The Default Line: THE INSIDE STORY OF PEOPLE, BANKS AND ENTIRE NATIONS ON THE EDGE (25 page)

The official corporate HQ was located in Scotland, but four top executives, including James Crosby and Andy Hornby, all came from the Halifax, and another was recruited from a top insurer. None of the five had banking qualifications. All the executives gave themselves massive pay rises of over 55 per cent for the success of completing the merger. Just a decade earlier, calculates Ray Perman, author of
Hubris
(2012), the salary of the highest-paid BoS director was sixteen times that of the average BoS salary. Now, including bonuses, James Crosby was earning forty-three times the average HBoS salary. Perhaps he would have deserved his pay if the new company had lived up to its billing as ‘the new force in banking’, illustrated with a closely shot handshake on the front of the Annual Report.

While the mighty Bank of Scotland had lasted 306 years as an independent entity, HBoS only lasted seven. Even once it was taken over by Lloyds, HBoS still needed to be bailed out. In fact, so rotten was HBoS that Lloyds itself had to be bailed out by the taxpayer. A bank run by overpaid amateur bankers that had a lifespan less than the average dog, and was so bankrupt it required taxpayer bailouts for two banks, HBoS might more accurately be described as a ‘new
farce
in banking’.

Before relaxing competition rules to allow Lloyds to pursue the takeover, the FSA had hawked HBoS around to other banking groups, but it turned out that only a purchase by Standard Chartered would have been legal under UK competition law. Tellingly, HBoS was not offered to Barclays. One chief executive who looked at the books could not believe what he saw. ‘We just thought this thing was deeply scary,’ he told me. ‘The wholesale [corporate] bank was asking for trouble.’ He went on to tell me that HBoS’s funding model for its mortgage book was ‘incredibly vulnerable’ to stress. ‘And this mattered obviously a lot more than, say, Northern Rock, which was bad enough. This was huge, a massive great institution.’

The consensus in the boardrooms asked to step in to buy HBoS was that it was a basket case. A key indicator of trouble was the high number of football clubs in its portfolio. The books of HBoS Australia, which had been auctioned in a last-ditch attempt to save the bank in the summer of 2008, were an eye-opener. One top banker who looked at the figures concluded that HBoS Australia was sitting on a ‘high-risk book of leveraged lending and commercial property, but entirely wholesale funded on a cross-currency basis. They didn’t really have any local funds. We were just stunned.’ At £3.6 billion, HBoS Australia’s cumulative loan impairments from 2008 to 2011 were worth 28 per cent of its entire 2008 loan book. As the Parliamentary Commission on Banking Standards (PCBS) concluded, this dire state of affairs was all the more remarkable given that at that time the Australian economy was growing robustly, and its banking system remained profitable and free of bailouts. In contrast, HBoS’s travails in Ireland could be partially excused by the generalised economic collapse there. Nevertheless, HBoS Ireland still managed to become the second worst bank in Ireland, with 2008–11 impairments at 36 per cent of its 2008 loan book. Of £11 billion in Irish losses (worth 6 per cent of Ireland’s entire GDP), £6.5 billion related to commercial real estate. So large were these losses that Alistair Darling, at one point, argued that the Irish government should take the rotting assets of HBoS Ireland and the problem loans of the RBS-owned Ulster Bank into NAMA (National Asset Management Agency), its state-backed ‘bad bank’. Eventually, the UK Treasury settled on being a ‘good neighbour’ and took the pressure off.

HBoS’s disasters abroad were all brought about by three factors: an aggressive pursuit of rapid market growth, limited deposit funding, and concentration on property. It was a toxic recipe, originally concocted in Britain itself. It is best illustrated by the table published by the Tyrie Commission report into the failure of HBoS. There is an anonymised version of its last book of large loan facilities presented by its infamous head of Corporate Lending, Peter Cummings, to the board. In 2008, of its forty-four largest corporate loans (worth between £85 million and £2.9 billion), twenty-nine were property companies. Most of the others were either related to property (hotels) – or to credit (debt collection). For context, there was one accountancy firm, one oil-infrastructure designer, one health-club company and one presumably Irish ‘whiskey distiller’. The bank did not even have the money to lend to these companies. HBoS’s ‘funding gap’ – the difference between loans and deposits – was £213 billion in 2008. It needed to find this money from market investors – but they had all disappeared. HBoS had turned into a machine for channelling hot money at property. Its bankers would agitate house-builders and retailers for mergers, takeovers and restructurings, predicated on rising property prices, cheap debt and easy funding. HBoS would then lend the money, invest risky equity in a share of the business, and take advisory fees. Competing banks could not get a look-in. HBoS had become, in the words of one of these competitors, ‘a giant UK property hedge fund’.

One FTSE-100 chief executive, not a banker, told me that in January 2007 he had asked an HBoS director why his board was not more concerned about the bank’s overall exposure to the UK housing market, mortgage lending and the construction industry. It was a question few dared ask. The reply was flippant, but no joke, and it exposed the recklessness of the people at the top of the bank. ‘We’re so exposed to the UK housing market anyway,’ the HBoS board member told him, ‘that if it goes tits up, we’re screwed anyway. So in for a penny, in for a pound.’ It was an open secret. Even after the collapse of Northern Rock, the HBoS board rebuffed enquiries from the regulators, who had begun to wake up to what was going on. ‘Our management has done enough,’ HBoS chairman Lord Stevenson, wrote to FSA chief Lord Turner in November 2007. ‘There could be some release of the FSA paranoia button!’

A few days before the inevitable catastrophe, HBoS tried one last brazen deal-making gambit. It offered to buy Bradford & Bingley. It would have been a desperate union of two shoddily run, bankrupt banks that had overstretched themselves fuelling an insane property boom. But it would have given HBoS access to a much-needed funding stream – the depositors of Bradford & Bingley. Both the Halifax and Bradford & Bingley building societies had been built on the common-sense saving habits of ordinary Yorkshire folk, but now they were being destroyed in an orgy of executive incompetence. As banks, neither lasted longer than a decade. If the takeover had gone ahead, it would have culminated in the supernova of all bank busts. Fortunately, the proposal was quietly and quickly turned down.

Under pressure from the regulators, some of the bankers around Darling’s table had pondered taking parts of HBoS from the FSA’s fire sale. One offered to take the retail bank for free, but only if there was temporary government liquidity support to fund mortgages, and the taxpayer took on the rotten corporate bank. It didn’t sound a bargain for the Treasury. That said, the bank’s models calculated that HBoS’s fair value was strongly negative. ‘We were stunned when Lloyds were prepared to pay a positive price,’ reflected one leading British banker. ‘Indeed, I asked our guys who’d done the analysis to have another look at it because I thought we must have got it wildly wrong.’ In fact they were wildly right. Little wonder that a few days after Lloyds bought the bank, Alistair Darling noticed that the Lloyds chief Eric Daniels, sitting around the bailout table, had a rather shocked look on his face. The high-street banks were, however, only half the story.

Under Gordon Brown’s chancellorship, the same Number 11 conference table had seen happier times. Brown had set up a ‘High Level City Group’ on financial services. All the names gathered in ignominy around his successor’s table in October 2008 were there in glory in October 2006 for the first meeting, hosted by Brown and his then City minister Ed Balls. The emphasis was on the high finance of the City of London, rather than plain-vanilla retail banking. Conventional banks had been largely left to their own devices. New Labour, always trying to triangulate rather than lead, convinced itself that competition and consumer protection were sufficient guarantors of the public interest.

On the odd occasion when the supine regulator got a little worried, bankers would complain to politicians. Tony Blair and Gordon Brown would send a letter or write a speech on the need for a ‘light touch’. This was not an accident. It was a choice. Other countries, even anglophone nations such as Canada and Australia, operated prudential limits on credit, with no suggestion of a lack of commitment to a market economy. ‘A combination of good supervision and good macro-prudential policy could have stopped all that happening,’ one UK bank chief executive told me. ‘For example, for the HBoS corporate lending practices, it didn’t take a rocket scientist to work out they were pretty adventurous.’ Another senior UK banker admits that such a ‘macro-prudential policy’ – involving the reining in of loan-to-value ratios on mortgages – would have been ‘a complete pain’, and that he and other bankers would have undoubtedly campaigned against it. ‘But is it what a central bank should be prepared to do?’ he asked, and then supplied his own answer: ‘For sure.’ As we shall see, banks rarely seem to know what is good even for themselves.

For its part, New Labour, in its desperate efforts to prove that the party did not secretly harbour Trotskyite instincts, settled on an approach to the UK’s tax-abundant, credit-spewing retail banking system that was somewhere between ‘light touch’ and ‘no touch’. For investment banking – the so-called ‘casino’ – the touch was heavier, but it was not a regulatory hand on the shoulder, but rather a crazed embrace. What passed for industrial policy in Blair’s Britain was to entrench London as a lucrative loophole in global finance.

‘In the computer industry, when there are security intrusions, the best experts today are those who are former hackers,’ said a smiling Christine Lagarde. ‘There’s something to be said about someone who knows the system from inside, who can actually suggest how to fix it, and I really welcome the complete change of view from UK authorities.’ Lagarde was in one of her more mischievous moods. This was in 2009, and Lagarde was then the French minister of finance. She was chatting with a senior British cabinet minister about the role of the City of London in the crisis, and the UK government’s sudden conversion to regulating the world financial system. In her analogy, the hackers in question were the ministers of Britain’s Labour government, former proponents of regulation-lite. But re-regulation of the world financial system was never going to start here in London: home to the most bankrupt floor of office space in the world that nearly bankrupted the whole European banking system; home of the worst bank takeover and the worst bank merger in world history; the manufacturer of toxic mortgage bonds for Lehman Brothers; home of the traders who nearly felled UBS; and base of the sober Treasury operation that cost J. P. Morgan billions. And then there was the systematic rigging of Libor, London’s inter-bank interest rate, the scandal that came to symbolise everything that was wrong with global finance. Why did all roads lead to London?

London was, and still is, the global clearing house for socially useless financial innovation. In France and in Germany this has long been the accusation. But even in the USA, accusatory fingers began to be pointed at London. The ever-lengthening shadows in the world financial system were being cast by the ever-rising skyline of the City.

Cut to Baltimore, the setting for the greatest TV drama series of all time:
The Wire
. Through five seasons,
The Wire
shone its spotlight on the frailties of human nature by exposing the rotten core of five strands of life in the Maryland capital: its drug gangs, its police service, its declining dockyards, its schools and its local newspapers. But they missed the banks. The non-existent sixth season should have been about rich bankers selling mortgages to poor African Americans.

Beth Jacobson glances along her mantelpiece. A number of trophies tell of the old times when she was the top-rated mortgage loan officer at leading US bank Wells Fargo. In some years she earned commissions of $700,000. She was rewarded with a swim with dolphins, an Aerosmith concert, crystal vases, and six iPods. ‘They treated you as royalty – making money on the back of people who couldn’t afford the loans,’ she says. ‘It seemed the good times were going to continue forever.’ Between 2004 and 2007 loan officers such as Jacobson earned commission of up to 1.8 per cent of the total value of the loan, if it was a high-interest subprime loan. An ordinary loan to a ‘prime’ customer – a loan that could be underwritten by the US government mortgage guarantee scheme (via Fannie Mae, Freddie Mac, etc.) – earned a commission of 0.5 per cent. In addition, subprime loans required less paperwork than the guaranteed prime loans, and could be signed off in days rather than weeks – all the more crucial in the crazy Maryland housing boom of the mid-2000s. Clearly there was an incentive for loan officers and external mortgage brokers to sign up as many borrowers to subprime loans as possible, even if some borrowers qualified for the cheaper prime loans. It was worth up to $1,500 extra for a typical loan. And according to the US Department of Justice, that is exactly what happened. In 2009 Beth Jacobson turned whistleblower on her former employer and her whole industry. She and her fellow employees had targeted poor African American communities in Baltimore. ‘These people did not stand a chance of paying the loans back. And you do have a certain amount of guilt thinking you’re putting people in that and you try to justify saying, “Well, they really wanted that house.” But they were looking to us as experts to guide them on their finances.’ She told of $300 donations made to churches to host mortgage seminars, with an additional $300 paid for every mortgage signed off.

In 2009 the mis-selling of mortgages to poor African Americans was taken up by Sheila Dixon, the entrepreneurial mayor of Baltimore, and the real-life inspiration for
The Wire
’s Nerese Campbell. When I met her she was indignant. ‘What they are doing to average citizens who want to meet the American dream…’ She left that thought hanging. ‘In this day and time you would not think a company like Wells Fargo would use subprime mortgages to target a certain population.’ The Department of Justice and the Office of the Comptroller of the Currency both published reports showing such a pattern. Wells Fargo always denied that African Americans had been targeted for what became known as ‘reverse redlining’ (targeting bad credit at poor neighbourhoods, as opposed to ‘redlining’ which was withholding it entirely). But the bank did in July 2012 settle a legal case brought by the Department of Justice, which cited 34,000 people from minority groups across the USA who had been sold mortgages on worse terms than white Americans of the equivalent credit standing. No guilt was admitted, but Wells Fargo paid out $175 million, including $50 million to initiatives in Baltimore.