Beware the Sanguine Banker

Iain Martin’s message in his excellent Making it Happen: Fred Goodwin, RBS and the Men Who Blew Up the British Economy is that a proper sense of fear is good for bankers.

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Walter Bagehot got it right. The mistakes of a sanguine manager, he said, are far more to be dreaded than the thefts of a dishonest manager. Someone should have told the board of the Royal Bank of Scotland, where Fred Goodwin was the sanguine manager. “Making it happen” was his slogan, and when disaster happened and the bank imploded, he was vilified. Iain Martin shows how it happened, and who let it happen.

Clever, awkward, compulsive, a Glasgow graduate, a classic Scotsman on the make — Gordon Brown, surely? This was Goodwin. No wonder the two got on well. An earlier disaster had set him on his way. He came into banking as a receiver, sent in to deal with the wreckage of BCCI, alias the Bank of Cocaine and Colombia. Within a few years he was at the Royal Bank and looking forward to the top spot. 

This kenspeckle old stalwart of the Edinburgh establishment was nerving itself to charge over the border and bid for the National Westminster, a bank twice its size. This would mean outbidding the Bank of Scotland, which had got its border raid in first — making a bid credible, getting it accepted and, hardest of all, justifying it in action. The raiders could and did pillage NatWest’s wine cellar, but that was only the beginning.  

Goodwin brought it all off, but it was not a trick he could ever repeat, though he tried, collecting banks in North America, where his rivals had so regularly burned their fingers. The Royal Bank must be biggest and best, and the Queen had to open its brand new head office, with its fountain and its easy access to the corporate jet. One analyst plucked up the courage to use the word “megalomaniac”.

The mega-bid for the Dutch bank ABN Amro followed: ¤71 billion (say, £60 billion), in cash, complete with the pleasure of trumping a rival offer from Barclays. The board duly nodded it through. At the time I thought that Barclays might make the Royal Bank pay too much, but this proved to be an understatement. Here was the NatWest deal with a different ending.

From across the Atlantic, the smell of burning grew stronger and spread. The flows of money began to dry up. Banks were failing. The Royal Bank’s directors, who had believed that their bid could be easily financed, started looking for something to sell. Then they turned to the stock market and issued new shares to raise a belated £12 billion. Six months later they came over with their hands up. Who let it happen? They did.

A frantic few days brought the taxpayer in as investor of last resort, and everyone from the Queen sideways asked why such a disaster had not been seen coming. A free and frank exchange of blame followed. Was the Bank of England asleep at the wheel? Was the regulators’ light touch altogether too delicate? Was it all Brown’s fault?

On arriving as Chancellor, he took supervision away from the Bank and set up the Financial Services Authority in Canary Wharf. At the other end of the Docklands Light Railway, the central bank would look after financial stability, while the Treasury, farther away, would hold the ring. This “tripartite system”, when tried out in war games, looked creaky. When tested in practice, at the moment of crisis, it offered no answer to the key question: who was in charge?

Different answers had been on offer a year earlier, at the Mansion House, when Brown told the City’s merchants and bankers that a golden age was ahead of them. Mervyn King, the Bank of England’s Governor, warned them of dangers ahead: not all that glistered was gold, not all that was labelled “champagne” was the genuine article. The bid for ABN Amro was then in full swing, and those who ignored his warnings soon complained that he ignored their cries for help.

He was blamed for his attention to moral hazard: the principle that a ready safety net encourages banks to run ill-advised risks. Alan Greenspan, his opposite number in Washington, had so reassured his own banks that they lent his name to an option: heads we win, tails he’ll look after us. This gave them the courage to make spectacular efforts and, in due course, to come spectacular croppers. Their example was infectious.

When it was all over, the banks came to realise that they had made old mistakes in a new wrapping. They had lent to borrowers who didn’t repay them. They had taken security which was not secure. They had assumed that cash would always be on tap. Moral: a proper sense of fear is good for bankers. Today’s generation has learned that the hard way. Their successors will need to learn from Iain Martin what can happen when complacent directors hire sanguine managers.