by Perman, Ray
HUBRIS
Ray Perman was a journalist in London and Edinburgh for thirty years. He was a co-founder of the business magazine Insider Publications and was Chief Executive of Scottish Financial Enterprise from 1999 to 2003. In 2011 he was appointed Chairman of the James Hutton Institute, the first institute of its type in Europe dedicated to making new contributions to the understanding of key global issues such as food, energy and environmental security.
This eBook edition published in 2013 by
Birlinn Limited
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www.birlinn.co.uk
First published in 2012 by Birlinn Limited
Copyright © Ray Perman, 2012, 2013
Foreword copyright © Alistair Darling, 2012
The moral right of Ray Perman to be identified as the author of this work has been asserted by him in accordance with the Copyright, Designs and Patents Act 1988
All rights reserved. No part of this publication may be reproduced, stored or transmitted in any form without the express written permission of the publisher.
Print ISBN: 978-1-78027-132-3
eBook ISBN: 978-0-85790-229-0
British Library Cataloguing-in-Publication Data
A catalogue record for this book is available from the British Library
Version 2.0
‘In the eye of the storm, Nemesis followed Hubris’
Lord Stevenson of Coddingham,
chairman, HBOS, annual report 2007
Contents
List of Illustrations
Foreword
Preface
Preface to the Paperback Edition
1 Banker to the Stars
2 Base metal into gold
3 A cosy world
4 Cometh the hour, cometh the man
5 The Cultural Revolution
6 The most boring bank in Britain
7 A dark land – we need to pray for them
8 No turning back at Derby
9 Morituri te salutant
10 ‘The next thing he does has got to work, otherwise he’s toast’
11 Peter’s Last Supper
12 A clash of cultures
13 Room at the top
14 Give me enough debt and I’ll move the world
15 As safe as houses
16 Ziggy’s stardust
17 The eye of the storm
18 Apocalypse now
19 Nemesis strikes
20 Hungry for risk
21 Why didn’t they realise?
22 The drive for profit at any price
23 Why didn’t the regulators stop HBOS?
24 The end of history
25 Gone, but not forgotten
26 Called to account – at last
27 Retribution of a sort
Notes & references
Bibliography
Index
List of Illustrations
Sir Walter Scott broods before the former Bank of Scotland headquarters in Edinburgh.
Covenant Close, off Edinburgh’s Royal Mile, once housed the Cross Keys Tavern, where in 1695 shareholders first subscribed for Bank of Scotland shares.
An early Bank of Scotland note.
The Bank of Scotland board in 1995.
The Bank of Scotland crest outside The Mound.
Peter Burt and Halifax’s James Crosby announce the merger which formed HBOS in 2001.
Gordon McQueen, Peter Burt and George Mitchell.
George Mitchell.
The HBOS board in 2006 in the old Bank headquarters.
Peter Cummings.
The former Bank of Scotland headquarters on the Mound.
Sir Philip Green.
Vincent Tchenguiz, one of the high-rolling ‘FOPs’ (friends of Philip Green).
Former Rangers Football Club owner Sir David Murray.
Tom Hunter.
Graeme Shankland, one of Peter Cummings’ key lieutenants.
Andy Hornby with Lloyds’ chairman, Sir Victor Blank.
Andy Hornby with Lloyds’ chief executive, Eric Daniels.
Sir James Crosby, deputy chair of the FSA.
Lord Stevenson, former HBOS chairman.
Foreword
My years in the Treasury during the financial collapse of 2007–8 gave me more hands-on practice dealing with banks than any Chancellor of the Exchequer in living memory. During frequent increasingly tense meetings I also came face to face with the men running those institutions. It is not an experience I would recommend. Northern Rock was the first British casualty of a storm which was to engulf dozens of banks in the US and Europe, but in August 2007, when I asked for a list from my officials of other banks that might be exposed to the US market, HBOS was there.
This is a story about the downfall of one bank, but it is more than that. The consequences of the 2008 banking collapse in Scotland, the UK and in Europe have proved catastrophic. The economic crisis that resulted threatens years of stagnation, with little growth, high unemployment and lost opportunities. How could it happen? We need to understand that to know what lessons to draw from it.
The headquarters of the Bank of Scotland on the Mound dominated the Edinburgh skyline for centuries. It was a symbol of strength. The Bank of Scotland, founded in 1695, had come to represent all that was best in Scottish financial acumen. It began lending money to the Scottish nobility with loans secured on good quality land. It understood the risks it undertook and it prospered. By the late 20th century it was seen as a solidly sound if unexciting bank. Then, in the late 1990s, the bank made the decision to merge with the Halifax Building Society to form HBOS. The Halifax was Britain’s biggest building society. It too had prospered. But this was a marriage made on the rebound.
The Bank of Scotland had decided to pursue the takeover of the National Westminster Bank, one of the UK’s biggest banks which was viewed as under-performing No sooner had it done so than its old rival, the Royal Bank of Scotland, entered the fray. The Royal Bank pursued an aggressive campaign to win Nat West, judging that whichever bank seized the prize would establish itself as a dominant UK presence. The Royal Bank won. Shortly afterwards, the Bank of Scotland felt exposed. Having lost the bid it could not afford to stand still – hence the merger with the Halifax.
The new bank was now under a different management style. It began to pursue an aggressive lending policy to personal and business customers. In particular it pursued a policy of expanding its market share in the domestic mortgage market and also started lending billions of pounds for commercial property. It was taking on risks that it did not understand. By 2008, as the global banking crisis took hold, HBOS found itself hopelessly over-exposed and facing collapse. It had no option but to agree to a takeover by Lloyds Bank in September of that year.
HBOS was not alone in lending billions of pounds on the back of rapidly rising house prices and a property market which seemed to promise limitless returns. In Ireland, the banks were similarly exposed. So too was HBOS and RBS, through its subsidiary Ulster Bank. The sheer scale of the losses incurred by the Irish banks were to bring down the Irish government which was forced to go to the International Monetary Fund and to fellow eurozone members for a bail out. A similar property bubble left many Spanish banks in a similar state, forcing the Spanish government to seek almost 100 billion euros from eurozone members in the summer of 2012. Other banks too, particularly in continental Europe, remained fearful that the continuing economic downturn would result in many of their loans turning bad, leaving them with losses.
Altho
ugh it is easy now to identify what went wrong, no regulator anywhere in the world picked up on the growing risks the banking system faced in the mid part of the last decade. But the warning signs were there. Indeed many of the symptoms were spotted, but nowhere did anyone bring together all the warning signs before disaster struck. In particular, the trade in sophisticated financial products which brought down many US banks and RBS here in the UK were not fully understood by the banks themselves. There seemed to be an assumption that if everyone was making money from these trades that they must be all right. Very few were prepared to ask themselves what exactly these products were worth. The answer was very little.
Primary responsibility must rest with the boards of these banks. The board of a company has a legal responsibility to its shareholders. Board members should have asked themselves whether they understood the risks to which the bank had become exposed. In lending such huge sums they should have asked themselves what would happen if the borrowers got into trouble and could not repay the debt. This is not rocket science, it is basic banking and as this book shows, it used to be second nature to bankers and to bank boards.
The regulators for their part failed to understand just how exposed some of these banks had become. Worse, they did not appreciate how interconnected the world’s banking system had become. They looked at each bank on its own. They did not ask what would happen if a bank got into trouble, perhaps on the other side of the world and how its problems would spread rapidly through the global banking system. Northern Rock was a well-established provincial building society with deep roots in the north east of England. It had, along with a number of other building societies, demutualised in the 1980s to become banks. During the course of the crisis every single building society that demutualised either failed or had to be taken over. It is instructive to see what happened in the case of Northern Rock.
When building societies were first set up they had a simple model. They took in money from hard-working artisans who in turn borrowed money when they wanted to buy a house. But in the 1990s and in the decade that followed a new model emerged. Banks discovered they could borrow money from other financial institutions across the globe and in particular in the US. The money there was to a large extent generated by the trade of sophisticated financial products, many based on what is now known as the ‘sub-prime mortgage market’, involving home loans to people on low incomes, secured on property of little or no value. It was inevitable borrowers would eventually default, and so they did, on an industrial scale. When the crash happened, the money that Northern Rock relied on from this wholesale market dried up and the bank rapidly became insolvent.
It was not just the former building societies that got into trouble. HBOS too had followed a policy of expansion based on lending substantial sums of money to as many people as possible. It was a classic case of pile ’em high, sell ’em cheap. For a bank this was disastrous.
That was bad enough in itself, but what the regulators failed to foresee were the consequences of banks being so dependent on each other for cash. They routinely lend billions of pounds to each other overnight and over long periods – perhaps six months or even two years. What happened at the end of 2007 was that as banks realised how exposed they were to other banks which had done exactly the same thing, they took fright and refused to lend to each other. The consequences were catastrophic.
So another big lesson for the future is that it is not good enough to judge the health of a bank by simply looking at its own position. Rather, regulators have to ask: what are the consequences of another bank failure, perhaps in another part of the world.
The economic, social and political consequences of a banking collapse mean there is a real public interest in what goes on in a bank. A noticeable feature of my tours of the country to speak about my own book (Back from the Brink, published by Atlantic Books in 2011), was the understandable concern and knowledge expressed by my questioners. Regulators cannot stand in the shoes of each bank manager and impose their judgement every time a loan is made, but they can insist that banks carry more capital in reserve as a safety cushion, and that the business is organised in such a way that in the event of a crisis it can be broken up or at least managed through it.
There is an argument that some banks are too big to be allowed to fail, so they should not be allowed to exceed a certain size. The problem with this is that in the event of a crisis no bank, no matter how small, can be allowed to fail. The risk is that if one bank goes, people will immediately ask: who is next? That is why we had to step in to deal with the Dunfermline Building Society when it collapsed in 2009. Under new legislation we were able to transfer it to the Nationwide Building Society.
In more tranquil economic times of course a bank, like any other business, can be allowed to fail. It happened with Barings and BCCI in the 1990s. And we must get to a situation where those who gain from a profitable bank share the losses when it goes wrong. But this will take time. So regulation needs to be tightened up, it must be more intrusive and there has to be far greater international co-operation between regulators.
As I write this, in the summer of 2012, the banking crisis is far from over. In the US and in the UK we cleaned out the banking system in 2008 when the crisis struck. Different mechanisms were used, but the bad debts and the toxic assets were identified and dealt with. More capital was put into the banks, and in the case of the UK, the government acquired major shareholdings in RBS and the Lloyds group.
In Ireland too, the government removed these bad assets from their banks. But there was a terrible cost as the banks were far bigger than the Irish state. When the bank debts became Ireland’s debts, the country was brought to its knees. There is an important point here. In the future, people will look very closely at who stands behind financial institutions. To put it bluntly, does that country have enough money to bail out any bank that needs it? Banks that grow too big for the country they are based in pose a serious threat. In the last decade the Scottish National Party used to boast of an ‘arc of prosperity’, including Iceland and Ireland. They wanted Scotland to be part of it. We don’t hear much talk of that now.
Unless and until the eurozone ensures its banks are cleaned up we will not get economic recovery. Spanish banks are exposed hugely to a collapsed property market. In turn the problems in Greece and Italy run the risk of defaults that could hit larger French and German banks. The inter-connections are still there and could still prove fatal.
The story of HBOS is salutary. Surely it is a classic case of trying to fly too close to the sun. The bank took on risks it did not understand and failed to make provision for. The result is that the name may exist but it is not the bank it was. A walk around the former headquarters on the Mound is a depressing experience. The building is more museum than the beating heart of the self-confident and prosperous bank it once was.
Alistair Darling
25 June 2012
Preface
In the autumn of 2008 I attended a black tie business dinner. I forget the occasion or the organisation responsible, they are all very similar and after a while the memories of each merge into one. Next to me at the table was a man with whom I had little in common. He managed a commercial real estate company and, although he took a keen interest in the collapse of the property market then in free fall, it did not directly affect him. His portfolio was mature with established tenants paying good rents. I only half listened to his conversation, nodding and smiling occasionally so as not to appear too rude. Then he said something which seized my attention: ‘I withdrew £20 million today from Bank of Scotland to put it in a safe place.’
There had been rumours for days swirling around HBOS, the unlovely conglomerate which now owned the Bank. (‘The Bank’, with an initial capital letter, might mean the Bank of England south of the border, but north of Berwick and Carlisle it had always meant Bank of Scotland). It was clearly in trouble, but the thought that it might go down, taking its depositors’ money with it had never occurred to m
e and came as a real shock. The Bank had been part of the Scottish landscape for more than 300 years, as solid and as tangible as the rock on which Edinburgh Castle stood. My wife and I had entrusted our savings to it. My sons had been Bank of Scotland customers since we opened Super Squirrel saver accounts for them as toddlers. The Bank had supported my own company – and countless other new start businesses – through thick and thin and when I sold it, that’s where I deposited the proceeds.
Now it was also banker to another small business I chaired. We had not been in business as long as my dinner companion and we did not have £20 million, but we had a substantial sum on deposit, hard-earned money which was keeping us safe through the recession. Britain had already seen the first run on a bank for 70 years. Unsettling television pictures of queues of savers waiting to withdraw their cash had spooked ministers and helped to hasten the end of Northern Rock. I had no wish to do even a small part in pushing Bank of Scotland down the same path, but our company could not afford to lose that money, nor see it tied up in administration or liquidation proceedings for months or even years. I called my company’s chief executive the following morning and told him to open an account in a safer bank and transfer the money immediately. When I called him later in the day his news was not encouraging. It had taken him hours to get through on the telephone and when he did it was to be told that because of the volume of new accounts being opened, it could be days or even a week before our application was considered. The rush away from the Bank was headlong.
What happened to HBOS in the weeks following is part of this story, but only part. The excesses of bankers during the first decade of the twenty-first century are lurid enough to grip the interest of readers, but to dwell too long on them would be to lose sight of what we have lost. The Bank of Scotland which all but disappeared with the collapse of HBOS was not the same Bank that I and many of its customers knew in the last few decades of the last century – and bears no resemblance to the institution behind the Bank of Scotland name which is still over the frontage of hundreds of bank branches – merely another brand of the massive Lloyds Banking Group.
