Tuesday, September 23, 2014

Other side of the great fall: Financial express 17th August 2014: Book review of Inside the banking crisis: The untold story: Hugh Pym

Inside the Banking Crisis brings out the financial meltdown as it unfolded in the UK—a refreshing change from the tomes available in the market focusing on the US
Inside the Banking Crisis: The Untold Story
Hugh Pym
Bloomsbury
R599
Pp 222

THE FINANCIAL crisis, which is over seven years old, is still referred to as a contemporary economic incident or catastrophe because several policies being pursued by central banks even today are trails of the crisis. In a way, the shadow cast is much longer than the event.
Hugh Pym’s book, Inside the Banking Crisis, brings out the crisis as it unfolded in the UK. The previous books on the crisis have generally been US-centric, as that was the epicentre of the financial earthquake that left several institutions and ideologies shattered. Therefore, one is more familiar with Lehman and the Federal Reserve than with what happened in other countries in Europe during that time.
Some crises in the UK were more on the global map, like Northern Rock Bank’s crumbling, but other stories are not on top-of-the-mind recall. This is where Pym’s book makes a difference, as it narrates UK’s untold story.
Pym, a member of the BBC team that covered the crisis, chronicles in a detailed manner the developments that took place covering four major stories: Northern Rock Bank, Halifax Bank of Scotland (HBOS), Royal Bank of Scotland (RBS) and Bradford and Bingley. Other players who come into the picture are Lloyds, Santander and the likes on one side and the government, chancellor of exchequer and the Bank of England on the other. Some of the protagonists were Mervyn King (of Bank of England), Alistair Darling (chancellor of the exchequer), Gordon Brown (the prime minister), Eric Daniels (of Lloyds), James Crosby (of HBOS) and Matt Ridley (of Northern Rock Bank), among others.
The book becomes interesting when it describes the discussions that took place to alleviate the situation and the strong ideologies that came in the way. The reaction time, hence, appeared to be longer than it was in the US or, for that matter, the European Central Bank (ECB). The end result, though, was to agree to save the financial system with the help of infusion of capital, as well as quantitative easing programmes.
The story revolved around three pillars: identification of the problem, realisation of it and the remedial action taken. Each one had its own problems in terms of interpretation, with certain ideological issues always coming in. The major question was who should provide the bailout? King was of the view that it was not the central bank’s concern, as its mandate was to conduct the monetary policy. As a corollary, the responsibility was that of the Financial Services Authority (FSA). The FSA, on its part, argued that the crisis was not in its domain because a banking crisis meant that the central bank had to play the role of lender as the last resort. Therefore, it was back to the Bank of England. The government had to contend on whether nationalisation was the best option, but that would have meant that its fiscal would be strained. Given these differences, different solutions were applied for failed banks, even as the search continued for a buyer.
Northern Rock Bank had a model of borrowing short and lending long, which was directed at the mortgage segment. The problem emerged when financing channels stopped after the crisis began in the US. The result was a run on the bank, as deposit holders feared that their funds were in jeopardy. The Bank of England, unlike its counterparts in the US and Europe, was not in favour of quantitative easing to begin with. Also, King took the issue of moral hazard seriously, which meant that if one bank was rescued then others would also line up for similar resuscitation packages.
The delay in action led to long queues of depositors at the banks. Coincidentally, the IT systems also crashed, as customers tried to offload their accounts online. This exacerbated the panic, as everyone wanted to cash out. Getting other banks to buy Northern Rock was not possible, as all major suitors were busy with the ABN deal (which finally went to RBS). The bank went down after the central bank had to reluctantly guarantee and pay deposit holders while taking on the assets.
HBOS was an enlarged model of Northern Rock with high levels of short-term borrowings—the difference was that there was greater dependence on foreign markets. Here, the parleys went on with Lloyds, which bought the bank. Scarcely had the government and the central bank found a solution here that the RBS was knocking at the door for a bailout. Finance had to be provided by the Bank of England. Here, the solution was for the government to take a large stake of 82%, but keep it on the stock market, thus eschewing the title of nationalisation. Santander took over Bradford and Bingley in the course of time.
The book gets into the details of how the discussions proceeded and the thought processes in the central bank over the entire time period. King was fairly obstinate and preferred to go by the rulebook, while others felt that the bank should be accommodating. Eventually, with government intervention, the deals went through, though a large number of payments were made in a clandestine manner to ensure that word did not get out that the Bank of England was supporting these institutions through infusion of funds.
Also, the Bank of England had its own quantitative easing, where it either bought back securities from banks to provide liquidity or exchanged mortgage-backed securities with government securities that could, in turn, be sold in the market. The crux was that banks cannot be allowed to fail, as it hits deposit holders whose interests cannot be ignored. Banks were also sliced into good and bad banks with the good ones being sold and the bad ones nationalised.
Almost five years down the line, things have stabilised. The good and bad banks concept has worked. The government took on the bad part of Northern Rock, while the retail side went to Virgin Money. The branches of Bradford and Bingley went to Santander, while the bad assets were combined with those of Northern Rock to form the UK asset resolution agency. Lloyds is back on the stock market after the HBOS episode. RBS, too, carries on today, but is still to recover from the crisis.
It is clear that the major lesson is that central banks have to be alert and prepared to take remedial action before a crisis escalates. Crises never erupt suddenly, as the conditions that create them take time to build up. Often, they are associated with bubbles, which are mistaken as signs of strength rather than weaknesses. It is only when the cracks become fissures that a crisis is recognised and by that time it is too late. Further, the issue of moral hazard always comes up for discussion as to whether central banks should intervene or not. And if they have to, how should it be timed. The author concludes by saying that the story of the crisis has no end. While future generations will be grateful to politicians, regulators and advisors for preventing a cataclysm, they will not thank them for leaving debts and liabilities, which could take decades to settle.
On a lighter note, when the British government mooted an idea to tax the bonuses of bank executives associated with the crisis at a higher rate as a kind of punishment, bankers felt that they deserved these bonuses and were unfairly targeted, as they had helped the system weather the crisis!

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