The Paul Gosling column
– this column was written on 22nd September for publication in the first October issue of Co-operative News
Washington Mutual remained in business as this sentence was written. By the time it is read there is a very strong chance that it will no longer be trading in its own right – perhaps bought up, or else bankrupt. It is not alone, of course – there is also Northern Rock, Halifax Bank of Scotland, AIG, Merrill Lynch, Alliance & Leicester, Fannie Mae and Freddie Mac.
What is interesting – and arguably significantly – is just how many of these organisations are not historically straight commercial businesses. Lehman Brothers, AIG and Merrill Lynch certainly were – they were gigantic financial institutions that made wrong decisions, getting involved in complex financial products they might not even have fully understood. Fannie Mae and Freddie Mac were what is called in the US ‘hybrid’ organisations – they were doing work on behalf of the government (issuing and guaranteeing mortgages), with the backing of government, but operating as limited liability companies. They came unstuck when the property market nosedived – but, it should be noted, there are legal actions they claim their accounting practices were misleading and had overstated profits.
It is different with the Washington Mutual, a former savings and loans institution that became the sixth largest commercial bank. Washington Mutual ceased, in fact, to be, a mutual in 1983, but kept what became a misleading name. Ronald Reagon approved of the widespread demutualisations of the US’s traditional savings and loans sector, in much the same way that Margaret Thatcher did with the building societies. But Reagon accepted the argument that savings and loans were too financially conservative and needed to generate larger incomes – which they did by entering into greater risks for higher returns, with less regulatory oversight than applied to established banks. As the risks turned bad, the US federal government had to step in to clear up a mess which its own president had been involved in creating.
Another cause of the great savings and loans collapse was that the institutions borrowed short-term to lend long-term, making them extremely vulnerable to changes in financial market conditions. This, readers will be aware, was precisely the mistake repeated by Northern Rock and other demutualised institutions in the UK. The cost of to the US Federal Government of the savings and loans crisis was around $185bn, leading to a massive federal deficit and was arguably the main factor in the onset of the subsequent recession.
Demutualisation has also been a sorry mess in the UK. Let us consider the roll-call of the UK’s once great mutual institutions, the building societies that have demutualised. The Halifax – merged with Bank of Scotland and then saved from collapse by Lloyds TSB. Northern Rock – collapsed and nationalised. Bradford & Bingley – in crisis and perhaps gone by the time this article is published.
Abbey National – now, as Abbey, owned by the Spanish banking group Santander. Alliance & Leicester – saved from collapse by Abbey. Cheltenham & Gloucester – part of Lloyds TSB, with the name presumably to disappear after the takover of Halifax. Bristol & West – owned by the Bank of Ireland. The Woolwich – bought by Barclays. Birmingham Midshires – bought by Halifax, so now part of Lloyds TSB and another threatened ‘brand’. National & Provincial – now owned by Santander as part of Abbey.
Of 10 demutualised building societies, just one (at time of writing) continued to trade as an independent PLC – Bradford & Bingley, which seems very unlikely to survive. Assuming it goes down, that will mean that four of the 10 have had to be rescued from crisis. Three are now part of a single Spanish banking group. Another three are part of a single giant UK banking group – Lloyds TSB – which was already a market leader, before the demutualisations.
Building societies have been largely resistant to the financial markets turmoil. The Derbyshire and Cheshire societies had to be rescued by the Nationwide – for some reason sparking calls in the Financial Times and Mail on Sunday for windfalls to members – but otherwise the sector has held up well. This may not last, as a recent report from KPMG suggests a wave of mergers as smaller societies seek to protect themselves by adding ‘scale’.
That, hopefully, does not mean more demutualisations, which can probably generally be recognised now as one of the worst policy mistakes by governments in recent years. One medium-term effect of the demutualisations has been that the banks that emerged played a central role in the over-lending and under-capitalisation of the UK mortgage sector, that has caused the UK economy and public finances so much damage. Another problem is that they have pushed the UK banking sector into much greater, and much more unhealthy, consolidation.
There is a terrible irony here. The US financial crisis has several causes. One is that the banks entered into vast risks that they did not fully understand, using complex financial products that they – and the regulators – did not fully understand. Another root problem is that the banks and other financial institutions simply grew to big – this was particularly the case with AIG, which issued guarantees on the complex financial products, as well as being involved in the debt market and insurance. It became so vast it was not allowed to fail.
Yet the solution to some of the symptoms of this crisis has been further consolidation. Merrill Lynch is being bought by Bank of America – which itself is now so vast that it could not be allowed to collapse. Lehman Brothers is effectively being bought (at a knock down price) by Barclays, after being made bankrupt. Halifax Bank of Scotland is going for a song to Lloyds TSB – which now has a worryingly large dominance in the UK mortgage market. Morgan Stanley looks like being absorbed by another bank. It is likely that in the long-term, Northern Rock, Fannie Mae and Freddie Mac will be transferred – wholesale or in bits – into the rest of the financial industry, building up the strength of the top players.
We will end up with financial markets in both the UK and the US that are more consolidated and controlled by a few very large banks, whose strength will be expanded to such an extent that they cannot fail – and will know they cannot fail. Not only is it unhealthy for governments to be forced into the role of bailing-out our foolhardy mega banks, the irony is that it is not even capitalism. The answer may not be to let the banks collapse – but the prevention would have been to stop them becoming so very large and foolhardy in the first place.