1 December 2010
The Financial Services Authority sat idly by while the UK’s building societies sector destroyed itself by gorging on Wall Street’s toxic waste, according to a leaked memo from a former FSA insider.
The letter, originally forwarded by Vince Cable MP to FSA chairman Lord Turner on April 15th 2009, provides an unprecedented insight into, as well as a savage indictment of, the FSA’s “light touch” approach to financial regulation in the UK.
The whistleblower, a former FSA senior executive, focuses on the FSA’s approach to regulating the building societies sector. Several of the building societies concerned went bust and ended up falling into the arms of larger players like the Nationwide or being bailed out by the taxpayer.
The letter, which was partially redacted to hide the identity of the whistleblower, made clear the FSA turned a blind eye to fraud – which he or she claims was widespread in the sector – with loan books labelled as “full status” – meaning mortgages where the income was properly evidenced income – actually being totally undocumented.
The letter was received via a third party who claimed to have received it from whistleblowers’ website Wikileaks. (Note: this is the most complete version made available so far with one-third more content visible than a more heavily redacted earlier version that was leaked to the Financial Times in April 2009)
The whistleblower said that one bundle of toxic debt, purchased by Dunfermline Building Society, was labelled as “full status” even though “not a single file contained any proof of the borrowers’ income from payslips, P60s, audited tax returns or bank statements.”
The whistleblower said he and his colleagues have incontrovertible evidence that societies were paying way over the odds for “what were ostensibly the safest residential mortgages, but were in fact risky self-certification loans”. He said they warned their bosses at the FSA but the bosses turned a blind eye. He said the purchase of bundles of toxic loans from GMAC was a significant factor in the demise of Bradford & Bingley.
The letter writer added: “FSA management turned a blind eye to that particular abuse, as it did to many others. [Name withheld] was not reprimanded or sanctioned, and the societies who bought its loans were not directly contacted. The FSA’s only action following the thematic review was to send a general “Dear CEO” letter to all building societies reminding them of the need to conduct thorough due diligence in advance of purchasing loan books from wholesale mortgage lenders.
The building societies must obviously share some of the blame.
After all, their boards of directors, both executive and non-executive, ought to have asked themselves some fundamental questions before allowing their institutions, and the members who they purported to represent, to be abused in this way. They should have been much more sceptical when targeted by the snake-oil salesmen of the City of London and Wall Street, aka “Greeks bearing gifts”.
But the real villain, according to the leaked letter, was the FSA which sat idly by while the building societies were duped into gorging themselves on a poisonous repast that ultimately killed some of them.
The letter outlines how, in 2002-03, building societies were struggling to compete with mainstream banks and the ‘shadow banking system’ on the pricing of either savings or loans. This spurred the Building Societies Association to lobby the FSA and government to let the societies “move up the risk curve” and get into specialized lending, including the purchase of loan books originated by third parties and other higher margin areas where they had zero competence or experience.
He said the Building Societies Association lobbied discreetly but insistently that the fate of the sector was “diversification or death”. “The FSA accepted this assessment unquestioningly. What followed was “diworsification” or “diversification and death,” the whistleblower wrote.
Building societies such as Dunfermline – which collapsed in March 2009 – went on a manic diversification spree, gorging on some £700m of toxic debt .
The boards of directors of such societies were apparently oblivious to the fact they were seen as gullible and naïve by people in the Wall Street and the City of London who, after the beginning of the subprime crisis in December 2006, were eager to offload toxic loan books as fast as possible onto less savvy financial players. Building societies were welcomed as “fools in the market” as the FSA sat by and did nothing, said the letter writer.
The whistleblower said: “I witnessed trusting and naive provincial building society executives and non-executives, who had no real understanding of securitization or structured finance or any other aspect of the workings of the global capital markets, being eaten alive by cynical, rapacious and short-termist investment bankers.
“That is how the Dunfermline, after 140 years of adhering to its raison d’etre of the traditional business model managed in three short years to destroy itself by acquiring £500 million of toxic commercial real estate loans at the peak of the greatest asset and credit bubble in history.”
The ex-FSA executive revealed that, in 2003-08, mid-ranking FSA staff were for the most part incompetent, poorly-qualified and of too low a calibre to effectively regulate the building societies sector. Others were too lazy and complacent to bother checking up on what financial firms were doing. He said none had the influence or the inclination to challenge the pervading “light-touch, laissez-faire regulation”.
He wrote: “Low calibre FSA management is perhaps the single biggest factor in this disaster …. A culture of apathy and complacency marked the FSA in the period of its nadir, with anyone standing up against the official “light touch” official policy criticized for rocking the boat and branded a trouble maker. In consequence many talented and conscientious people retired or left for the private sector.
“FSA supervision was hollowed out and its depleted ranks were staffed with mediocre people who cared little about the business of supervising firms. The then CEO John Tiner de-resourced frontline supervision of firms and increased the ranks of policy specialists and MSU staff (a form of management consultancy service). I fear that the FSA so degraded its capacity that it will take many years to restore an acceptable quality of supervision for retail financial services form.”
The whistleblower indicated that FSA executives including former director Sarah Wilson and current director Sheila Nichol, as well as Julia Dunn, head of the department that supervised all UK building societies, with the exception of the three largest ones, were at least partly culpable for the near destruction of the sector.
“In the run up to the crisis the FSA’s attitude to the mortgage industry ranged from indifference to willful ignorance. FSA management’s mantra then was “we don’t regulate business models”. Supervisors were told not to worry about building societies since if anything went wrong, Nationwide or another large building society would always be willing and able to take over a failing smaller one “for the good of the movement.”
The letter writer said that as a result of the FSA’s apathy a great Victorian movement was more or less consigned to the dustbin of history.
It has separately emerged that in 2006, owing the illness through stress and other maladies of his superiors, a 24-year-old graduate trainee at the FSA chaired a meeting between the FSA and former building society Bradford & Bingley. The meeting was on the “prudential regulation” of the now failed mortgage bank.
Last week the FSA, following a 17-month investigation by the accountancy firm PWC, concluded that none of the board directors who led Royal Bank of Scotland to within hours of bankruptcy, including former chairman Sir Tom McKillop and former chief executive Sir Fred Goodwin, had not done anything wrong other than to make a few “bad decisions.” Bailing out RBS and other UK banks has cost UK taxpayers an estimated £1.3 trillion.
The memo was received by Vince Cable MP when in opposition and forwarded to FSA chairman Lord Turner on April 15th 2009. A heavily censored version of the letter was leaked to Financial Times soon afterwards.
In his covering letter, Cable told Lord Turner that, while he was not particularly surprised by the revelations “what may surprise you is the extent to which the problems continue and pose a threat to other societies including [names redacted in the source document]. ”
[The leaked memo from a former FSA insider has been mildly edited by Cable and apparently redacted by Wikileaks to conceal the whistleblower’s identity]
Minor edits: October 4th, 2012 and February 12th 2014