Friday, February 15, 2013

The corrupt amoral culture at the heart of the UK banking sector

When, sometime in the future, historians come to undertake an historical analysis of the culture of banking in the UK at the beginning of the 21st Century, the following words may prove to be a prescient starting point for them.

'You can't impose moral standards on people who don't wish to be moral':

This statement of the glaringly obvious was uttered by disgraced former RBS banker, John Cameron in answer to questioning in front of the Parliamentary Commission on banking standards, and it is on this issue I wish to focus in this blog.

Cameron was seeking to make a big distinction in the culture of bankers as opposed to those people employed by the banks to trade in financial markets. He was saying that although he and his fellow directors had done everything they could to inculcate an environment of ethical standards and 'best practice' within the dealing environment, the traders themselves had proved to be impervious to these attempts and had just ignored all management efforts and had carried on regardless of Cameron's or anyone else's pronouncements.

Cameron referred at one stage to the trading misbehavior being so blatant but that 'no-one had seen a need to cover up their conduct'.

It never seemed to occur to him that it was his job as a director of the bank, indeed, as the senior director at one point, to take the necessary steps to take control of this state of affairs, and therein, lies his own cultural dilemma, and indeed, part of the answer to the problem of why the financial sector has sunk to its present level of cultural dysfunctionality.

We can trace it back, I believe, to the changes in  the City of London introduced in the era of 'Big Bang'. I believe that the transformation of London from a UK-centric financial market, with international links, into a  24/7 global hub, operating on equal terms with New York and Tokyo, completely changed our financial culture and turned us, almost overnight, into a clone of the US market model, but without enabling us to adapt our traditional  methods and practices to take account of these changes within the same time frame.

Probably the single most important element of the financial revolution of the late 1970s, was the ultimate abolition of what was called 'single capacity' dealing. Back in those days pre 1986, the rules of the Stock Exchange required that the broking and dealing function of share trading, be split into two, entirely separate, single capacity functions. Those who were involved in bringing securities to the stock market, the 'jobbers' acted as principals to the market in the contracts they offered, so they could name their price, and were regulated by the element of price competition that each firm of jobbers had with their competing firms. The people who acted for the individual clients, the 'brokers' had the job to negotiate the best price for their clients, buying from or selling to the jobbers who dealt in those specific stocks. The brokers were paid by a fixed commission rate which was laid down by the Exchange, and no-one could deal below that price. This enabled the brokers to act completely independently for their clients, secure in the knowledge that they would get paid a sensible profitable fee rate, whatever happened, so their income was secured. In this way they were encouraged to put the interests of their clients first, because they were going to be paid come whatever.

This system had operated for a few hundred years and was a well recognised primary function of the London market. However, it differed radically from the way in which the Americans operated the New York Stock Exchange and other, smaller regional exchanges.

For some theoretical reason to do with a political view of competition best practice, a number of influential Labour politicians and civil servants considered fixed commissions for stockbrokers to be anti-competitive, and they had taken positive steps to bring pressure on the Stock Exchange to abolish the fixed commission structure. Roy Hattersley, under an earlier Labour Government, had referred the Rule Book of the Stock Exchange to the Office of Fair Trading, for them to consider its competition issues, and the case was grinding on and on.

Certain very experienced City practitioners tried to point out that abolishing the single capacity of jobbers and brokers, would, de facto, spell the end of the traditional role of the Stock Exchange in the management of the City markets, and undermine the very careful balance of competing interests which had developed over hundreds of years, being in the interests of both market practitioners and market users.

I interviewed Sir Peter Tapsell  a senior stockbroker and a Conservative Member of Parliament when I was researching my book on city fraud called '...Fraud in the City - Too Good To Be True...' which was published in 1987. On the issue of the abolition of fixed commissions and single capacity dealing he said this;

"...I immediately pointed out that there would be very large-scale repercussions from that decision, but it was denied from the Treasury Bench by Ministers. 'Oh No' they said ' we are only interested in getting rid of minimum commissions, we want the separation of functions to continue in the Stock Exchange.'...I don't think even the Council of the Stock Exchange appreciated that if you abolished minimum commissions, it was extremely unlikely that the separation of functions could survive, and the reason why the separation of functions couldn't survive is that without minimum commissions, there would not be sufficient profit to be made unless firms were going to deal on their own account (which hitherto, they had been strictly prohibited from so doing, because it posed a conflict of interests)...They would have to follow the American example and start speculating on their own account..."

Really, it is from this moment, we can begin to observe the change of the culture of the City of London's traditional ways of dealing and also the built-in effects that the old ways of separation of function produced in providing a disincentive to sharp dealing on behalf of clients.

Later, in another interview with me Sir Peter said something that with the benefit of hindsight has proven to be very prescient. He was talking about the new face of the City of London, the invasion of American methods of trading and American market culture, and the wider merging of business models and moral principles, where financial houses traded on their own account (proprietary trading) as well as trading on behalf of clients (dual capacity); where banks underwrote securities issues and then traded the very shares they were underwriting; where new financial contracts, many of them very little understood were created by one department of an institution and traded by another, but with direct access between the two sides to the operation. He said:

"I suspect we shall lurch from scandal to scandal as a result of moving into dual capacity, particularly as it is to be internationalised...Whether in the long run the general community will be well served by having these huge new financial conglomerates, where you get (retail) banks, merchant (Investment) banks, and foreign banks all mixed in together with a British stockbroking firm, I very much doubt. I think it's going to be extremely difficult to regulate, I think that the authority of the Bank of England will be greatly undermined  and I think a great many of the people who will be operating in future (in the City of London) will have different traditions from those in which my generation has grown up and I think you will get a lot of scandals and when these scandals break, the Conservative Party and the Government will be held responsible for them..."

These words were uttered in 1986 but Sir Peter's wisdom has proven to be exquisitely accurate, particularly with reference to the most recent crises.

However, we have to look more closely at the attitudes of the traders to appreciate how much their own trading culture predicates their willingness to break the law and commit criminal acts. I describe these people as being 'regulatorily resistant' and I will spell out my logic in identifying this phenomenon.

Much of the trading activity which takes place within the banking environment, particularly in the area of proprietary trading is literally no different from gambling on horse races or games of chance and its practitioners tend, generally, to possess the same commercial mentality as the gambler.

 At the same time, both floor and desk market professionals tend to be heavily influenced by a trading culture which preaches the virtues of      adopting a grossed-out, high profiled, aggressive, risk-taking personality, which needs to be constantly attested to.

 Psychologically, many of these men and women can be defined as being 'regulatorily resistant'. Theirs is a primarily deviant, norm-evasive, criminogenic culture, not much given to the willing acceptance of regulatory control. Such an uncompromising statement should not be immediately interpreted to mean that these practitioners are committing wholesale overt criminal acts. It simply means that their risk-taking culture, itself the antithesis of the traditional perception of the risk-reduction function of these markets; coupled with the highly competitive environment within which they work, whose new traditions give all the impression of flouting traditional, 'old market' norms; predispose them to break the rules more readily than practitioners in other commercial sectors. These are the traders to whom the compliance officer is generally seen as 'the business prevention officer' and the traders tend to view each new regulatory notice as an irritating inconvenience standing in the way of increasingly innovative trading.     Each new regulatory requirement is looked upon as a challenge to the ingenuity of the traders, and competitions are held by dealers to see who can get round the controls undiscovered, and in the most profitable manner.

In his article, 'Mavericks at the Casino: Legal and Ethical Indeterminacy in the Financial Markets',  Christopher Stanley identified the development of this new phenomenon of regulatory resistance within the previously ordered environment of the City of London. He says;

"...The New City reflected the ideological aspirations of a system of political administrations which disrupted the post-war consensus of relations between polity and economy. It also reflected the Casino or Disorganisation of Capitalism: 'an international financial system in which gamblers in the casino have got out of hand'. The New City was international, technological and subscribed to the 'Enterprise Culture' ethos which stressed individual success and self-reliance as the primary indicators of excellence. The structural changes which the Government introduced, in terms of trading practice and regulation, operated with the new financial products and markets to ensure that the particular elite of the Old City, which was perceived as a dangerously destabilising hegemonic counterforce as a result of the tension between Establishment and Disestablishment, was dislodged in the face of externally imposed change. Thus settled norms of conduct were open to disruption'. 
Pursuing the 'Legitimation of Deviancy' theory, Stanley drew upon the concepts of the 'Anomie of Affluence' (on which topic I have blogged previously) to attempt 'explanations in this formulation of individual conduct within this particular field of moral and economic deregulation.'  He posited a vision of a market in which money no longer possessed any intrinsic value as a benchmark of the underlying value of the commodity traded, but became a 'free-floating signifier detached from the real processes to which it once referred...there is therefore a transition in its nature as a commodity to which moral or ethical values can be attached. In addition the artificiality of electronic money enabled the further disappearance of the victim and the possibility of justification through reference to prevailing economic rationality, ie 'Greed is Good'.

Thus, no matter how much money these people were paid in salaries or bonuses, it was never enough and the figures needed to be increased constantly in order to provide any sense of value or self-worth. The bonus payment became a justifier of their actions, regardless of their criminogenic potential.

This specific problem of ‘regulatory resistance’  or if you like, 'moral delinquancy', has been endemic in the regulatory model of the UK’s financial sector since the passing of the Financial Services Act 1986. In this blog, one of my areas of focus is to attempt to expand and develop the concept of the ‘criminogenic’ nature of the state of regulatory resistance, or ‘legitimised deviancy’ which so many financial practitioners espouse. This is what is meant by the phrase that you cannot impose moral standards on people who don't wish to be moral. By ‘criminogenic’ I mean conduct or behavior which has the potential to become criminal, or at least, so vitally damaging at some stage in the process, that any attempts to deal with the problem will almost inevitably lead to further potential criminal behaviour.

By examining the behaviour and conduct of persons within the financial sector, we can establish traits which indicate a potential to be more or less willing to engage in conduct or behavior which may result in the commission of criminogenic activity. Alternatively, where, through ignorance of the underlying criminogenic potential of new products or sales practices, those employed to ‘apply compliance procedures’ in the market ignore the likelihood of the new risks being generated. In so doing, they allow the damaging conduct to continue, and in examining this conduct, we can begin to determine where they are exposing the market to far greater systemic risk than it either needs or can cope with.

.A derivatives trader who habitually spends his evenings spending vast amounts of his firm’s money entertaining clients in lap-dancing clubs, the kind of man who is willing to pay the bill for confirmed criminal offences, ie hiring prostitutes  (supplying prostitution) and supplying recreational narcotics,  is not the kind of man who is going to spend too long worrying about the finer niceties of the Insider Dealing rules, the money laundering regulations, or the way in which he trades LIBOR!

‘As long as we got results, as long as we got our commission and good feedback from the clients, they (the employing bank) didn’t really give a shit…I think the banks know the situation, and so they don’t do the random drug tests, because they know half their staff would be on it, and they know that in a high-pressure job, they have to allow their traders to have these excesses. They don’t care about the health of their workforce as long as they’re making money…’ (Seth Freedman) 

‘ …prompted by the beckoning finger from the clearly coked-up Asian chick nearest the open door, I nervously walked towards the car. I clumsily shuffled into my seat and saw in the gloom my three colleagues all sitting with their respective new lady-friends. They were all snorting yet more lines of cocaine that our ever-so-thoughtful hosts had prepared for us on little mirrors…’ (Geraint Anderson)

The basis of the underlying theory is a concept which is well-known to any experienced street detective who is trained to deal with crime and to recognize the signs of the criminogenic personality,  and briefly put, states that those who act or behave in an anomic fashion in their ordinary, every-day existence, who bend or break minor rules or simple laws for their own self-gratification, or who refuse to conform to ordinary norms of human conduct at times when their surrounding conditions would require such behavior,  will have a greater propensity to act in a similar, anomic way in many other circumstances, and where a situation arises which gives them a series of choices, they will          inevitably take the line of least resistance.

The American criminologist James Q Wilson has alluded to this kind of ‘behavioural arbitrage’ when defining his “broken windows” theory of criminal conduct. Those who are prepared to commit minor acts of criminal activity as a matter of course, have little difficulty in committing more serious acts of criminality when occasion demands. 

These phenomena are familiar to criminologists because we have been trained in their understanding and we have experienced their reality, which is why you will read my consistent demands for a greater degree of criminalisation for these actors, because as potential criminals, they have to be treated like criminals because it is the only sanction they fear and understand..

Unfortunately, our skills and our experiences are routinely denied and ignored by financial practitioners and financial regulators, all of whom believe that they know better, and think that they can regulate financial markets by simply denying that there is the potential for financial criminals to commit financial crimes. It has been ever thus, and will continue in the same vein, and when the next major financial scandal erupts, as it will as surely as the night follows the day, the Great and the Good will still be asking themselves why no-one has been prosecuted, and why no bankers have gone to prison, and Sir Peter Tapsell's wise words will prove themselves to be even more perspicacious than before.

Listening to John Cameron giving evidence to the Banking Commission, I found it quite sad when he said, rather wistfully; 'You can't impose moral standards on people who don't wish to be moral': If the banks and the regulators employed people who understand how and why this situation exists, perhaps he wouldn't have needed to make that observation!


Jason said...

This is a genuinely fascinating history lesson. I would never have guessed the rot began with shortsighted labour tinkerings.

The psychology rings true as well -- although it’s clearly not just “refusal to conform”, it’s based on a sense of outright superiority vis-à-vis rules, very much as in the Bonfire of the Vanities’ “Masters of the Universe” attitude -- “There was no limit!

Hattersley or no, I think this was likely to begin sooner or later. Human beings almost never take the advice of Laozi to live as cautiously as a fox crossing the ice. Once a period of safety has settled in overconfidence tends to be next. Many civilisations with major futures trading components, since Babylon, are bankrupted by them at some point.

I’d love to see the faces if fixed rates returned!

ilene said...

Hi Rowan, Is there a way to get in contact with you - email? Mine is I'm wondering if you allow reposts with links of some material in your blog. Thanks, Ilene

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