The aim of any self-respecting blogger is to make original points. I’m no exception, so it is time to start to wind down this thread on the Libor “scandal” (previous instalments: Saint Mervyn: King by Name, King by Nature; Bashing Barclays Badly and Battling for Mount LIBOR, the Moral High Ground), for the world has in many respects come round to my way of thinking.
Yesterday’s City a.m. egged on the politicians with the momentarily confusing headline:
MPs CALL FOR CAP ON KING’S POWER
and opening salvo:
“REGULATORS grossly overreached themselves by forcing Bob Diamond out of the top job at Barclays, top backbench MP Andrew Tyrie declared yesterday…”
And the refrain “Who will guard the guards?” echoes through the land (and I noticed has even seeped, with the rapid mutation typical of memes, into the consciousness of the brigade of the commentariat more concerned with the easy target of the G4S Olympic security fiasco).
“Holding the next governor accountable will be as important as choosing one. The Bank of England was rightly given considerable independence in 1997 to prevent politicians meddling in monetary policy in order to advance their electoral interests. But the institution and its leader have slipped up on enough occasions that leaving them entirely to their own devices isn’t a good option either.
For example, King didn’t sound the alarm loudly enough during the credit bubble and was slow to act when there was a run on Northern Rock, the mortgage bank, in 2007. He then long resisted any investigations into the Bank of England’s own failings in managing the crisis. Now its hands-off approach to the Libor scandal is being revealed.
Based purely on its record, the central bank wouldn’t be receiving extra powers. However, the Conservative-led government has tried to pin the blame for the credit crunch on the previous Labour government’s policies – in particular, its decision to take away the central bank’s responsibility for banking supervision. Hence, it has become politically convenient to reverse that move.
Given this, the priority should be to enhance the Bank of England’s accountability. Under the current system, the government sets inflation targets and picks the governor. It also chooses the deputy governors and members of two committees: the monetary policy committee which sets interest rates; and the financial policy committee which will soon be responsible for financial stability. Their independent members help prevent the governor becoming too dominant.
The Bank of England also has a board, called the Court. But this has been largely ineffective. Though it has recently stepped up its scrutiny of the central bank’s executives, it is hamstrung because it rightly has no say over policy or who is the governor.
Meanwhile, parliament can call the governor and other senior officials in to give evidence. Although this is a potentially important check to the central bank’s power, MPs haven’t yet used this tool effectively.
One way of improving democratic control would be to give MPs the right to hold nomination hearings and, in extremis, reject the government’s choice for governor and other top positions. Indeed, that’s what parliamentarians want. But the government is resisting. If MPs are to change its mind, they must first show they are up to the job.”
Let’s come back to this when we’ve diagnosed the problem.
Because I still feel I haven’t made my point fully.
What the Libor affair shows us is that regulation must be mechanical, not moral.
This is a lesson we failed to learn from King’s behaviour during the financial crisis, despite his starving the UK banks of liquidity in a misguided attempt at preventing “moral hazard”; his expressed desire to stitch up Lloyds shareholders with a backroom deal to take over Northern Rock; and the actual outrageous stitch-up of Lloyds shareholders with a backroom deal to take over HBoS without adequate due diligence, to which he must at least have given a nod.
My first post on the Libor-fiddling topic touched on the subject of culture:
“The excuse for laying into Diamond seems to be some problem with the ‘culture’ at Barclays. Is it any different to that at any other investment bank? Doesn’t the ‘culture’ in any occupation go with the turf? Presumably they don’t want traders to behave like, say, Premier League footballers, or Hollywood actors. Something less flash perhaps: doctors, say or IT guys. But would they still be able to do the job? These occupations surely require quite different qualities and aptitudes. Maybe something a little more sales oriented, perhaps, then: used car dealers or estate agents. Or politicians! But are these professions more or less honest than investment banking? I’m stuck. Perhaps our politicians could spell out exactly how they want investment bankers to behave.”
The aim of yesterday’s post was to develop the idea that the “scandal” is being treated as a moral issue. There’s something “bad” about Barclays, we’re told, and the Bank of England Governor, with ex officio moral authority, judges it comes from the top and fires the Chief Executive.
But what is “culture”?
This is what an editorial, “Culture shock”, in yesterday’s FT (I’m getting my full £2.50 worth!) suggested:
“Culture is not a fluffy chimera of business how-to books or self-congratulatory corporate reports. Culture, real and unnoticed as the air we breathe, is the web of unspoken mutual understandings that frame what people expect from others and think is expected of them. This web shapes the fortunes of any organisation or social group. Bob Diamond, Barclays’ disgraced ex-chief executive, knew this; he once declared ‘the evidence of culture is how people behave when no one is watching’. He was right…
… [non sequiturs omitted]
A culture cannot be heavy-handedly ‘managed’ by legislation or compliance rules alone. It must be more subtly cultivated and tended.”
OK, we can all agree that behaviour within an organisation is determined by executive example and communications; organisational stories; dress code; building architecture, location and decoration; the presence or absence of game rooms; and so on and so forth – as well as the nature and demands of the work, as I previously stressed. But within all that complexity, all we’re really concerned about here is that rules are followed. There may be indirect ways of achieving this goal by means of some kind of arcane cultural alchemy – would Fairtrade coffee, beanbags and dress-down days work? who knows? – but most people would consider it sensible to simply focus on the outcome.
Obviously the “rules alone” are not enough. There also needs to be an expectation of enforcement. A rooting out of dishonesty. And maybe by spending £100m on investigating Libor-fixing rather than, say, carrying out some “routine email housekeeping” (didn’t something like that come up with News International?), Barclays have shown a willingness to steer their internal culture in the direction of obeying the rules.
With this unsatisfactory view of “culture” in mind, let’s consider the crucial question for the future, the “Mervyn King Question”: Is it possible for the Governor to both exercise moral authority AND for there to be effective oversight of the role?
No, of course not. The Governor can’t both exercise his judgement AND explain the detailed reasons for a decision. If he can explain the precise reasons to whoever he, the Governor is accountable, for example those for firing Bob Diamond (“he broke rule 44b clause 3, which is a sacking offence”), then by definition he isn’t exercising judgement.
The Mervyn King Question suggests then that we have to decide which way we jump. Do we want, in the modern world, to trust the personal judgement of an unelected official, or do we want a team expert in banking regulation to ensure that the rules and sanctions for breaking them are clear to banks and that bank behaviour is monitored and the rules enforced?
Do we want a ruler or do we want rules?
The traditional role of the Governor of the Bank of England was one of arbitrary power. This is where Mervyn King believes we should return. No wonder the job of Governor is so coveted.
But there’s a different path. Surely we’d be better off rejecting the moral approach and focusing on the technical aspects of the role of Governor of the Bank of England?
Let’s take as an example the critical case, where it all started to go wrong, when I first became concerned about the outlook of Mervyn King. Instead of arbitrarily allowing banks (such as Northern Rock) to fail to try to prevent “moral hazard” shouldn’t the Bank have made the rules absolutely clear in advance? NR would not, I’m sure, have relied on interbank funding had it’s executives known that funding may be allowed to dry up and they would have to retire in disgrace.
I would suggest that the Bank start by announcing that it will not allow any Bank to fail due to systemic problems (as opposed to Baring-style sudden catastrophic losses), but will provide liquidity as lender of last resort. What constitutes “systemic” would need clear definition, as would the cost of such support which would include a requirement for banks to raise capital. We have to recognise that we can never allow banks to fail under stress – such failures simply cascade through the economy – and dismiss the nonsense that such a backstop is some kind of subsidy for institutions that are “too big to fail”. This is like saying that Tesco is subsidised because the State provides resources for the prosecution and punishment of shop-lifters.
The Libor-fiddling that mattered – that before the financial crisis – was arguably criminality, pure and simple. It was orchestrated by a small group of traders who knew they were breaking the rules, as their emails make clear: “I would prefer this not be in any book!”, “if you breathe a word of this I’m not telling you anything else” and so on. It became a “scandal” because politicians – principally Ed Miliband – immediately made hay. But business isn’t politics. It’s not primarily about character (neither should politics be, of course, but the UK political process is becoming ever more Presidential and less policy-driven). The danger of allowing the political process to drive banking or other business regulation is that there is no satisfactory answer to the Mervyn King question. Even were we to confer moral authority on the Governor as we do the Prime Minister (who is not only elected, but easier to get rid of than the Governor – men in grey suits and all that), business is not hierarchical like government. It is fundamentally about choice and competition. Differences in outlook are necessary.
Dismissing company bosses in an attempt to change the corporate “culture” would seem to necessarily worsen group-think. If all our banks had been the same perhaps they’d all be part owned by the State now. Perhaps they’d all been like HBoS. As it is, Barclays managed to recapitalise without calling on government funds, Santander expanded and the “elephant” HSBC simply marched on barely affected. Diversity matters.
At worst, of course, there is no difference between condemning a bank’s culture and firing the boss simply because you don’t like the cut of his jib.
I promised I’d return to the points Hugo Dixon made. We may well need some or all of the means Dixon suggests for holding the Governor to account. But before we can do that, Parliament needs to step back and look at how the Governor’s role is defined. They need to review his Terms of Reference. Make sure he’s clear what the rules are.