominate international finance. Sir Kenneth Keith, the Chairman of Hill Samuel, was the first London merchant banker to grasp the problem – Hill Samuel was consistently among the top 10 houses in global foreign exchange dealing, which as the collapse of Bankhaus I.D. Herstatt was to show in 1974, had large hidden risks. Keith made three attempts to solve the problem: a merger with the real estate company MEPC in 1970, a merger with the entrepreneurial bank Slater Walker in 1973 and a sale to Merrill Lynch in 1980. For various reasons, none of these attempts worked – they were sharply opposed by many of Keith’s colleagues – but the principle was correct, as I determined when working on one of Hill Samuel’s strategic studies in 1975-76.

By 1980, the merchant banks’ problems were even worse; a decade of inflation and god-awful economic management had shrunk their capital base to half its 1970 size in real terms, now far smaller than the U.S. investment banks, which were bulking up. In addition, the new government of Margaret Thatcher was infected with a lunatic “level playing field” approach, which in practice meant putting the now midget London merchant banks on a level playing field against the Green Bay Packers of Wall Street – clearly a recipe for death and destruction.

Jacob Rothschild had joined the family’s London bank, N.M. Rothschild & Co. in 1963 and enjoyed a highly successful career in corporate finance, specializing in mergers and acquisitions and building up a separate closed-end mutual fund Rothschild Investment Trust (RIT). In 1980, seeing his way to the Rothschild chairmanship blocked by his cousin Evelyn, he sold his 11% share in the bank for £6.6 million (about $30 million today) itself an indication of how far merchant bank values had fallen, since N.M. Rothschild was one of the largest and most successful ones. It was indeed a bad period for the family banks – the Paris outfit was nationalized by the incoming socialist government of François Mitterrand, causing its chairman Guy de Rothschild (1909-2007) to remark:

“To be a Jew under Pétain was bad enough; to be a banker under Mitterrand, c’est insupportable.”

Jacob Rothschild then took over RIT, merged it with another closed-end fund Northern Investments and acquired the mid-tier merchant bank Charterhouse Japhet, forming a group Charterhouse J. Rothschild, with a market capitalization of £400 million, then bigger than any of the traditional merchant banks. He also organized tie-ups with the stockbroker Kitcat and the U.S. investment bank L.F. Rothschild, Unterberg and Towbin (not related to the European Rothschilds). Finally in 1984 he attempted to buy the entrepreneurial life assurance company Hambro Life, but this approach was rebuffed.

Jacob Rothschild’s purpose in putting together this financial conglomerate was, apart from sheer capital to reduce risk, to marry the investment generating capacity of a merchant bank with the investment absorbing needs of life assurance companies and closed end funds. In the oligarchic world of the merchant banks, this worked very well; everybody concerned was a gentleman, and if the occasional merchant bank-generated investment turned out a dud, arrangements could be made. Bad apples among the staff were quickly spotted and quietly rejected from the system.

Shortly after the Hambro Life failure, Rothschild turned round and over the next three years divested the companies he had assembled, thus ending merely as a private investment group RIT Capital Partners. It is not clear why he did this, but there are two possibilities. One is that he may have realized that he still lacked sufficient scale to compete in the emerging post-1986 world – £400 million, about $1.8 billion today, would still be dwarfed by the capitalizations of the largest U.S. and European banks.

The second possibility is that he saw the Financial Services Act of 1986 taking shape and realized that it would hugely increase the costs and risks of high-level merchant banking business. When a deal went wrong, instead of “arrangements being made,” under the new system some idiot regulator would come along 3-4 years after the fact and impose ruinously expensive fines or, if the regulator was of the mind of New York Attorney General Letitia James, draconian jail sentences. The risks of merchant banking would be dramatically increased, and so would the costs of employing senior merchant bankers – they would need to be maniacal hyped-up risk-takers like the Stratton Oakmont partners of “The Wolf of Wall Street” — jail sentences being like drug addiction, just one of the hazards they faced in day-to-day business.

Jacob Rothschild thereafter moved away from finance, devoting himself to philanthropy, his late Victorian cad’s palace Waddesdon Manor (a house in which no Duke would be seen dead) and his collection of bad art (Lucian Freud, David Hockney and Jeff Koons – Good God!) – an inspiration only to The Simpsons’ Mr. Burns.

Requiescat in Pace. But what a huge opportunity was missed!


(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.)