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Wednesday, 24 September 2008

Scotch this rumour!

For the record, I wish to scotch the rumours circulating that my 'noo's the 'oor tae buy the bank' investment note issued Wednesday of last week had a direct influence on Warren Buffet's decision to u-turn after two decades of shunning stakes in Wall Street. His $5bn investment (plus option for a further $5bn) in Goldman Sachs is not a departure from buying on fundamentals or book value although clearly sentiment will be supportive of GS's conversion to traditional banking. Investment banking per se is not in Skid Row. What is happening is that the economists are taking over from the accountants at the top just as macro-funds have come to dominate in Hedge Funds' performance stats.
For example, Naguib Kheraj, who studied economics with me at Cambridge and learned investment banking at Salomon Brothers 20 years ago, becoming CFO Europe before joining Flemings (when I bought their and RBS's perpetuals both paying north of 9%), then FD at Barclays and dep Chrmn Barclays Global Investors AM, has now been appointed CEO JPM Cazenove. Banks at the end of the boom years feared that economists could now take over, and lo, this is what is happening. And what should be happening in a deeply uncertain climate, since the only alternatives are the mathematicians whose risk assessments have proved somewhat abstract or virtual. I expect this trend to last for several years until good times return and the economists are again ejected sideways. Until then, more economists who studied Keynesian analysis 20 or more years ago will get leadership jobs in banking and rebuilding business strategies around comprehensive economic capital models.
This brings me to the questionable criticism, also doing the rounds, of Lehman's non-executive board members, 9 out of 10 of whom were retired, if not actually pensioners, including Roger Berlind, a board member for 23 years, who left the brokerage 2 decades back to produce Broadway plays(like myself who staged 50+ theatre festival shows this year). Bankers are no less astute for having wide cultural interests, something many of the Gen-X generation, working 60-80 hour weeks at their spreadshets, had sadly no time for!
The fact is that, back then, risk analytics were more econometric, more fundamentalist, before being rapidly replaced by the pricing algorithms of the fast-growing derivatives markets (leading to the LTCM collapse). Through the '90s, most of a generation of bankers who had reached their 50s (the baby boomers) and were about to take control were pushed into early retirement (supposedly as a net saving to banks' pension funds) and the result was that risk capital trading became dominated by a younger generation (Gen-X) who could only manage relatively simple financial engineering models that failed spectacularly once the markets turned and decided to put structured product valuations to a real world stress test! James Crosby after the HBoS merger wanted to cut back on exposure to mortgages, but young Andy Hornby staged a palace coup (as surmised by The Scotsman) to defend the one-sided strategy of aggressively growing the mortgage business like Northern Rock!
Lehman Bros. elderly board may have been a source of great good sense, with Lehman's five-member finance and risk committee chaired by Henry Kaufman, the respected former Salomon Brothers economist, but they could not stem the tide of ageism that turned great financial brands into franchise operations in which each business silo does it own thing, chasing its own returns (bonuses) regardless of holistic risk to the group's economic capital.
This reality is no more starkly revealed than by Nomura's purchase of Lehman Brothers Europe for $2 only plus $1bn to pay bonuses and wages of up to 2,500 staff ($400,000 per employee!), which, by the way, seems to place a big question mark over PwC's liklihood of recovering the $4bn transferred from London to New York just hours before Lehman's Chapter 11 announcement! Another example is that when Lehman in the USA was bought by Barclays they found $2.5bn of bonus money intact, a tidy sum that could and should have been applied to saving the bank? These two sums are not directly related?
I do not wish to sound self-serving in saying that this is a time when for some years it will pay to cede control back to older wiser heads, by which I mean also those who understand real world economics. And I wonder whether looking back years from now Generation X (credit card junkies, mortgage fraudsters, sub-prime banker brokers)will be subject to accusations of financial licentiousness subverting and suborning society's traditional moral and ethical values of probity in a similar catch-all way that the sixties generation (hippies, revolting students, baby boomers) have been roundly condemned for ushering in sexual licentiousness, long hair, drugs and moral relativism. Which would you prefer?

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