Simmering financial crisis began to boil when 'the Americans, at a hastily convened meeting, cobbled together a club of big banks' and 'the latter agreed to join the regulatory authorities in shoring up the tottering edifice' of a minor institution.
That didn't prevent extreme embarrassment in Switzerland, the supposed home of prudence, where revelation that a 'giant bank had sustained substantial losses' in related dealings raised a frightening question: 'How many other banks were nursing big losses in secret?'. To put it another way, 'Can You Trust Your Bank?'.
That was the title of my 1977 book, co-written with Norris Willatt, in which the above passages occur in a nightmare scenario for 'The Greatest Crash'. Today's virtual collapse of Long-Term Capital Management and the £413 million loss which Switzerland's UBS suffered in consequence perfectly fit that fictitious horror-story - inspired by actual banking bungles of the 1970s.
The next decade was no freer from fiasco, and the 1990s look more horrendous still. Every ten years or so, the world's banks carry to hazardous extremes an infinitely renewable capacity for mismanagement. That generally involves jumping on rickety bandwagons - like grotesque overlending to Third World governments, inane backing of inflated property booms, or the misjudged 'one-stop shopping' splurges in stockbroking and investment banking.
These mistakes, like most of the one-stop acquisitions, are dead, buried and all but forgotten by the time of the next tidal wave (such as today's massive lending to hedge funds, Russia and the Paper Tiger economies of the Pacific Basin). The collective amnesia may well explain why lessons remain unlearnt. Each generation of bank executives seemingly needs to relearn what was taught at ruinous cost only a few years back.
Bankers can argue, with small comfort, that their errors are only those of all management. Corporate managers commonly leap on bandwagons that their combined weight causes to crash. The late, unlamented mega-merger boom is an example - some prices paid for recent mammoth buys are little higher than current values for the entire combination. Commonly, too, non-banking managements blithely ignore time-honoured basics, like covering the true cost of capital with real profits.
Banking managers are apt to carry these faults to excess. The mega-marriage between Travellers Corp. and Citicorp became an instant stock market disaster - not surprisingly, given the two-thirds slump in profits. Moreover, banks have been ignoring the oldest, least subtle basic in investment strategy: the higher the yield, the greater the risk.
If some sharp fellow is hawking a scheme offering 40% returns, always suspect a 'Ponzi' fraud: the promoter is probably paying first-comers from the investments of later comers - who never get paid. John Meriwether's 40% pay-offs at Long-Term Capital depended on a different deception: that they were achieved by Nobel Prize-winning brilliance at exploiting differences between quoted prices for securities.
Such discrepancies are generally minute. Long-Term Capital really made vast returns by borrowing vastly, and thus multiplying the minute. For every billion of Meriwether's money, banks coughed up maybe $25 billion - if not more. While a small gain then makes mighty profits, a tiny loss wipes you out. Bankers are taught at the maternal knees to dodge such dangerous gearing, along with other deeply conservative advice.
The mind-set is generally correct. The prime directive of any bank is to safeguard the deposits of its customers, which will also inevitably protect the assets of its shareholders. But bank managements are in no way immune from the external pressures that reached their apogee in 1997-98. Shareholders, especially institutional investors, increasingly valued dynamic growth well above solid stability.
Nor do managers as a class like to stay out of apparently winning games (especially those that, through stock options and salaries, steeply enrich the managerial participants). Banks, though, face a genuine growth problem - non-banking competition for their safest business. The rivals include their own major corporate customers, who readily go direct to the market for finance.
Moreover, competition for retail customers has forced banks to pay interest on deposits that were once free. To grow fast enough to appease the analysts, banks have had to keep on finding new borrowers with healthy, greedy appetitites. Hence the relentless series of disasters with governments, property, dubious tycoons like Robert Maxwell and Alan Bond, and now financial geniuses like the hedge funds.
In Meriwether's case, perfectly respectable banks were investing at one remove in wildly speculative operations without properly assessing the risks. At UBS, the risks were allowed to run riot, which is why chairman Mathis Cabiallavetta and three other top men lost their jobs. In this sometimes cavalier approach to risk, bankers are again no different to the generality of managers - except that risk analysis is supposedly a banker's expertise.
Analysis, however, is only as good as the underlying assumptions. If you oddly think Russia's economy and banks perfectly sound, you will plunge happily into lending and, if you're Barclays, lose £250 million. A basic management process should protect against such errors: Best World, Worst World. What happens if the best comes to the best? And if the worst comes to the worst, will the impact be tolerable?
If not, can you cover the risk? Computer models like Long-Term Capital's, a Texas professor told Business Week, 'tend to ignore low-probability catastrophic events'. So do managers. But the current world financial crisis had a probability too high for any commentator to ignore. The bubble was bound to burst. The only issue was when. Yet banks merrily went on financing the bubbling, including the hedge funds (to the tune of $3.2 billion at Chase Manhattan alone).
While investing in certain failure, what's more, the banks are wary of sure successes, like applying the new cyberspace technology with might and main. Thus one supplier trying to sell the future of banking to a British mammoth finds it 'very slow on the uptake and reluctant to step in'. That applies both to customer processes, like the amazingly cheap internet banking, and to the internal IT applications which could rapidly transform constipated bureaucracies into genuinely responsive, customer-facing engines of real growth.
Most of the banks' corporate clients are also shy about true transformation, even though their executives are better versed in the ways of entrepreneurial, market-led and market-leading management. Lack of such training and experience is the underlying explanation of banking's recurrent nightmares. In the past, horrors have been exorcised by overdue return to conservative practices and thus financial stability. It's not much of a compliment, but banks make great recovery stocks.
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