Terry Smith, chief executive of Tullett Prebon and author of “Accounting for Growth”, on why the big banks should be split, securitisation banned and the Big Bang reversed
Terry Smith gave the annual Tacitus lecture at the Guildhall on 16 February 2012, taking as his theme the question “is the Occupy movement right?” – and enabling him to give his views on:
The need to separate retail and investment banking:
“The great problem is that the evolution of banking over the past 25 years had led to investment and retail banking becoming inextricably intertwined so that it was not possible to save one without saving the other….This process of convergence of investment and retail banking included the repeal of the Banking Act of 1933 more commonly known as the Glass-Steagall Act by a law signed by Bill Clinton in 1999. This Act was already being largely by-passed and, as a result, banks’ investment banking operations have been able to rely upon the implicit and eventually explicit government guarantee of their retail operations in order to secure funding at lower rates for their trading operations than would otherwise be the case. Without this guarantee, most standalone investment banking and trading operations should be rated closer to Triple Z than Triple A.
What is needed is the full separation of retail and investment banking. The Volcker rule is bogged down in the minutiae of the definition of proprietary trading and Vickers is so far off from implementation of even ring fencing that it will have no impact at least for many years. What I would suggest is just simply undo the repeal of Glass-Steagall and introduce the same restrictions on this side of the Atlantic. I know that the bankers operating in banks which combine retail and investment banking will threaten to leave the UK as a result.
But why we should listen to the opinions of people who have got things so disastrously wrong is beyond me. And where will they go? Neither Paris, Frankfurt nor Berlin look very banker friendly to me and neither does New York. It would be very nice if instead of threatening to leave one of them would actually engage in what I will call for the sake of this speech is the intellectual argument on this subject – “I am leaving” strikes me as a playground argument.”
Why securitisation should be banned:
“When I last worked in a bank and you made a loan, both the banker and the borrower were concerned about its servicing and repayment. All of this changed when securitisation was invented. Banks generated loans but these were then on-sold to other banks, hedge funds, fixed income investors, and others. With the advent of the credit derivative market, the bank could still hold the asset on its balance sheet and hedge the risk of default with someone else.
The severance of the link between lender and borrower which existed when I was in banking led to a mispricing of risk with catastrophic consequences. Historically, lenders exercised caution because eventual repayment depended upon the viability of the borrower.
Securitisation not only broke this all-important link. Now, lenders could issue mortgages in the comforting knowledge that, if the borrower failed to meet his commitments, someone else would bear the loss. This distortion of the relationship between lender and borrower led not just to the mispricing but to the reverse pricing of risk, such that lending to the riskiest borrowers became a high-returns process because risk could be unloaded. This process ran its wholly predictable course in the subprime disaster.
Securitization should be banned. People should have to hold assets they are responsible for until maturity.”
And on why the 1986 “Big Bang” in financial services led to insuperable conflicts of interest and should be reversed:
To recap for those of you who are under 50, the background to this was that shares had been traded on the London Stock Exchange which was literally a mutually owned private members club. The members were firms – brokers who dealt with investors and who charged commissions for doing so and jobbers or market makers who provided liquidity for dealing and in return took a spread between the buying and selling price – the bid-offer spread. Prior to Big Bang commissions on dealing were fixed: all brokers charged the same rate of commission and did not compete on price. Investors could therefore not shop around and get the best deal. But at least investors were protected in the sense that the brokers’ relationship with the jobbers was an adversarial one – the broker would try to get the best price obtainable from the jobber when dealing…
These Big Bang changes also introduced insuperable conflicts of interest. No longer were investors protected by a broker acting as their agent and trying to get them the best price. Instead they were dealing with integrated firms which maximised profits by giving investors the worst deal they could as they were principals on the other side of every transaction. And these were not the only conflicts of interest which arose from Big Bang. Integrated securities businesses also provided Merger & Acquisition advice to companies – formerly the domain of independent merchant banks, as well as providing research on those companies’ shares for investors in those shares, trading in those shares as principals and raising equity or lending money to fund the deals. The potential for conflict of interest and for profit at the expense of investors as a result were manifold.
These conflicts are supposedly policed by so-called Chinese Walls which keep these functions separate within banks but the long line of scandals on both sides of the Atlantic in the securities markets over the past two decades show that this has unsurprisingly proven to be ineffective. A regulatory concept like Chinese Walls is no match for greed.
Mr Smith also laid into the fund management industry – “‘hedge fund’ no longer defines an asset class or an investment strategy. It merely describes a fee structure, and an unsupportable one at that” – and the bond market’s reality check for EU politicians:
“The free markets in the City are feared because they are the last thing which holds politicians to account as they need an outside source of funds. At the beginning of the Clinton administration in the early 1990s, adviser James Carville was stunned at the power the bond market had over the government. Carville said: “I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter. [He wanted to come back as someone powerful.] But now I want to come back as the bond market. You can intimidate everybody.”
The people of Greece and Italy can no longer hold their politicians to account. But the markets can and we need to keep them free.Last week Lucas Papademos, the unelected so-called “technocrat” imposed on the Greek people commenting on the riots which greeted the austerity package accepted as part of the latest bailout said without any hint of irony: “Vandalism, violence and destruction have no place in a democratic country and won’t be tolerated”. It seems not to have occurred to him that in a democracy, leaders are elected.”
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