By Ian Fraser
Published: Scottish Review of Books
Date November 17th, 2012
It was intended as a memorial to the Scots who died in the Napoleonic Wars. But it wasn’t long before the incomplete replica of the Parthenon on Calton Hill was labelled ‘Edinburgh’s disgrace’. This was because the so-called National Monument was left half-finished, with just twelve Doric columns before the money ran out in 1829. However, the ersatz temple doesn’t seem that ignominious any more.
Perhaps it is time to transfer the epithet to two Edinburgh-based institutions that are perhaps more deserving of the name – HBOS and the Royal Bank of Scotland. Both were founded nearly one century before the abortive memorialising of the Hanoverians. For most of their existence they were reasonably civilised firms. During the 1980s and 1990s both the Bank of Scotland, headquartered on the Mound, and RBS, headquartered on St Andrew Square, were well-managed, innovative and reputable. After undergoing internal ‘cultural revolutions’, involving job losses, greater use of technology, and the centralisation of decision making and credit processes, both banks were able to successfully outpace their English rivals in terms of profits growth, without losing sight of the interests of customers and staff.
As Ray Perman writes in Hubris: How HBOS Wrecked The Best Bank in Britain, the banks were actually trusted by their customers. When the Bank of Scotland adopted its ‘A Friend for life’ slogan in 1984 Perman claims ‘it was not greeted with cynicism. People believed it meant it, and more importantly, it did.’ But around the turn of the millennium both of Scotland’s two big banks started to lose sight of their raison d’être. To a greater or lesser extent, they broke the cardinal rules of banking that had seen them through the best part of three centuries. Both banks were responding to wider opportunities and threats in banking and the financial markets at the time, together with the onset of an increasingly laissez-faire approach to regulation that was introduced by Margaret Thatcher, but was also fervently championed by Tony Blair and Gordon Brown.
A critical moment came in 1999-2000, when the two Edinburgh-based banks fought tooth and nail for the right to buy their poorly managed but much larger English rival, National Westminster Bank. In the end, the Royal walked off with the prize, paying £20 billion. This takeover instilled a feeling of inviolability in the bank’s recently appointed chief executive Fred Goodwin, who had been brought up in Paisley’s Ferguslie Park, and had risen to the top of RBS via a law degree at Glasgow University, the accountancy firm Touche Ross and the Clydesdale Bank. As older managers were forced out, salesmanship, spivvery and profits growth became its driving force.
At the Bank of Scotland, this was especially true following its September 2001 tie-up with Yorkshire-based former building society Halifax. Just like Goodwin, the HBOS chief executive Sir James Crosby was convinced of his own brilliance. It wasn’t long before the pay and benefits packages paid to the likes of Goodwin and Crosby broke through the £2 million a year barrier. The banks were determined to grow at almost any cost, and HBOS took a ‘cheap and cheerful’, ‘pile it high and sell it cheap’ approach to financial products. The bank didn’t really seem to care if it was burdening people and the economy with debt they could ill afford or that the underlying assumption that underpinned its behaviour (that UK house prices were now on a permanent upwards trajectory) was a fallacy. Staff were rewarded for sales, not service and shareholders were being rewarded with an inflated share price. Treasury divisions were transformed into profit centres and the shuffling of complex derivatives which were poorly understood by the banks’ boards of directors became a fast-growing part of their business.
As the recession of 1990-93 disappeared into the rear-view mirrors of these bankers’ Mercedes, Lamborghinis and Ferraris, and the Rover-driving ‘Captain Mainwarings’ who had been through the pain of that difficult period drifted into retirement, a dangerous collective amnesia set in. The forgetfulness and complacency was reinforced by reassuring claims from the Federal Reserve chairman Alan Greenspan that volatility had been eliminated from the global financial markets as a result of wondrous new financial innovations like derivatives and ‘credit default swaps’. And Chancellor of the Exchequer Gordon Brown gave confidence with repeated claims that the Labour government had banished boom and bust. A drowsy numbness pained the bankers’ sense.
At the RBS, the determined manner in which Goodwin melded NatWest’s businesses together with those of RBS meant he was lionised in the City. He started to believe his own hype. Pacman-like, he stalked under-performing financial institutions round the world, in the hope of executing ‘mercy killings.’ By this, he meant buying them, sacking their managements and restoring them to financial health. He also became increasingly unpleasant towards his lieutenants. Rather than face the consequences of trying to argue with him, talented RBS executives decided they could no longer bear working there and made themselves scarce. Few of those who remained dared challenge him.
Meanwhile Goodwin allowed himself to become seduced by the ‘myth of unlimited liquidity’ – the idea that the torrent of cheap money, and cheap funding, unleashed by the credit bubble, would go on flowing forever. He therefore saw nothing wrong with managing RBS on a wafer-thin capital layer or of allowing the bank to become ‘over-leveraged’, City-speak for under-capitalised and too dependent on external borrowings. In their quixotic pursuit of ever higher returns, both RBS and HBOS massively grew the balance sheet by piling into risky lending, other speculative deals and proprietary trading in the financial markets. When the credit markets started to dry up as a result of massive fraud in the subprime mortgage market in July 2007, both banks were left perilously exposed.
RBS had to some extent been even crazier than HBOS. Despite warnings, Goodwin ploughed ahead with a €72 billion takeover of Dutch bank ABN Amro in October 2007. Goodwin and colleagues became so obsessed with proving this unprecedentedly complex deal – which they shared with Spanish bank Santander and Belgian bank Fortis – could be done, that no-one bothered to ask the obvious question, should they be doing it? In the end both RBS and HBOS would almost certainly have gone bankrupt, which would have led to customers losing their deposits, more than 230,000 employees losing their jobs, and financial mayhem in the United Kingdom, had not the Labour government stepped in at the last minute to rescue them from the consequences of their own folly. At the time Gordon Brown chose to single Fred Goodwin out for special blame – it helped divert attention away from his own economic mismanagement and pivotal role in the bank’s near demise – but I would argue that the former directors of HBOS are no less worthy of opprobrium, and perhaps also prosecution, than the boy from Paisley.
In Hubris, Perman, a former Financial Times correspondent who also ran Scottish Financial Enterprise, an industry lobby group, reveals that in the early Noughties some members of the HBOS board had serious concerns about the bank’s behaviour in the UK mortgage market but failed to intervene. When the bank started offering 125% loan-to-value residential mortgages in November 2006, it was, Perman writes, ‘to the mute astonishment of some board members’. What he does not reveal was who was mute and why they bit their tongues. Given that their role is to look after the interests of shareholders, surely these individuals ought to be named and shamed.
Such insane lending would have been unthinkable at the old Bank of Scotland in the 1980s and 1990s. Although it was at the time a slightly boring institution, it proved itself capable of delivering consistently strong financial performance whilst adhering to what Perman calls ‘Presbyterian’ principles. In 1985, ‘the Bank was riding high, but instead of gloating or greed there was a rectitude bordering on Calvinism’. Much of this culture emanated from the Bank of Scotland’s former chief executive Sir Bruce Pattullo, who ran the bank from between 1979 to 1998, and its former chairman Sir Tom Risk. Pattullo had a habit of reminding people that the 300-year-old bank, the institution itself, was more important than the individuals who worked there. Writing in the Scotsman to celebrate the bank’s tercentenary, Pattullo said: ‘Mistakes are more likely to occur in corporate life, especially in a bank, where one individual is anxious to achieve too much in too short a space of time. There is no substitute for good old-fashioned common sense.’
The words seem to have been forgotten soon after Pattullo retired in 1998. Perman charts Bank of Scotland’s disastrous tie-up with the right-wing, American, television evangelist Pat Robertson. His extremist and bigoted views triggered a furore and account closures in Scotland. Having eaten humble pie, the chief executive responsible for the ill-starred alliance, Peter Burt, then had the misfortune to be beaten by Good-win to the NatWest prize. On the rebound, Burt’s attempts to forge alliances with other banks including Abbey National turned to dust. Perhaps more out of desperation than genuine ardour, he opted for a merger with the Halifax. Led by James Crosby and Lord Stevenson, it already had a polyester-suited culture of salesmanship and was using the singing branch manager Howard Brown in its adverts. Unsurprisingly, the marriage turned out to be made in hell, not heaven.
Perman describes with aplomb some of the wilder excesses HBOS’s retail and corporate banking arms, capturing the cynical mind-set of its Crosby-led management and the internal chaos that ensued. In particular he highlights that the 15% to 20% annual growth targets laid down by Crosby and his co-directors were ‘startlingly demanding’. One of its biggest problems was that while the merged bank’s corporate governance and risk management procedures were ‘very elaborate’, as Perman explains, ‘they did not work’.
Perman shies away from probing the well-documented instances when HBOS broke FSA regulations but also, probably, the criminal law. These included how it encouraged customers who were taking out so-called ‘self-certified’ loans to lie about their income, and how it imposed known embezzlers on between fifty and two hundred small and medium-sized corporate borrowers, with devastating results. Nor does Perman mention the infamous HBOS board meeting, held at the bank’s Mound headquarters (now a museum) prior to its September 2008 collapse, at which senior insiders allege that Crosby’s successor as chief executive, Andy Hornby, and HBOS’s head of corporate lending, Peter Cummings, got into a fight. One version is that Hornby had his hands clasped around Cummings’ throat in an apparent attempt to throttle the pugnacious Glaswegian. Other directors are said to have had to call security to calm things down.
Former HBOS insiders insist the fisticuffs were triggered by Cummings’ refusal to risk lending even more money to property developers and other flaky corporate borrowers, who by that stage were already toiling under collapsing asset values and intolerable debt burdens, and therefore even less likely to repay the loans than those people to whom he had lent in 2007. Even he, it seems, had decided it was time to take the foot off the accelerator. But it was much too late. To have had any chance of survival given its dependence on a now non-existent resource – wholesale funding – the bank was kaput. What is astonishing is how Hornby and Goodwin seem to been have so shielded from the reality that many others could see clearly.
In his conclusion, Perman writes: ‘The sales culture had been creeping in [since before the merger with Halifax], dependence on wholesale funding had been increasing and most pernicious of all, the growth imperative had become ingrained. The Bank believed that if it stopped growing it would lose its independence. So it made a Faustian bargain…’ Bank of Scotland is today little more than a trading name within the enlarged Lloyds Banking Group. RBS is a ward of the state that may yet have to be fully nationalised. The tumble weed isn’t quite blowing through Goodwin’s folly at Gogar-burn yet, but it is beginning to feel decidedly empty. On a day-to-day basis, what remains of Goodwin’s empire is being gradually dismantled by the new chief executive, Stephen Hester, from Bishopsgate in London.
RBS seems to be living on borrowed time. Hester is nervously awaiting news of the costs of a string of criminal and civil actions dating back to Goodwin’s years of excess, mainly in the US, UK and continental Europe. Some have suggested the fines and damages arising from these could kill the bank, leaving the government with little choice other than to opt for a third bailout. That might be extremely difficult to justify politically. Having squandered our trust, these banks could take more than a generation to regain it. And whatever else comes out of ‘Edinburgh’s Disgrace, Mk II’, one’s main hope is that everyone with an interest in the future of the UK economy – including regulators, politicians and financial journalists – is extremely wary of any banker who is impatient for growth.