Tuesday, April 29, 2008

The binge culture of banking

(Abigail Hofman in the FT) A friend, who is a teacher, lamented to me recently: “For years we have been told that bankers were paid so much because you were cleverer than the rest of us. Now it turns out you were not clever at all and we are all suffering for your stupidity.”

In the past two weeks, big financial institutions in Europe and America have announced losses and savage job cuts caused by new writedowns for US subprime mortgages. So far, we have seen more than $250bn (€160bn, £126bn) of writedowns related to the debt bubble of the past few years. I am reminded of the remark attributed to Everett Dirksen, a former US senator: “A billion here, a billion there and pretty soon you’re talking real money.”

We have become blasé about large banking losses and no one weeps when overpaid bankers lose their jobs. However, we must remember the true victims of this crisis: the underprivileged Americans encouraged by the unscrupulous to take out mortgages they could not afford. “Home ownership is better”, was the siren call. Those who were seduced are now sitting amidst the rubble of their dreams. As global banks, faced with depleted balance sheets, move to hoard cash, ordinary people are finding the well of liquidity has run dry. It is increasingly difficult to borrow money, even for those with pristine credit histories.

Some blame the politicians (not enough regulation), others the central bank officials (for creating asset bubbles). However, I blame the corrosive culture of investment banking.

I worked for 18 years in investment banking and several aspects of the culture unnerved me. Investment banks are all about making money. At the extreme, this means making money for employees not shareholders. The big revenue producers are revered. It is not considered prudent to upset them by asking too many questions. The subprime meltdown is a perfect example of the “emperor has no clothes” phenomenon. These were complex products, yet obfuscation was considered acceptable. Bank chief executives should have asked more questions. I suspect they saw the juicy profits and hoped underlings understood the risks.

Moreover, investment banking culture has a cult aspect to it. If you work on Wall Street or in the City, you toe the party line. Despite lip-service to “diversity”, diversity of thinking is not encouraged. This atmosphere of craven conformity breeds at first complacency and then mistakes.

The past is littered with the fallout of banking binges. Think about the dotcom fiasco of the late 1990s or the leveraged buyout mania of the late 1980s. The sad truth is that the culture is one of lemming-like imitation. There is too much looking over the shoulder at rivals and not enough scrutiny of internal decisions. “It is not how we do,” a senior US banker told me last summer, “it is how we do relative to our peers.” This attitude caused the problem in the first place. If X bank is making millions on an innovative product, Y bank feels pressure to do the same. There is a terror of stepping off the escalator even as it approaches the edge of the cliff.

A recent report from Morgan Stanley and Oliver Wyman claims this is the worst investment banking crisis in 30 years and that it could last for 10 quarters. But it also noted that investment banks bounce back quickly, typically taking less than two years for industry earnings to match previous levels.

So where do we go from here? Some argue that investment banking needs to reinvent itself by developing new revenue sources. That may be true but it will not be easy or rapid, especially in an era of tighter regulation, lower leverage and doubts about the last wave of innovation.

Yet what is most needed is more fundamental changes. Costs must be cut. The compensation model must be modified with bonuses for top performers being risk-adjusted to take account of future business developments. The composition of bank boards has to change. Very few bank non-executive directors have a financial background, raising doubts about whether they are competent to challenge executives on either the general direction or the subtler nuances of the business. The most important thing to change is investment banking culture. Dissonance should be viewed not as disobedience but as necessary debate.

Finally, I would appreciate some sensitivity from financiers who still have jobs: lose the Learjets and limousines and ride the Tube with the rest of us.

The writer is a former investment banker. She is now a commentator on the financial industry and a columnist for Euromoney

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