10.29.09
Re-thinking the Structure of the City of London
The following letter was posted in the FT Online on 29 October 2009, in response to an article by John Gapper on the wisdom of breaking up ING:
An excellent article. As a long-time user of the system, I was painfully aware of the internal conflicts even within the relatively less complex investment banks of 1986, and was extremely distressed by how the quality of service declined after Big Bang. As far as I was concerned, London was following a model created in America which had made a generation of brokers (the ex-partners) and bankers very rich, whilst creating financial conglomerates which no one would be able to manage. Typically, the big American banks had no idea what they had purchased, usually ran it into the ground, and then, having sunk so much money in the expansion already, put in more in order to rebuild from the ground up. Middlemen, rather than the shareholders of the ex-commercial banks, made most of the money.
Eventually, they got it right, but only at the expense of the quality of service they offered clients. As analyst recommendations became less and less trustworthy, funds had to import more and more costs in the form of hiring large staffs of analysts to check up on the work being done by the sell side. The same process was going on in New York. I am reasonably sure that any small improvement in investment returns being made through ever lower trading costs were more than offset by the vastly higher overhead institutions suffered through these changes.
Issuers were also being fleeced, as the merchant bankers were replaced by deal-makers. Without cozy advisory relationships, bankers began churning their corporate clients, selling them on deals which frequently proved disastrous. Advice which one cannot trust is worse than useless, and the City became, more than ever, a competing business marketing turnover, at the expense of its users, the rest of the business world. It was but a short jump from there to the massive explosion in proprietary trading, which has made the new ‘universal’ banks direct competitors of almost all their customers.
It was the quality of service in the face of conflicts of interest and ignorant owners which led me to start complaining about the new model as early as 1988, but the collapse of Barings and other banking disasters convinced me that I had been correct for other reasons as well, that bigger was almost always worse, and that there had been much to be said for the old partnerships, after all. Subsequent crises have only reinforced my opinion: the model is no good, anything that users of the financial system are taught to believe they are saving in lower costs, they are losing many times over in deliberately bad advice, inefficient pricing, financial instability, and systemic risk.
Curiously, the consolidating industry has begun to eat its own farrow, and many of those bankers who are most vociferous in their arguments for the necessity of the present system, will be among those discarded, as a formerly entrepreneurial business becomes more and more bureaucratic, without losing its appetite for self-destructive growth. I would argue that the closer a financial entity comes to risk, the greater the necessity for a partnership-like structure.
Mr. Gapper’s threefold division of the banks would not only be a good idea, it should be complemented by requirements that major risk-takers be risking their own wealth above all. Commercial banks can be limited-liability corporations; investment banks should be at most closely-held corporations, and active position-takers and risk traders should have to have a major unlimited partnership element to their legal structure.