"Credit crisis shows that banks need wise men not wide boys"

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Although we have spoken from time to time about the managerial and cultural failings of the financial services industry, an article today in the Telegraph by Roger Bootle provides a nicely balanced, colorful, and deceptively insightful overview of the issue, while also giving a taste of how the British variant of the problem differs from its Yankee counterpart.

From the Telegraph:

Don’t get me wrong. I haven’t got it in for all senior executives and corporate board members. Some of my best friends are chief executives. Really. But I have come to wonder whether their colleagues are all quite what they are cracked up to be.

We all get things wrong. Even the most brilliant general or politician fails in some respect or other. Never mind economists. For us, getting it wrong is a way of life.

But for someone trying to analyse how good or bad a great leader was the key question to ask is why they failed. Was it bad luck, or bad judgment, or bad information – or what? Similarly when they succeeded, was this rooted in good decision-making or in good luck? The same is true for corporate leaders. But who makes such careful and critical assessments of them?

In practice, my concerns are most acute regarding financial businesses, and principally banks. I could be wrong, but I suspect that the degree of incompetence there is greater.

I do not mean to imply that the quality of people involved is necessarily lower, but rather that there is more chance that skills and practices do not match up to requirements. Financial businesses are inherently more complex and they can change that much faster. Accordingly, it is probably easier to make catastrophically bad decisions in finance than in any other business.

What has prompted these thoughts is the recent news of large-scale losses by banks. The shocking thing is that in the case of major corporate decisions we know so little. We don’t really know whether individual senior bankers are culpable. Stock market analysts have, as so often, failed to ask the pertinent questions. Major shareholders, who have often been part of the problem by pushing managements to deliver short-term performance, could ask key questions. But their activities seem to be mainly confined to pushing for the occasional executive scalp, without really knowing whether that person was the root of the problem. On the whole, journalists have given corporate executives and their decision-making processes an easy ride too.

About the only powerful source of scrutiny is the Treasury Committee of the House of Commons (to which I act as an adviser on monetary policy). A grilling by those rottweilers can rattle the most confident of chief executives and raise a mighty stink. But the Committee does not have the time or resources to conduct major investigations into corporate decision-making.

Even though they have a clear self interest in understanding why they made a bad decision, I doubt whether even within the corporations themselves there is much self-analysis.

I have more than a suspicion that in most cases the answers would make your hair stand on end. There are several characteristics of senior bank executives which should make you worry.

First, they are not by nature very ruminative and not normally given to self doubt. This can, of course, be a good quality, but not when the world is so uncertain and the consequences of bad decisions so serious. Second, they do not lightly tolerate dissent and tend to attract sycophants among the ranks of other senior executives. Third, they normally have distinct blind spots in the two areas where a financial organisation can most easily be brought to fail, namely IT and complex financial instruments. Fourth, if an activity is making money they usually give it the benefit of the doubt.

In a properly functioning corporate world these failings of the executive would be both recognised and counter-balanced by the wisdom of the board. But many boards are best regarded as a form of club. The City is a peculiar mixture of geekish quants and rocket scientists, wide-boy traders who would otherwise be selling apples and oranges down the Commercial Road and time-serving apparatchiks. Typically a board consists of no one from the first two groups but quite a few from the third. In what position is Sir Thingummy Whatnot to question the real risk exposure of a bank? Does Dame Noditthrough really know her onions on complex derivatives?

And for presiding over all this, of course, senior bank executives get rewarded on a scale that ordinary mortals find fantastical. And when they fail, they get packed off into the sunset, often begonged, with a very comfy nest-egg indeed.

The inability of most normal human beings to understand what the quants are up to is devastating. Of course, the banks all have their risk assessment teams and procedures. But they are also highly quantitative and to normal people speak gobbledegook. More fundamentally, their model-based approach rests on the continuing relevance of recent experience – often over pathetically short runs of data – with scant regard paid to the “off-the-model risks” which in the real world are the usual sources of upset. Personally, I would sack at least half of the risk assessment boys and replace them with historians and people versed in English literature. Their brief would be to think the unthinkable – not to measure the easily quantifiable.

Not long ago, banks and other lenders were falling over themselves to lend on wafer-thin margins to people and propositions which their predecessors would not have touched with a bargepole: 125 per cent mortgages; huge multiples of earnings; self-certification. Now the lenders are shutting up shop and fancy mortgages have disappeared like melting snow. Both approaches cannot be right.

The silence about the corporate behaviour which led us to this pretty pass is scandalous. Come off it boys, you were sucked into a bubble of the classic sort. You were persuaded to believe that nothing could go wrong. Yet any study of financial history would have set the alarm bells ringing. But do you ever read any? To his great credit, the Governor of the Bank of England warned explicitly and publicly of the risks. But did you listen? Outside commentators and analysts, and even, in some cases, your own in-house experts, pointed out the over-valuation of property. But did you pay any attention?

We cannot go on like this. There are all sorts of ways in which banks must be restrained and regulated to be better behaved in future, including with regard to their remuneration packages. But the structure and behaviour of boards and banks’ procedures for assessing risk should also be an important part of this reform.

Supposedly the justification for the gargantuan pay packages of recent years has been the supreme cleverness of bankers. Yet so much of modern banking is a form of gambling. Those clever bankers, nodded on by their gilded boards, have done the equivalent of put a few billion quid on the 3.30 at Newmarket – and lost. Clever or not, what they really need more of is not cleverness but wisdom. And what they need less of is money.

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  1. François-Paris

    The telegraph has been a pleasant daily read for a couple of months.

    I’m French. Cultural at odds with Ambrose and others’ WASP background in spite of the geographical nearness. But still both the Telegraph economic prose and the “luminous” comments of their educated readership has proved a valuable source of information.

    My current readings include :
    – French financial advisors,
    – UK economic press (FT and telegraph),
    – US blogs. A la roubini.

    I’m fairly certain that one could get poor quite fast if you alternate any terms above…

    It’s quite a telling evidence about what is behind in terms of legal systems, business practices and human behaviour.

    Kind regards for you superb work.

    Another great daily read.

  2. Richard Kline

    “More fundamentally, their model-based approach rests on the continuing relevance of recent experience – often over pathetically short runs of data – with scant regard paid to the “off-the-model risks” which in the real world are the usual sources of upset.” Bootle is so deadshot on with that remark, I can only commend him. I’ve grown a callus on the point of my jaw dropping my mouth to the floor reading _endless_ financial industry blurts going something like, ‘ . . . Consistent with the trends of the last seven years . . .” Statements like that are bizarro if one has any context, but financial tyros eat them up and then pass them along to others who can’t be bothered to read for pleasure or understanding.

    Regarding dozy boardmembers and me-too senior management . . . . Look, _nobody_ wants to know where the bodies are buried, what’s in the black box, or why the bangers are so cheap so long as the income statement has a gratifying number of numerals to the left of the decimal place: that is all the skill at mathematics really desired. Only personal financial liability and a definite loss of social standing motivates ANYONE at all with standing to gain on the profit side to ask any questions; if it’s only the one or the other at risk, then they don’t want to know, either. This is the reason for financial regulation, because in the presence of briefcases full of green cocaine nobody can restrain themselves and absolutely nobody wants to ask any questions. Regulations constrain stupidity.

    Picture, if you will, our Captain of Finance, wide-boy or whiz kid, rather more in the postion of Ulysses tied to the mast going forward. Should he scream out “More to the left,” or weep aloud “Oh please to the right,” the crew just keeps pulling on their oars with their heads down on right and true centered on the mid-term trend along a course plotted well before. Much safer, this approach. And I rather like the view of Captains of Finance tied to just about anything . . . .

  3. a

    “More fundamentally, their model-based approach rests on the continuing relevance of recent experience – often over pathetically short runs of data – with scant regard paid to the “off-the-model risks” which in the real world are the usual sources of upset.”

    Welcome to VAR.

  4. foesskewered

    Where was this guy when I was looking for a banking job?! Got the impression that as long as one was not an MBA or did not speak in binary/logarithims, one stood a very low chance of being employed by most banks. Somehow, the ability to be cogent or literate in any linguistic medium was a handicap, oh, of course, they didn’t like my blog either!

    Well, let’s just see how the people they did employ dig themselves out of this one…

    BTW, both local banks and local subsidiaries/branches of foreign banks are pursuing the same employment policies in ; expect historian friends are beating their breasts right about now , what’s that about not learning from history (even recent history?)

    Richard Kline; Ulysses tied to the mast, was it the Sirens incident? hey mebbe Joyce’s Ulysses would be more appropriate -degeneration on every level. As for accounts, well, they (banks) tend to prefer employing people with Big 4 experience, who incidentally are their past/present auditors, de ja vu?

  5. foesskewered

    Sorry, meant to say pursuing the same employment policies in Asia; becoming less careful linguistically, mebbe becoming more employable in banking!

  6. Anonymous

    The last paragraph of “God and Golem” by Norbert Weiner goes like this:

    Thus the economic game is a game where the rules are subject to important revisions, say, every ten years, and bears an uncomfortable resemblance to the Queen’s croquet game in Alice in Wonderland, which I have already mentioned. Under the circumstances, it is hopeless to give too precise a measurement to the quantities occurring in it. To assign what purports to be precise values to such essentially vague quantities is neither useful nor honest, and any pretense of applying precise formulae to these loosely defined quantities is a sham and a waste of time.

    Here some recent work of Mandelbrot is much to the point. He has shown that the intimate way in which the commodity market is both theoretically and practically subject to random fluctuations arriving from the very contemplation of its own irregularities is something much wilder and much deeper than has been supposed, and that the usual continuous approximations to the dynamics of the market must be applied with much more caution than has usually been the case, or not at all.

  7. Anonymous

    “For this is the general rule that never fails: a prince who is not wise himself cannot be wisely counseled…” There could be such a situation, but it would not last long, for the counselor would soon deprive the prince of his state. An unwise prince, having to consider the advice of several counselors, would never receive concordant opinions, and he would not be able to reconcile them on his own. His counselors would pursue their own interests and he would know neither how to rule them nor how to understand them. They could not do otherwise, for men will always prove bad unless necessity compels them to be good. Therefore I conclude that good advice, no matter where it comes from, ultimately derives from the prudence of the prince, and the prudence of the prince does not derive from good advice.”—Niccolo Machiavelli, “The Prince”

  8. Anonymous

    One of the key characteristics of good leaders is that they learn from their mistakes. Unfortunately, the characteristics Bootle lays to senior banking executives virtually assures that they will NOT learn from their recent experience.

    I guess we can expect more boom, bubble, and bust finances in the banking sector.

  9. Anonymous

    Human organizations tend toward incestuous information exchange, intellectual inbreeding and a fixed mindset that disallows for any other perspective.

    The greatest lesson of history is that humanity does not learn from history.

  10. Anonymous

    Good article and comments. But the article says virtually nothing about the true core issue, I think, which is the complex nature of the relationship between the “senior executives” and the wide boys. It is the wide boy culture and power that has driven the carnage, along with the near complete delegation of the “senior executive” role to the wide boy population (in most cases it effectively has been). The elbowing in of this arrangement also precludes any valid risk management function. There are no wise men because the wise man role has been fully abdicated with kool-aid abandonment by any who may have pretended to be candidates at some time.

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