Making It Happen: Fred Goodwin, RBS and the men who blew up the British economy

by Iain Martin

  Cameron also oversaw Alan Dickinson, who reported to him as head of UK Corporate Banking with 50,000 staff in branches and regional headquarters. On its own it served 90,000 British business customers. At that time it was expanding fast too, like some other banks pushing to eat up more of the UK commercial property market and making large loans to developers and companies wanting to capitalise on the roaring British property boom. As well as growing Greenwich, GBM was trying to push into other markets in Tokyo, Singapore, Hong Kong and elsewhere. The combination was a remarkable construct, considering that at the beginning of the decade RBS had been a relatively small Scottish bank. Now it was in an entirely different league. For a large fee in 2006, RBS teams in Spain and London arranged the £15bn of funding needed for Ferrovial, the Spanish construction company, to load itself with debt and buy BAA, then the owner of the UK’s main airports.9 When the football club Arsenal wanted to sell £260m of bonds to refinance the construction loans it had taken out to build the Emirates Stadium in North London, it turned to RBS for help. In North America it raised a large part of the finance for a $35bn energy deal, when ConocoPhillips bought Burlington Resources.

  It required armies of structured finance experts, analysts and teams of highly competitive traders who all swam in the giant bonus pool. In the highly competitive environment at the height of the boom, star investment bankers and traders could make millions by moving, or threatening to move, to rivals. The more they made for the bank the bigger their bonuses, although across the industry the profits, which the personal bonuses were based on, were sometimes opaque. Were they always real profits, or had they been booked as such when some of it might turn bad, or turn out not to have been a profit at all, if conditions changed? Those who made a cash bonus from selling a CDO one year did not have to give the money back a year later if what they sold turned toxic. Indeed by then they might have been poached and moved on. Few in London or Edinburgh stopped to consider the risky implications of this in 2006, or if they did they did precious little about it.

  GBM did have a well-staffed ‘risk function’ in London tasked with monitoring all this activity. For this Cameron relied on Howard Burnside and Riccardo Rebonato and their teams. Rebonato, RBS’s global head of market risk and quantitative research and analysis, reported to Crowe as well as Cameron and to the group risk managers David Coleman, and the ultimate boss of that part of the operation Peter Nathaniel. Rebonato was in the curious position of also being an academic and author who had written extensively on banks, risk and the financial crisis. Indeed, he even published a weighty book in September 2007, just as the crisis was beginning, in which he argued that the model of risk being used by banks was overly reliant on large numbers of staff taking measurements and ticking boxes and thinking that this somehow eliminated risk. Bankers needed to return to making commonsense judgements, he argued in Plight of the Fortune Tellers: Why We Need to Manage Financial Risk Differently. This important theory could have done with being applied more forcefully in 2006 and 2007 at RBS, where Rebonato was employed. ‘Riccardo grimaced a few times and thought we should have been hedging a bit more,’ says a colleague, ‘but he certainly didn’t put up a big red flag.’

  On top of the meetings to discuss risk, the bank had numerous daily credit committees, where bankers looking to loan or make major decisions had to go to have their initiative approved. There was an internal audit function with a licence to tour the entire business, external auditors Deloitte and Archie Hunter’s audit committee, on which sat Robson and other directors. That committee made visits to Greenwich and was generally happy with assurances received. There was no shortage of lookouts posted. Then again, everything seemed to be going so well.

  For steering the ship Cameron earned less than Levine, although the rewards were still titanic by most standards. In 2006 Cameron’s basic salary was £889,000. A bonus of £2,340,000, plus other benefits, made for a combined total of £3,496,000. This was half a million less than Goodwin in the same year. He took home £1,190,000 in salary plus a bonus of £2,760,000, making a total of £3,996,000. The chief executive’s renumeration was rocketing. Between 2005 and 2006 it rose by £1,103,000, an astounding increase in one year of 38%. Still, by the epic standards of Barclay’s Bob Diamond, the American investment banker who had built Barclays Capital and who was despised by Goodwin, they were modestly paid.10 That same year Diamond was paid a total of £10,692,000. Like their colleagues, all these people were also tied into various stock options potentially worth additional millions. And then there were their pensions, although Cameron did not have the preferential deal that Goodwin had secured for himself.

  In 2006 and 2007 Goodwin was loyal to Johnny Cameron. To those who sometimes asked questions about him, such as the RBS chairman Sir Tom McKillop and board member Peter Sutherland, the chief executive would say they had to understand that RBS Global Banking & Markets was run by a three-man team with Crowe and Leith Robertson. Cameron, although the chairman of GBM, was only one third of the equation. ‘If you wanted someone to get on a plane and go to Paris for lunch to charm a big client he was your man,’ acknowledges a critic. There was no one better with clients than Johnny, Goodwin emphasised. Those who had concerns should not think for a moment that Cameron was running the investment banking division alone, which now accounted for such a large chunk of RBS profits. Cameron himself found that ever more of his time was spent on the road, visiting major clients in France, Germany, Italy, Spain, and New York, where he would look in on Jay Levine and his team in nearby Greenwich.

  The GBM chief executive, Brian Crowe, was in daily contact with Levine at Greenwich as well as overseeing RBS’s two trading floors in London. Crowe was regarded as the markets man, a brainbox, someone steady and cerebral seemingly immersed in the full complexities of investment banking. He was also an Anglican lay preacher, and since the financial crisis he has been ordained. ‘If Brian said something was so then you believed it,’ says a colleague. Cameron and Crowe had adjoining offices in 135 Bishopsgate on the ninth floor. It was a peaceful, calm and reassuringly charming environment in which to earn a lot of money. There was even a fish tank.11 Crowe’s deputy was Leith Robertson, a pugnacious Edinburgh banker and dealmaker who oversaw structured, leverage and project finance, lending to large corporates. Cameron was the chairman of this trio, who was now on the RBS board and the main presence in the morning meetings with Goodwin and his colleagues in other parts of RBS. ‘Johnny very much liked the kudos that went with being on the board,’ says a board member.

  There were some in 280 Bishopsgate and at Gogarburn who thought the set-up in GBM was much too ramshackle and potentially confusing. ‘Have you got clear written down lines of management responsibility from Fred?’ a friend of Cameron’s asked him. Cameron didn’t answer. Neil Roden, the HR director, said to Goodwin that the structure in GBM was a mess and needed tighter control. It relied too much on Crowe, as the numbers man, knowing everything. ‘It’s all stored in Brian’s head,’ he told the RBS chief executive. Goodwin was initially not overly concerned, keeping faith with ‘Johnny, Brian and Leith’. It was paradoxical. Goodwin normally thrived on the accumulation of precise detail, whether it related to the shape of filing cabinets, or to executives whose numbers were flawed, or to vintage cars he worked on at a weekend. Yet he had shown almost no interest in the workings of RBS’s booming investment bank. Even though Cameron’s office was only 100 metres down Bishopsgate in another building, Goodwin hardly ever visited. Cameron and others cringed when Goodwin made a rare foray and tried to show the GBM team that he understood how a derivative worked by explaining it in terms of the workings of a car engine.

  Goodwin’s main concentration was on the numbers, targets and goals that each divisional head would sign up. ‘Meeting your numbers every year was what mattered to Fred,’ says one of Goodwin’s most senior executives. ‘He didn’t want to get too closely involved with anything he didn’t know about. Fred was good at branding and giving RBS discipline and he func
tioned quite well in a traditional banking environment. But eventually nearly half our profits were coming from non-traditional banking, the part he didn’t understand. If it feels like you are making too much money for it to be true you usually are.’ It was as though, a member of the board says, he had fenced off GBM and was reluctant to engage. ‘Fred is one of those guys who has to be 10 out of 10. He always has to come top in everything he does. When he’s not in complete control and command of something he would rather avoid it, which means that he is uncomfortable in front of people who know more. He always likes to be on topics where he is an expert.’

  There was some confidence on the part of the board that the arrival of a new finance director at RBS in February 2006 had strengthened the entire operation. With enviable timing, Fred Watt had opted to leave for family reasons. His replacement was Guy Whittaker, who had been group treasurer at Citigroup, one of America’s largest banks.12 Whittaker had been very much the board’s own appointment to balance Goodwin. ‘On paper,’ says a member of the board, ‘Guy looked the part. But I’m afraid it turned out he wasn’t.’ It was hoped that Whittaker’s experience on the other side of the Atlantic would make him a strong finance director. He was obviously able, although there might be a question mark over the temperament of this mild-mannered soul. Would someone so diffident and eager to please be prepared to say no to a strong-willed chief executive, as finance directors sometimes have to?

  There was much more than Cameron’s divisions for Whittaker to get to grips with and try to understand. The rest of RBS – retail in the UK, insurance, wealth management and private banking brands such as Coutts and Adam & Company – had been expanding too, although at a less frenetic pace. In these businesses the vast majority of RBS staff worked for rewards that would not have bought them so much as a parking space in Greenwich Connecticut. Many of the staff had invested in the bank’s shares when they were offered options each year, expecting to create a nest egg for themselves and their families. And why not when the tone of those at the top was so confident?

  Goodwin and the other senior executives were particularly bullish on Thursday 9 November 2006, when they hosted an investors’ day conference for analysts under a ‘Drivers of Growth’ banner. Jay Levine was beamed in on video. Cameron enthused about the prospects. Gordon Pell, now running the retail bank, noted that some of the air was ‘coming out of the tyres’ in terms of the UK consumer lending boom, but he also explained why the stirrings of a row about PPI (payment protection insurance) miss-selling by UK banks including RBS had been much overdone. As ever, Goodwin was optimistic: ‘Whatever the economy, whatever the world throws at us I am very confident that we will deliver growth which when compared to our peers is superior and sustainable, as we have done historically. So, I do believe that and we will, I believe, make it happen.’

  One of the most upbeat of all was Cormac McCarthy, the chief executive of Ulster Bank. The Irish property market had gone bananas in recent years and RBS, with Ulster Bank, was right in there. In private, McCarthy had expressed concerns to colleagues about what Goodwin was asking him to sign up to in terms of promising growth. The percentages struck him as aggressive and he had emerged upset from several meetings, needing to be calmed down by colleagues.

  Today he told of prospects for growth in Ireland that were ‘almost limitless’. With so many newly rich Irish people, McCarthy had set up a team to connect with ‘high-net-worth individuals’. Ulster Bank was expanding on every front, in personal loans, mortgages, the youth market and business lending. The booming Irish economy meant a wave of infrastructure building by the government and an opportunity for RBS to profit by helping those bidding for the lucrative contracts. ‘The Irish economic story is very, very good both North and South. In the South the demographic effect, interest rates, the State finances, low tax rates continue to provide a very confident outlook for the next three to four years as far as anyone out there can see.’

  There was one speck on the horizon. Larry Fish referred that day to ‘headwinds’ in the US banking market, although he did not elaborate. ‘Headwinds’ was a polite way of pointing out what was not then widely appreciated: US house prices had peaked in the summer of 2006 and there were the first signs of a decline. Instead, Fish talked in a folksy way of business banking and the increasing use of debit cards by American customers. The reality was that the progress of Citizens had slowed almost to a halt, as the annual results for 2006 published a few months later demonstrated. It turned out that Citizens’ profit had hardly increased on the previous year. At $2.9bn it was up just 2 per cent, nothing when compared to the rate at which GBM was ballooning. Goodwin had long looked for an opportunity to remove Fish from his highly remunerated post and this slowdown at Citizens was his chance. The £5.9bn acquisition of Charter One in the United States in 2004, which ironically Fish had only reluctantly gone along with pushed by Goodwin, had not been a success. Several fellow members of the board had complained privately about Fish. In particular Joe MacHale, the former J. P. Morgan investment banker, had twice come back from trips to America as part of the audit committee claiming that Fish, a fellow board member, appeared to be running the Citizens business too much for short-term profit with bonuses, his own included, in mind. McKillop, apparently fearing ill feeling, would not put such concerns in front of the board. But Goodwin wanted to ‘sort out Larry’. Now, finally, it seemed when viewed from London that Fish was about to get fired. He did not yet suspect it, but Goodwin was getting ready to remove Fish as head of Citizens, although yet again he would stop short of sacking him.

  There was another possible explanation for those ‘headwinds’ and the recent poor performance of Citizens, of course. Fish’s division was in the old-fashioned mortgage and personal lending business in the world’s largest economy and if there were to be a serious problem in America, with falling house prices, negative equity and consumers facing problems paying, it might show up first as a flicker in the results of institutions such as Citizens. Goodwin – an ‘optimist’ as Cameron used to observe to his team – told Cameron and other colleagues that it was fine: ‘US house prices are not going to fall by 30 per cent. They just aren’t.’ Goodwin was not for slowing down and as 2007 began he was ruminating on the possibility of even more growth. Anyway, RBS didn’t do sub-prime, did it?

  The American economy was wobbling; the machine Goodwin had built was spread across continents; reporting lines were confused; his management style had been questioned; the chairman was new; and the rate of expansion had been quite staggering since he and Mathewson masterminded the purchase of NatWest in 2000. The RBS balance sheet – its total assets – had ballooned. It was more than £800bn by early 2007. Imagine if, on top of all that, Goodwin and his colleagues purchased large parts of a Dutch bank and in the process doubled the size of their own balance sheet. That was precisely what they were about to do.

  11

  Light Touch

  ‘Three of the four largest banks individually have assets in excess of annual UK GDP’

  Bank of England

  When John Campbell and a handful of colleagues set up for business in the Royal Bank’s offices in Ship Close in Edinburgh in 1727 banking was very simple. The activities of British bankers remained more or less straightforward for much of the following two centuries. A bank such as the Royal Bank of Scotland was merely an institution that took in deposits from customers – initially only a very small number of depositors – and then lent it out to others whom the bank judged capable of paying the money back. For this loan the bank charged interest and accrued a profit, some of which could be dispersed to its shareholders with the rest used to expand the bank’s activities and make further loans. When it issued notes or made loans, it did not keep a matching amount in its vaults. That would be prohibitively expensive and would defeat the point of the exercise, which was to provide increasing amounts of capital to individuals and businesses with good ideas that could make a profit, and might flow back into the bank in
deposits and be lent out to others with potentially profitable ideas, and so on.

  Of course, successful banks also have to navigate around storms in the economy, trying to detect when a period of sustained economic improvement has become a bubble that might burst. Historically, this tended to mean that successful banks were naturally suspicious, particularly of their own customers. Human frailties such as a tendency to over-optimism and the propensity of some people to lie and commit fraud necessitated caution. Sensible bankers have always known that while they lubricate the economy, providing those who can turn a profit and create employment with capital, they can still be caught with their trousers around their ankles. In such circumstances a racy bank – its directors motivated by excitement, lust for bigger profits or a misguided belief that they are cleverer than their predecessors – can easily find itself in trouble. If there is then a sudden panic, caused by bad news in the wider world that knocks confidence or the emergence of fears about a specific bank, there might be a ‘run’ on one or more institutions. Panicked customers, the depositors with which the process began, then rush to take their money out and discover to their horror that the bank obviously does not have every penny immediately to hand.

  Complicating the process, banks sometimes borrow from each other, in order to oil the wheels of credit and so that they can lay their hands on money if they need it in a hurry or want to smooth the transaction of daily business. In the onset of a sudden crisis this does create the possibility of a chain reaction, as a panic about one bank spreads to others that are connected to it by lending. That is what happened when the Ayr Bank (mentioned in Chapter 2 and cited by Adam Smith) went bust in the eighteenth century having overextended its line of credit in London. Good banks discovered early on that it should be possible to avoid such disasters if they prove over decades that they are sound and trustworthy organisations. A bank must have access to liquidity, in safe assets such as government bonds that it can sell quickly if it needs cash. And if it keeps sufficient capital itself then, in the event of some loans going bad, there will be enough to be able to write off the losses and assure other customers that, this blip aside, all is well with the underlying business. No bank can ever eliminate the possibility that it will have to take such a hit. After all, banking by its nature is rooted in risk and the decision to lend someone money involves the possibility that it might be lost. The question is how the risks might be minimised and the profits maximised. That is banking.