11 Bank Failures Cause a Global Crisis: How the Complexities of United States Mortgage Securities Devastated Banks and Made the Banking Crises Global

AIG had another major exposure to subprime completely unrelated to credit default swaps. As a major insurer, it was a major investor and AIG had investments of $70 billion in highly rated mortgage-backed securities (Blair and McNichols 2009).

The incentive plans of the capital markets division were unique within AIG. The incentive plans originally retained close to two fifths of profits up front including for longer-term contracts for payment to employees and then passed on the rest to the parent company. In 1994, this was changed to a one-third, two-third split with part of the retained compensation deferred over several years. But the capital markets activities remained highly incentivised to grow.

The United States government decided that AIG’s bankruptcy would have catastrophic consequences for the banking industry because of the close to half trillion of credit default swaps sold by AIG. A rarely used Federal Reserve act enables the Federal Reserve to lend AIG $85 billion, receiving a stake of four fifths of AIG’s equity capital in return. By November 2008, the deterioration in AIG’s results meant that the total rescue package had to be increased to $153 billion including from the government’s Troubled Asset Release Program, which will be described later. AIG’s $62 billion loss for 2008 was the largest of any company in history. Eventually the rescue was estimated at $182 billion.

There was significant poor management in the failure of AIG. The incentive schemes for the capital market division were one example. When these schemes were left in place, after the failure of the company, with the argument that staff that knew what had gone wrong needed to be retained, this caused a public outrage.

The absent management in the failure of AIG was due to complexity and uncontrolled growth. Entering into capital market activities involved a level of complexity beyond the capabilities of AIG’s top management. The four levels of complexity between a subprime loan and the credit default swap sold by AIG, with the packaging and repackaging, tranching and associated credit ratings, were supposed to provide diversity and remoteness from loss. But the need to post collateral to counterparties when AIG itself was downgraded and the requirement to value its exposures in deteriorating markets were completely different from its insurance business. The uncontrolled, but incentivised, growth of this highly complex and different business resulted in absent management and the largest corporate loss and bailout at the time. Such large losses requiring an enormous government rescue, starting on the same day Lehman Brothers failed, significantly added to the size and impact of the crisis.

RefeRences AIG. 2007. AIG Residential Mortgage Presentation. 9 Aug. 2007 (financial figures are as of June 30, 2007). http://www.aig.com/Chartis/internet/

UnitedStates/en/REVISED_AIG_and_the_Residential_Mortgage_Market_

FINAL_08-09-07_tcm3171-443320.pdf. Blair, Nathan T., and Maureen McNichols. 2009. AIG–Blame for the Bailout.

Stanford/Boston: Harvard Business School. Fortune Magazine. 2007. http://archive.fortune.com/magazines/fortune/fortune_archive/2007/11/26/101232838/index.htm. November 2007. Gilson, Stuart C., Kristin W. Mugford, and Sarah L. Abbott. 2017. The Rise and

Fall of Lehman Brothers. Boston: Harvard Business School. Hawkins, John, and Luann J. Lynch. 2011. American International Group, Inc.-

The Financial Crisis. Charlottesville: Darden School Foundation, University of Virginia. Ho, Mary, and Yanling Guan. 2008. Merrill Lynch’s Asset Write-Down. Hong

Kong: The Asia Case Research Centre, The University of Hong Kong. Liechtenstein, Heinrich, Jorge Soley, Joan Juny, and Sergi Cutillas. 2009. Banking

Industry Analysis. Madrid. IESE Business School of Navarre. Maedler, Markus, and Scott van Etten. 2013. Risk Management at Lehman

Brothers, 2007–2008. Madrid: IESE Business School of Navarre. Meagher, Evan, Rebecca Frezzano, and David Stowell. 2008. Investment Banking in 2008 (B): A Brave New World. Illinois: Kellogg School of Management,

Northwestern University. Nagel, Stefan. 2015. From Free Lunch to Black Hole: Credit Default Swaps at AIG.

Illinois: WDI Publishing. University of Michigan. Nicholas, Tom, and David Chen. 2011. Lehman Brothers. Boston: Harvard

Business School. Pozen, Robert C., and Charles E. Beresford. 2010. Bank of America Acquires

Merrill Lynch (A). Boston: Harvard Business School. Rose, Clayton S., and Anand Ahuja. 2011. Before the Fall: Lehman Brothers 2008.

Boston: Harvard Business School. Stowell, David, and Evan Meagher. 2008. Investment Banking in 2008 (A): Rise and Fall of the Bear. Evanston: Kellogg School of Management, Northwestern

University. Wilchins, D. 2007. Merrill Writedowns May Signal Broader Risk Problems. 24

October 2007 Reuters.

CHAPTER 11

Bank Failures Cause a Global Crisis: How the Complexities of United States Mortgage Securities Devastated Banks and Made the Banking Crises Global

Of the five largest investment banks in the United States, Bear Stearns was bought by J.P.Morgan with a $29 billion government loan in March 2008, Lehman Brothers filed for bankruptcy and Merrill Lynch was bought by Bank of America both on 15 September 2008. The two remaining, Morgan Stanley and Goldman Sachs, did not fail. But they stopped being pure investment banks and converted into bank holding companies on 23 September, just one week after Lehman Brothers’ bankruptcy and Merrill Lynch’s rescue (Pozen and Beresford 2010). This meant that these two pure investment banks would become regulated by the Federal Reserve, could accept deposits and would have to deleverage their balance sheets considerably. Most importantly, they could access the Federal Reserve’s window for liquidity.

The following month both Morgan Stanley and Goldman Sachs accepted a capital injection under the Troubled Asset Relief Program or TARP. This was part of the United States Emergency Economic Stabilization Act of 2008, a systemic solution initially allowing the government to buy up to $700 billion of assets from banks but changed to enabling the government to inject capital into financial institutions. This late change was done as injecting equity could be done much faster than buying assets, which would require evaluation. Originally $250 billion was allocated to banks of which half went to the eight largest being Citigroup ($25 billion), JPMorgan Chase ($25 billion), Wells Fargo ($25 billion), Bank of America

© The Author(s) 2020 C. Dinesen, Absent Management in Banking, https://doi.org/10.1007/978-3-030-35824-2_11 201

including Merrill Lynch ($25 billion), Goldman Sachs ($10 billion), Morgan Stanley ($10 billion), BNY Mellon ($3 billion) and State Street ($2 billion). Receiving TARP funds meant that the compensation of the top managers and earners would be restricted. Some banks, allegedly including Goldman Sachs, tried to refuse the TARP injections claiming they did not require it. The Federal Reserve, as the regulator, insisted that all the large eight banks accepted the injections to avoid only those banks accepting the injection becoming subject of speculation (Pozen and Beresford 2010).

Morgan Stanley and Goldman Sachs are two important examples of the fact that not all banks fail in a crisis. And that the difference between failure and survival is management.

Morgan Stanley had been created by the largest ever regulatory effort to simplify banks, the Glass-Steagall Act of 1933. This Act forced J.P.Morgan, then the largest bank in the world, to divest its investment bank from its deposit-taking commercial bank. The resulting Morgan Stanley had leveraged up its capital 35 times, only just overtaken by Merrill Lynch in 2007. Morgan Stanley had lost $10 billion on mortgage-related securities by the end of 2007. But Morgan Stanley’s management acted to save the bank’s independence. It sold just under one-tenth of itself to the China Investment Corporation for $5 billion and later that year obtained a $9 billion investment from Japan’s Mitsubishi UFJ Financial Group. Combined with access to the Federal Reserve liquidity window and the TARP injection, Morgan Stanley’s management preserved its independence (Pozen and Beresford 2010).

Goldman Sachs had been the last of the top five investment banks to become a listed company, in 1999, 13 years after the last of the other top four investment banks had ceased being partnerships and 28 years after the first. Merrill Lynch had gone public as early as 1971, Bear Stearns in 1985, Morgan Stanley in 1986 and Lehman Brothers in 1993, having been owned by American Express since 1983.

Although owned by shareholders some of the Goldman Sachs partnership culture had been maintained. In particular there appears to have been a greater sharing of information across activities, as well as top management involvement in risk management, than in the other large investment banks at the time. All risk management functions within Goldman Sachs ultimately reported to the 16-member Executive Management Committee chaired by the chief executive officer (Harris 2014).

Goldman Sachs had never been as exposed to subprime as the other investment banks. As early as between December 2006 and February 2007, Goldman Sachs reduced its subprime exposure by two-thirds. This happened when most of the market was still positive on these exposures (Harris 2014). But it did not stop there. One division took a short position on the mortgage market amounting to $10 billion of exposure, expecting that the subprime market would deteriorate further. This contrarian position earned Goldman Sachs a significant profit as the mortgage market continued to deteriorate. The short position was then significantly reduced in March 2007. Goldman Sachs was later criticised for continuing to sell mortgage-backed securities to investors, while at the same time making money on the deteriorating mortgage market.

With the third largest subprime lender, New Century, having filed for bankruptcy in early April 2007 and Bear Stearns’ two hedge funds collapsing in early June, Goldman Sachs then increased its short position, reaching close to $14 billion by late June 2008. Goldman Sachs still had to take a loss on subprime exposures of $322 million in July, but the very large profits on the short positions mitigated this, with a profit of $1 billion that month alone (Harris 2014).

By 2008 Goldman Sachs’ leverage had not risen above the still very high 30 times. Its write-down of mortgage-related losses was comparatively low at $2 billion. Its reliance on short-term Repo financing from counterparties was only one-seventh of its balance sheet in comparison to Lehman Brothers’ one-third. During the summer of 2008 management substantially reduced risk, including lowering real estate exposure by over $6 billion. In spite of these measures Goldman Sachs still reported its first historical quarterly loss of close to $400 million in the fourth quarter of 2008 (Harris 2014).

So Goldman Sachs was involved in the mortgage market, lost money and announced 3200 redundancies, being over ten per cent of total. But it lost substantially less money than the other big banks. On 23 September, Goldman Sachs raised capital of $5 billion from Warren Buffett and his investment company Berkshire Hathaway. The following day Goldman Sachs was able to raise an additional $5 billion of new equity capital from the stock market (Meagher et al. 2008). Goldman Sachs converted to a bank holding company. It had to accept $10 billion of TARP injection, whether it needed it, wanted it or neither, because the regulator, the Federal Reserve demanded it. But Goldman Sachs was different. The risk management in Goldman Sachs was not perfect, but it was not absent.

The complexity of Goldman Sachs’ business was not beyond the capabilities of its risk management. The drive for growth was not so overwhelming that it made management absent.

What started with Lehman Brothers’ bankruptcy was not limited to a crisis for subprime lenders and investment banks in what was becoming a global banking, financial and sovereign crisis. The banks with absent management were in grave peril.

The largest bank failure in American history happened on 25 December 2008 when federal regulators took over Washington Mutual or WaMu, put its assets up for sale and then sold most of it to JPMorgan Chase for $1.9 billion. WaMu had been worth $46 billion in 2006. WaMu customers’ deposits were left safe and accessible. Shareholders and other investors lost most of their investment. It was the inglorious end to what had been an apparently successful and very rapid growth story. At the end, management had been absent.

The Washington National Building Loan and Investment Association was founded in 1889 using the example of the United Kingdom building societies. Depositors owned the Association and had the right to borrow for building homes. WaMu survived the Great Depression by allowing depositors to make withdrawals, amounting to 12 per cent of total assets, until confidence was restored and many depositors returned their money to the Association. In surviving the Great Depression, WaMu was well managed. It is simple, brave approach, enabled by having adequate liquid assets to pay enough deposits back to customers, meant that it survived when many other banks failed.

WaMu’s customer and community focus also enabled it to grow (Dewar and Hayagreeva 2010). It lobbied successfully to change regulation to allow it, having first become a mutual savings bank, to merge with a savings and loan association in 1966. In 1969, it was allowed to compete with banks on consumer loans. WaMu experienced severe losses during the Savings & Loan Crisis in 1981 and 1982, when interest rates were 17 per cent, but it survived and was the able to expand. One thousand and forty-three of the other 3034 savings and loan associations in the United States failed. WaMu became the first bank, rather than investment firm, to own a securities brokerage firm. It gave up its mutual status and went public in 1983. From the late 1980s to 2002 WaMu made 32 acquisitions, starting small but later doubling its assets to over $40 billion by buying the American Savings Bank in 1996 and increasing to $135 billion by buying Great Western Financial Corp and Home Savings of America in the next two years. WaMu had a total of 60,000 employees by 2000.

There were many strong management traits in WaMu, from strategic focus on retail customers, brand development, learning from successful retailers such as Starbucks and technical innovation. Branch managers were given a great deal of autonomy and the incentive scheme was simple with a high proportion based on total company performance particularly at the higher levels of seniority. By the early 2000s WaMu was the largest bank holding company in the United States and issued one in eight home loans (Dewar and Hayagreeva 2010). WaMu returned an impressive 20 per cent to shareholders from 1983 to 1996.

Mergers and acquisitions are the riskiest actions in business due to the inability to truly understand the complexity of what you are buying. Compared to this the buying itself is easy and mainly a question of whether you have the finance. Going public and performing well enables you to use your shares to buy other banks. The greatest uncertainty for any business is whether you have bought what you thought you have bought. That is why hostile takeovers are particularly risky and dangerous because they prevent you from conducting thorough due diligence beyond the public information available. Hostile takeovers almost always involve an element of absent management. Deciding to take over a bank that is not well understood is not only a bad decision but absent management. The really hard management task is integration of what you have bought with what you already have. If the integration is incomplete that is absent management. The management work has not been done. In common with many other merged entities, WaMu had nine separate and outdated loan origination IT systems from its acquisitions by 2000. The new system that was supposed to take over never got off the ground and was abandoned in 2004 (Dewar 2010).

WaMu succumbed to the consequences of unmanaged, uncontrolled growth. The growth originally involved 32 acquisitions over 15 years. Mortgage lending growth was next. A campaign called ‘The Power of Yes’ was not only advertising but also internally influenced the rapid growth in lending. By the early 2000s over one-eighth of United States mortgages were with WaMu, and the revenues from home lending grew from $707 million in 2002 to $2 billion in 2003. Retail branches almost doubled in three years from around 1170 in 2000 to 2000 branches in 2003 (Dewar and Hayagreeva 2010).

The lack of up to date systems contributed to the inadequate hedging against higher interest rates. Hedging is a protection purchased in the financial markets to reduce exposure to a change in prices or other variables. Hedging costs money but reduces volatility. When interest rates

rose in 2004 the WaMu mortgage business made no money after having made $2 billion the year before.

The growth came from lending at such a growth rate, and with so little consideration for the risks attached, that it cannot be considered to have been managed. The data upon which mortgage loans were made was inappropriate, inadequate or fraudulent and sometimes two or all three. There was considerable pressure on employees to lend, while also handling their other tasks. The incentives offered to the independent distribution channels, such as mortgage brokers, were so high that the incentives distorted these agents’ duty to their clients. The agents became overly dependent on WaMu for their income rather than from serving their clients, the borrowers, to get them the best loan deal. The loans offered could be beyond the ability of the borrowers to repay them, particularly the subprime loans to borrowers with low incomes.

This uncontrolled growth was made possible by the ability of lenders, including WaMu, to package the loans and sell them as financial structures to investors, as described earlier. However not all risk was passed on.

House prices in the United States fell over 2 per cent in 2006, 6 per cent in 2007 and almost 11 per cent in just the month of January 2008 alone. In 2007 WaMu stopped subprime lending having suffered a small $67 million loss. By the middle of 2008 bad loans in WaMu, those that required provisions against possible non-payment, had reached $12 billion, triple the $4 billion in mid-2007. Loan losses in the first three quarters of 2008 came to $6 billion. There was a run on deposits in WaMu in July 2008 amounting to $9 billion of withdrawals. In September 2008, a second run reduced deposits by an additional $17 billion. Then the bank was taken over by regulators and sold.

Lending ever more mortgages had completely consumed WaMu. All traces of the management of the past had disappeared. The autonomy of the branches had been overruled by ‘The Power of Yes’ campaign. Growth, perhaps for the sake of growth, but certainly to grow returns to shareholders, was all that mattered. It was a far cry from the customer and community-focused bank that had survived the Great Depression by allowing depositors to withdraw their money until confidence, and subsequently deposits, was restored.

It is not easy to understand how management was so completely abandoned. Perhaps the example of retailers, more branches, more types of coffee and more and more sales, had persuaded WaMu’s leadership that more sales was all that counted including for a bank. Perhaps the past per-

formance of 20 per cent return to shareholders for well over a decade could only be achieved by growing lending.

One argument is that the top management had always been producer managers with 32 acquisitions as their production. Management had always played second fiddle to production, as seen by the lack of completion of the integration of many of the acquisitions. Fully integrating the acquisitions would have been active and present management. This was abandoned for the sake of the next acquisition. And the next. Once further acquisitions were no longer going to make a significant difference to the now extremely large WaMu, the top producer managers turned their production attention to sales. And what impressive salesmen they were. The increased sales were phenomenal. Possibly they were so great that they contributed to the increase in United States house prices by enabling borrowers who were unable to repay loans to participate. This loan growth added unsustainable demand to the housing market. This would mean that the absent management in WaMu contributed to the rise and subsequent fall in United States house prices and the 2008 financial crisis. The sales production then consumed the top management and the rest of WaMu to an extent where management was absent.

If bank failure is defined as the closure of a bank by its regulator, Citi did not fail. But in 2008 it lost close to $28 billion, almost exactly a quarter of its equity capital (Rose and Sesia 2011). The year before Citi was the largest financial institution in the world. It had 375,000 employees, was present in over 100 countries and had assets of over $2 trillion and equity capital of $113 billion (Rose and Sesia 2011). Citi had been the second largest underwriter of collateralised debt obligations in the first eight months of 2007 with $34 billion, after Merrill Lynch with $43 billion. It was in early 2007 that the Citi chief executive officer was infamously quoted as saying that “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing” (Nakamoto and Wighton 2007). Admitting to not stopping dancing, however incongruous, is an admission of absent management.

The Securities and Exchange Commission had banned the short selling of shares in close to 800 financial institutions on 19 September 2008. The day after Citi’s share price increased by 24 per cent. This recovery was a strong indication that short positions were being taken on Citi’s shares, possibly by the hedge funds that had taken similar positions on Bear Stearns and Lehman Brothers. The ban on short selling provided

protection against further pressure from this type of speculation for Citi and other financial institutions.

Citi received an initial $25 billion of injected TARP capital in early October 2008 followed two months later by another $20 billion, after regulators had more thoroughly been through Citi’s financial position. In the intervening month Citi had reached agreement with the Government that the Treasury would guarantee $301 billion of Citi assets if losses of $29 billion of assets were incurred (Greenwood and Quinn 2015). The Government’s total involvement in Citi was now $346 billion.

The ban on short selling and the massive government support were still not enough to quell rumours around the future of Citi. The concern amongst investors was whether Citi would be able to pass the new regulatory capital tests planned for 2009. If the bank would not be able to pass these new regulatory requirements, the consequences could range from requiring more capital to being closed down (Greenwood and Quinn 2015).

Citi not only had the largest and one of the most complicated banking operations in the world, it also had a very complex capital structure. Like most large banks, Citi’s capital was made up of different types. Some was fully paid up equity capital based on shares with a discretionary dividend and considered the highest quality of capital. Another type was preference shares with a fixed interest coupon that could only be cancelled in more extreme circumstances. To improve its tangible common equity Citi converted $58 billion of preference shares into common equity. This meant that the Government owned just over one-third of the total equity share capital of Citi (Rose and Sesia 2011).

So while Citi did not fail it was effectively taken over by the Government, given the combined $45 billion of TARP injections, $351 billion of asset guarantees and one-third shareholding.

In 2009 a Citi Board director wrote in his retiring letter of his regret that “I and so many of us who have been involved in this industry for so long did not recognise the serious possibilities of the extreme circumstances that the financial system face today” (Rose and Sesia 2011). If there is no recognition there can be no management. This lack of recognitions meant that, for a long time, there had been absent management at the highest level of the largest bank in the world.

The United States did not have a monopoly of fast growing loan associations as shown by Northern Rock. Halifax, the largest British building society, was one of the last to demutualise in 1997. It was an almost exclusive retail loan provider and the largest mortgage lender in the United

Kingdom with a market share of a fifth of all mortgages. In 2001 the Halifax merged with the Bank of Scotland, a retail and commercial bank with a limited deposit base relative to its corporate lending and a reliance on wholesale funding. The result was HBOS.

In 2004 the British regulator characterised HBOS with “the Group’s growth has outpaced the ability to control risks” (Parliamentary Commission 2015). This is a good description of absent management. If growth is so extensive that the associated risks cannot be controlled, then the management is not good or bad but absent. HBOS was further described as an “accident waiting to happen” (Parliamentary Commission 2015). And the growth causing absent management was considered by the regulator to be “markedly different than the peer group”. That difference was management, which was present in some other United Kingdom banks, but absent in HBOS. Because HBOS was all about growth, all about production.

After the merger of Bank of Scotland and Halifax Building Society in 2001, lending more than doubled by 2008, but deposits only grew by two thirds or only one-third as fast as lending. This created a greater dependency on other funding than deposits, funding from the wholesale or capital market through the extensive use of securitisation. In the lending to corporates the gap between deposits and lending was £33 billion in 2001, almost trebling to £85 billion by 2008. The amount lent to a single corporate increased from just under £1 million in 2001 to nearly £3 billion in 2008 with nine corporates being lent over £1 billion. In addition the bank increased lending to corporates with lower credit quality and therefore greater risk. Growth was further accelerated in 2007 when other banks reduced their lending. HBOS also added complexity to growth by expanding internationally, primarily in Ireland and Australia. Furthermore HBOS grew the investment return on its own capital, through its treasury function, by investing in securitised instruments too complex to be understood by most senior HBOS management or its board. In February 2008 half its £81 billion debt investment portfolio consisted of asset-backed securities including mortgage-backed securities (FCA and PRA 2015).

Retail was HBOS largest activity where aggressive growth was also pursued, including in risky areas such as buy-to-let and self-certified mortgages, achieving higher proportions of these risky loans than its large peers. The size of the retail activity and the aggressive growth resulted in retail accounting for more than half HBOS’ total funding gap between deposits and loans of £213 billion (Parliamentary Commission 2015).

Although the British regulator had pointed out serious weaknesses in 2004, a subsequent review by one of the large accounting firms appears to have eased regulatory pressure for change. A later identification of overreliance on non-deposit funding by the regulator was also not followed up with enforced change. In 2006, the bank acknowledged internally that it had the highest non-deposit funding requirements of any United Kingdom bank. So HBOS was one of the top five banks in the United Kingdom that was most reliant on wholesale funding including securitisation. Not only was it the largest. The total non-deposit funding requirement was close to the combined non-deposit funding requirement of the four larger peer banks combined (Parliamentary Commission 2015). HBOS dependency on funding by other sources than deposit was therefore equal to the dependency of its four largest peer banks combined.

Impairments and losses from these high-risk strategies included £25 billion from corporate lending, £15 billion from Australia and Ireland, £7 billion from own capital investments by the treasury function and an estimated £7 billion from retail from 2008 to 2011. The impairments for this period were one-tenth of the 2008 loan book, twice as high as any of the other five largest United Kingdom banks (Parliamentary Commission 2015). In contrast a well-diversified bank, such as the Rothschilds historically and HSBC at the same time as HBOS, had ensured that losses in one area could be covered by profits in other areas plus capital.

Once Lehman Brothers failed on 15 September 2008 HBOS suffered over £30 billion of deposit withdrawals from its corporate customers. This was a corporate bank run rather than a retail bank run. There may not have been queues out HBOS branches, but the telephone lines with corporate customers must have been glowing. HBOS’ £60 billion liquidity pool proved inadequate because the complex but high-yield and risky investments made by the treasury function could not be sold or borrowed against. So the liquidity pool contained illiquid assets. Many of these investments were those that contributed to Lehman Brothers’ collapse.

When non-deposit financing, particularly securitisation, became extremely constrained, HBOS was unable to finance itself and had to be rescued. Importantly HBOS failed because of a lack of funding and liquidity at an extremely difficult time in the wholesale markets. However the impairments on its loan book would possibly have required a rescue a few years later, even if liquidity had not caused it to fail in 2008 (Parliamentary Commission 2015).

The senior management of HBOS said that they were caught on a beach by a tsunami and admitted that they were not on the high ground when it struck in September 2008. To stay within the management’s metaphor HBOS management had been swimming naked for years. This was exposed by a historically low tide but would probably have been exposed within a few years anyway. Not all banks fail in a crisis. Those who grow without management are much more likely to do so.

HBOS was rescued by a combination of being taken over by Lloyds TSB and significant injection of capital by the government. HBOS received a total of £21 billion from the government, £9 billion directly and £12 billion provided to Lloyds TSB, now Lloyds Banking Group, by the government. Lloyds Banking Group itself injected £8 billion into HBOS. The terms of the takeover were announced on 18 September 2008, three days after the collapse of Lehman Brothers, and completed one year later in September 2009. During this year, HBOS required Emergency Liquidity Assistance from the Bank of England (Parliamentary Commission 2015).

Lloyds TSB was one of the big four United Kingdom banks, having been established in 1765. A string of acquisitions included the building society Cheltenham and Gloucester and the formation of Lloyds TSB with the merger with the former Trustees Savings Bank in 1999. By 2001 Lloyds TSB was so large that the competition authorities blocked an £18 billion takeover of former building society Abbey National. In 2006 Lloyds TSB considered a takeover of HBOS but decided against it as such a merger was also expected to be blocked by competition authorities.

Lloyds TSB’s eventual takeover of HBOS was either poor management or absent management, given that it resulted in Lloyds TSB requiring government support. Lloyds TSB wanted to take over HBOS. If this takeover had not happened and no other buyer had been available, the British Government would most likely have had to take over HBOS. The government would probably have had to nationalise HBOS like it had Northern Rock, in order to preserve financial stability. That is what the Chancellor of the Exchequer (the British Finance Minister) said subsequently (Dunkley and Jenkins 2017). With a buyer willing to take over HBOS, the government waived the competition rules that would most probably have prevented a takeover. And Lloyds TSB then agreed to buy HBOS. But Lloyds TSB did not have to. Lloyds TSB decided to. A number of banks had refused to buy Lehman Brothers. But Lloyds TSB buying HBOS was a case of absent management, because the decision was so driven by growth and involved such complexity that Lloyds TSB management was absent.

Lloyds TSB had been determined to grow further in the United Kingdom. It had considered buying Abbey National and HBOS in previous years but had been prevented by competition or perceived competition rules. So when these rules were waived, because the government preferred a market solution to nationalisation, Lloyds TSB went ahead. And it was done with so little assessment of the risks involved that management cannot have been said to have been present.

Lloyds TSB knew about the risk of subprime in the United States. In December 2007, the bank had taken a £200 million write-down related to subprime and in July 2008 a further £585 million of general write-down related to the financial crises. Lloyds Banking Group including HBOS eventually lost $8 billion on United States subprime (Wikipedia 2010) with the majority coming from HBOS’ investments.

But it was the unique aggressive lending growth of HBOS and its absent management that Lloyds TSB failed to comprehend. In spite of having considered a takeover of HBOS in 2006 and having been approached by HBOS in July 2008 about a possible merger, Lloyds TSB decided to take over HBOS in just two days in September 2008. There was time for only two days of due diligence after the government waived the competition restrictions.

Taking over HBOS caused Lloyds TSB to fail. The results of absent management are rarely seen so quickly. Only one month after the takeover the government had to rescue Lloyds TSB and provide £20 billion of capital and in 2009 take a two-fifth holding in the bank, becoming by far the largest shareholder. Lloyds TSB had paid £8 billion for HBOS and incurred losses of £53 billion from the acquisition.

Another leading British bank, Royal Bank of Scotland (RBS), was established by royal charter in Edinburgh in 1727. Having expanded to London in nineteenth century it expanded further through the United Kingdom, mainly through acquisitions. In the 1980s the bank also diversified into different lines of business, including into property casualty or general insurance, by distribution channel becoming the first United Kingdom online bank and geographically by taking over Citizens Financial Group in the United States. Citizens then made 25 acquisitions in the United States while owned by RBS.

In 2000 RBS took over one of the largest British banks, National Westminster (NatWest), in a £23 billion transaction, the largest ever in the United Kingdom, and beating Bank of Scotland for NatWest in the process. The RBS group was one of the largest banks in the world by April

2008 with 171,000 people, operating in over 50 countries and having made £10 billion profit in 2007 (Financial Services Authority 2012). It would be its last profit for ten years.

The NatWest takeover was not only very large, but also hostile and considered extremely successful. NatWest was larger than RBS at the time of the merger. It essentially did the same type of retail and commercial banking, primarily in the United Kingdom. A hostile acquisition is where the target does not agree to be acquired. It is rare amongst large bank takeovers because it allows for no due diligence. The acquiring bank, RBS, was limited to the publicly available information such as NatWest’s annual reports and regulatory filings. There was no access to non-public information, little understanding of the increasingly important IT systems or any meetings with senior management in the target bank. Because of this limited ability to carry out due diligence, hostile takeovers involve an element of absent management.

The NatWest acquisition was also unusual in that it was very successful. RBS’ strong track record of taking over other banks enabled a fast and efficient integration of a very large bank. The successful NatWest acquisition significantly enhanced the reputation of RBS and its chief executive officer, with shareholders, regulators and in the financial services industry and capital markets.

What made the NatWest acquisition by RBS particularly unusual was that it was an example of successful absent management. Perhaps it is the most important exception that proves the rule that absent management is a bad idea. After all Lloyds TSB taking over HBOS with limited due diligence caused Lloyds TSB to fail.

RBS’ later hostile takeover of Dutch bank ABN AMRO, in the middle of a financial crisis, would be central to RBS’ failure. The failure of RBS was due to those who financed it no longer being willing to do so. This unwillingness was strongly accelerated by RBS’ perseverance in the hostile takeover of ABN AMRO.

RBS was not the only bank relying on wholesale market and shortterm funding but it was one of the most exposed in the United Kingdom. By September 2007 RBS had the second highest reliance on overnight funding of the largest five British banks and twice as large as the third bank. It was still much lower than HBOS’ dependency but still large. Counterparties providing RBS finance were not perfectly managed themselves, but they knew who their largest counterparties were and who to worry about the most.

The wholesale market must have faith in a bank to continue to finance it. A bank that becomes dependent on wholesale markets for its financing and then loses the trust of the wholesale markets is either badly managed or not managed. A bank that becomes dependent on the wholesale market for funding, particularly short-term funding, and then loses that trust will no longer be able to fund itself. And that trust will depend on what the wholesale market thinks. A loss of trust can cause a wholesale market bank run, a liquidity run.

This is central to the historical importance of trust within banking. Depositors must trust a bank to be able to repay their deposits. The wholesale market must trust a bank to be able to repay its financing. If the depositors or the wholesale funding market loses confidence in a bank it does not matter if the bank is either solvent, liquid or both. To maintain this particular and specific trust that deposits and financing will be repaid is perhaps the single highest priority of bank management. To forget this is absent management in banking. It assumes that your bank is bigger than the market, because the banking market is based on this trust. And RBS lost this trust because of absent management.

The £47 billion takeover of ABN AMRO by a consortium including RBS, Spanish bank Santander and Dutch bank Fortis significantly raised RBS reliance on wholesale market finance. RBS initial share of that takeover was about two fifths or about £19 billion, but RBS paid for its share with increased borrowing rather than with its own shares. The NatWest acquisition had been much larger but had been financed by shares. Future financing also became more difficult because counterparties had limits on what they would lend to a combined RBS–ABN AMRO entity. Additionally ABN AMRO had a large trading portfolio, which almost doubled RBS’ own trading book, thereby doubling the risk if assets were to become more volatile. The market already knew that RBS had aggressively expanded its securitisation business in mid-2006. All of these were issues the wholesale market would know about in lesser or greater details from being trading counterparties with, and lenders to, RBS and ABN AMRO.

Importantly RBS did not need regulatory approval for the ABN AMRO takeover. The merger did not affect competition issues in the United Kingdom. Because other banks were also interested in ABN AMRO the acquisition was hostile and diligence was limited to public information, as had been the case for NatWest. But ABN AMRO was a much more complicated bank than NatWest had been, operating truly multinationally as opposed to mainly in the United Kingdom and with a significant trading

portfolio of the same size as RBS. So in the same way as there was absent management in the takeover of NatWest so there was in that of ABN AMRO, caused by limited due diligence. This time this absent management would be a cause of RBS’ failure.

The British regulator did not have to approve the takeover but it did want RBS to have stronger capital and the bank was able to raise £12 billion by issuing new shares in April 2008. By this stage RBS had reported credit market losses of £9 billion for 2007 and the beginning of 2008. In August 2008 RBS reported its first quarterly loss for 40 years of £691 million.

Once Lehman Brothers failed the wholesale market lost confidence in RBS. The bank then required the Bank of England’s Emergency Liquidity Assistance to fund itself. On 13 October 2008, the government provided £20 billion of new capital, increased in the following year to a total of £46 billion with the Government now owning four fifths of RBS. The management of RBS had been absent in ignoring the risks of dependency on the trust by the wholesale market. When this trust was lost, RBS failed. Different types of swimwear become apparent when the tide goes out. Dry suits and wet suits, Victorian full body swimsuits, bikinis and speedos. But naked is naked.

In addition to London and New York, Zurich is a major banking centre. Zurich had bred two global universal banking giants, as global and complicated as any United States or United Kingdom banks.

In the universal Swiss bank UBS, whose growth by merger and acquisition was detailed earlier, a key strategy was to operate as ‘One firm’. This strategy involved being able to refer clients across the offerings of the bank from corporate to investment banking to asset management and also exchanging products between these businesses (UBS 2008). No client should need to go anywhere else than UBS for any banking service, in any country. With the right management the universality of UBS should ensure that the growth strategy put in place for 2007–2011 would be successful.

One growth initiative was developing alternative asset management products for investors. Swiss Banking Corporation, one of the main predecessors of UBS, bought United States investment bank Dillon Read in 1997 for $600 million and merged it with its existing investment bank SBC Warburg. Within this operation the asset manager Dillon Read Capital Management was created in 2004, partly to allow asset management clients to invest in certain strategies developed by investment

banking (UBS 2008). This was an example of the ‘One Firm’ approach that was central to UBS’ strategy.

To identify specific growth areas where the investment bank was behind its competitors, an external consultant produced a report. This suggested that UBS lagged behind its major peers in a number of areas including mortgage-backed securities for subprime. The strategy recommendation from the investment bank to the group management was to build a new securitised products group for origination and trading for UBS own account (UBS 2008).

Dillon Read Capital Management had more than one trading strategy for UBS’ own capital and its assets management clients. It traded in and out of mortgage-backed securities, bonds and derivatives, going long and short, buying and selling credit default swaps, providing warehousing for clients’ collateralised debt obligations and investing in AAA-rated tranches of collateralised debt obligations. When the subprime market deteriorated, Dillon Read Capital Management was responsible for close to one-fifth of UBS total subprime losses or $6 billion in 2007.

In addition to asset management, the UBS investment bank was also involved in several other activities with subprime exposure that accounted for around two thirds of UBS subprime losses or $25 billion. Of the various activities, the single largest loss came from investment in the highest rated tranches of collateralised debt obligations, as had been the case at Merrill Lynch. These tranches were the part of the packaged mortgages that were considered the most remote from losses on default of the underlying mortgages, because they would be the last tranches to be affected by mortgage defaults. For this reason these tranches were known as super senior and generally given the highest credit rating of AAA by the credit rating agencies. UBS retained these tranches for two reasons. Firstly they were seen as attractive given the higher investment yield compared to other AAA investments. Secondly retaining AAA tranches assisted the bank’s underwriting of collateralised debt obligations. Traditional buyers of these tranches were reducing their involvement due to the large amounts they had already bought as part of the explosive growth of the issuing of collateralised debt obligations. Losses on these positions amounted to half of UBS subprime losses or about $19 billion. There was a lag of one to four months between accumulating the mortgages, packaging them into mortgage-backed securities and selling the tranches to investors. During this time the mortgages were warehoused by UBS on its balance sheet. When the accumulated securities could not be sold in 2007, this cost UBS about $6 billion (UBS 2008).

To complete the picture UBS’ treasury function was also exposed to United States subprime mortgages. The treasury function of a bank is responsible for financing and liquidity of the bank as well as investing the bank’s own capital. In addition to its trading investments in AAA-rated government and corporate bonds, the UBS treasury function invested in AAA-rated collateralised debt obligations tranches and incurred a loss of close to $4 billion (UBS 2008).

UBS losses from subprime amounted to $38 billion. This was the largest loss from subprime from any bank outside the United States. Total losses from the crisis amounted to $53 billion. A loss of this size was partly due to absent management. While there was an active management effort to grow this highly diversified, universal and very complex bank, there was no management of the accumulated exposures. By July 2007 the top management did not have a reliable assessment of its subprime exposure nor did the investment bank, the part of the bank with the largest exposure. Given that another bank, HSBC, had made a profit warning and an $11 billion provision for subprime five months earlier, this was not poor management but absent management in UBS. The absent management of a loss this size came from the combined complexity and growth of this universal bank (UBS 2008).

There were many underlying reasons for the failure of UBS, underneath the absent management of the complexities of the large and complex, universal bank. Inadequate risk management, reporting and challenge of and by management at senior levels are all listed as reasons for failure in the UBS Shareholders Report of April 2008. One specific example of absent management that UBS had in common with many other banks including Merrill Lynch was that it did not itself consider the creditworthiness of the rating of super senior AAA-rated tranches of collateralised debt obligations. It was convenient and supportive of the growth strategy of the bank not to challenge the ratings of the credit rating agencies. Neither was there management of the risk that these instruments could become completely illiquid and impossible to sell if every buyer already had enough. The super senior AAA tranches did not have to incur losses to cause losses to their owners. It would be enough if their value was affected by a lack of liquidity or by downgrades of their credit ratings.

When UBS reported its first quarter results for 2008, it also announced a CHF15 billion rights issue and that the chairman of the board would not seek re-election. When markets continued to deteriorate, including due to the failure of Lehman Brothers in September 2008, Swiss government

support followed in the form of a $38 billion loan to rescue UBS from bankruptcy. In October 2008 the Swiss Government created a Stabilisation Fund, a so-called bad bank, that took over large amounts of deteriorated assets that could otherwise have caused UBS to fail (SWI 2013).

One important effect of UBS’ problems from being a universal bank was concerns amongst its asset management clients. In the third quarter of 2008 it saw $75 billion of assets withdrawn from its wealth and asset management businesses (Gow 2008). Rather than the asset management business providing diversification to this complex, universal bank, losses in several parts of the ‘One Firm’ caused damage to other parts of the firm due to a loss of the single most important asset of any bank, the trust of its clients.

The other Swiss Universal bank Credit Suisse saw the subprime crisis coming early. It reduced its exposure to subprime as early as the last quarter of 2006, acting on information from its mortgage servicing company on subprime mortgages regarding increasing arrear of payments (Finma 2009). This active management enabled Credit Suisse to have a comparably less damaging crisis than many other large banks. It entered the crisis with a subprime exposure of CHF6 billion by the end of 2007, further reduced to below CHF2 billion by the end of 2008. Its total subprime loss was CHF9 billion. A part of the loss related to collateralised debt obligation assets. The Swiss regulator insisted that Credit Suisse raise capital, and in October 2008, the bank raised CHF10 billion from large Qatari, Saudi Arabian and Israeli investors (Rose and Sesia 2010). No government support was received, Credit Suisse did not fail and after a loss of CHF8 billion in 2008 was profitable in 2009.

However, the subprime crisis was to come back to haunt Credit Suisse. While it did manage the crisis better than many other large banks, two later developments indicated absent management. The first was the only jail sentence of a high-level banker for fraud during the subprime crisis, when a Credit Suisse employee was sentenced to two and a half year in prison in April 2013. This trader had deliberately overvalued collateralised debt obligations positions to hide a $100 million loss in 2007, contributing to the $3 billion loss for collateralised debt obligations positions. This was done, according to his own admission, to enhance his position in the bank, and possibly also to receive a large bonus. He returned $25 million of received remuneration to Credit Suisse. Credit Suisse had reported the suspected fraud immediately upon discovery and no corporate charge of the bank was made. While Credit Suisse recovered past remuneration, the

judge did not sentence the trader to pay any restitution to Credit Suisse because of the “terrible climate” created by the bank (Matthews 2013).

Secondly, Credit Suisse agreed to pay the United States Department of Justice a fine of $5 billion for alleged miss-selling of mortgage-backed securities, made up of half in a civil penalty and half in consumer relief. Other banks agreed similar fines, including Deutsche Bank and Citi with $7 billion each (Rodionova 2010).

Many other banks in at least 24 countries suffered severe losses and failures due to the financial crisis of 2008. Iceland and Ireland in particular suffered worse than most due to the catastrophic failures of their banks. There is little doubt that absent management could be detected in many of the bank failures outside those considered in this book.

However the 2008 financial crisis was not the only recent event at least partly caused by an absent management and in turn exposing numerous examples of absent management in banks. Other examples not related to the recent crisis deserve a mention and in particular the absent management around the setting of interbank lending rates.

Official lending or interest rates are set by central banks. The United States Federal Reserve, the European Central Bank and the Bank of England periodically set official lending or base interest rates. The interest rates at which large banks borrow from each other each day are reflected in the London Inter-Bank Offered Rate or LIBOR. In turn, LIBOR can be used as the reference interest rate for what banks charge their customers for loans in many different forms, including mortgages, credit cards, student loans, other consumer loans and so on. When used as such a reference, LIBOR affects not just banks dealing with each other, but also millions of people and many trillions of dollars, pounds, euros and so on of loans, derivatives, futures and hedging contracts (Rose and Sesia 2014).

From 1986, the British Bankers Association, an association of 200 banks, became responsible for managing LIBOR. By 2012 this developed into a 150 multicurrency and maturity benchmark system, involving 10 currencies and 15 maturities (Rose and Sesia 2014).

LIBOR was constructed each day by a selection of banks electronically submitting the rates they estimated to be borrowing at between 11.00 and 11.10 United Kingdom Time. Of the 15 banks submitting rates, the four highest and four lowest were ignored, and the average of the remaining seven rates became the LIBOR rate for that currency and maturity, say Pound Sterling for three months. The rates, and all the submissions, were then made public at 12.00 United Kingdom time. There were different

panels of banks for different currencies and maturities. A similar process existed for the Euro Inter-Bank Offer Rate or EURIBOR overseen by the European Banking Federation. Here between 40 and 50 banks made submissions with the top and bottom 15 per cent being excluded (Rose and Sesia 2014).

Submitting a very high or low rate does not affect the outcome, because these will be ignored in calculating LIBOR. But if a bank submits an artificially slightly higher or lower rate, which remains amongst the seven that make up LIBOR that day, this affects the final result. Once the final LIBOR is used to calculate payment on that day, the bank and specifically the trader involved in a contract with payment on that day can benefit from a higher or lower rate.

As an example, if a bank has a $4 billion contract coming up for payment on a given day, submitting an interest rate of 4.815 per cent rather than 4.820 per cent might affect the average of the eight submissions by 0.000625 per cent. The actual effect would depend on the other seven submissions. This manipulation may not seem worthwhile but on $4 billion it enough to reduce the payment by $25,000. If the settlements are big enough so is the material difference. In one case a bank had settlements of $80 billion. In that case the possible gain would be $500,000. Should there be collusions with other bank or banks, so that other submissions are also marginally lower, then this further affects the average and the possible gain.

The person in the bank submitting the rate will not be the same person involved in trading with a reference to LIBOR. It will be necessary for the trader to make an internal request to the person submitting the daily rate for a slightly lower or higher rate on any given date.

In addition to seeking a lower or higher settlement, a second incentive for a bank submitting an incorrect rate is to appear strong. The cost at which one bank can borrow from another bank is an indication of the bank’s financial strength. Submitting lower rates indicates that the bank is stronger than it actually is. This can be helpful in a situation where the bank is suspected of having problems, individually or in a broader banking crisis such as in the 2008 financial crisis. As all the submissions to calculate LIBOR are made public, it is possible to analyse which banks are submitting higher or lower.

Barclays plc was the sixth largest bank in Europe based on total assets and one of the largest banks in the world. It was founded 300 years earlier and had been primarily a retail and commercial bank. It later established

an investment bank, BarCap, and became a universal bank by 2011 with activities also including credit cards and asset management. One-third of Barclay’s revenues came from BarCap, where trading made up half the revenues and was focused on debt trading and underwriting. Barclays had purchased parts of what remained of the failed Lehman Brothers’ United States business in 2008, adding equity trading and underwriting as well as mergers and acquisitions advice. The value of the Barclay’s brand had been ranked a top ten banking brand in the world (Rose and Sesia 2014).

In June 2012 Barclays admitted that it repeatedly attempted to manipulate LIBOR between 2005 and 2009 (Melvin and Shotts 2013). When Barclays settled with regulators in the United Kingdom and the United States, Barclays admitted two wrongs. Firstly, rate manipulation; between 2005 and 2009, Barclays had submitted incorrect LIBOR rates to generate profits or reduce losses for its derivative trading desk, and for the benefit of traders at other banks. Secondly low-balling LIBOR; between 2007 and 2009, Barclays had submitted LIBOR rates that were lower than they should have been to try to avoid the perception that the bank was financially weaker than its competitors. Barclays was the first bank to acknowledge wrongdoing and to settle with the authorities (Melvin and Shotts 2013). As part of the settlement Barclays agreed to pay $453 million in fines and penalties to bank regulators in the United Kingdom and the United States. The $93 million fine to the United Kingdom regulator had been reduced by a third because of Barclays’ cooperation with the regulator and early settlement. The largest LIBOR fine of any bank was the $2.5 billion paid by Deutsche Bank, with the United Kingdom regulator fining a dozen other banks (The Independent 2016).

During the investigations extensive evidence came to light of communication between traders and those submitting interest rates in the LIBOR system. These were requests for lower or higher submissions to serve the bank’s purposes rather than reflecting the interest rates the bank was able to borrow at. Between 2005 and 2007 regulators identified at least 173 instances within Barclays where traders requested those colleagues submitting daily rates to manipulate the United States dollar LIBOR. In some 120 of these instances, the submitted LIBOR rates were consistent with the traders’ requests (Rose and Sesia 2014). The requests were made on standard internal communication systems, such as email or messaging, which were known to be recorded. There were also records of traders trying to influence the submission of other banks.

Given the immense complexity of Barclays it is by no means certain that the bank benefitted from each manipulation of LIBOR. Requests from traders were most probably made when they had a particularly large settlement on a given day where a lower or higher LIBOR rate would benefit this particular trader. However Barclays may well have had other positions that were negatively affected by the specific manipulation. Barclays would almost certainly have clients who were negatively affected, and those in Barclay responsible for these clients would have been against a specific manipulation, had they known about it. So not only was the LIBOR submission absent of any management, so were the individual trader’s requests for manipulation.

Separately, and unrelated to trading, it became public in September 2007 that Barclays had submitted comparatively higher rates than other banks. This raised questions about Barclays’ having to pay more to borrow than competitors. There are records of senior managers instructing subordinates to submit no higher than one-tenth of a percentage higher than competitors. Using the figures from the above example, this would mean not submitting a higher rate than 4.920 per cent if the average was 4.820 per cent.

Suggestions were made that misrepresentations under the LIBOR arrangement had taken place as early as 1991 (Melvin and Shotts 2013). This would indicate that the behaviour had become path dependent. The openness with which traders asked for submissions to be higher or lower, using recorded communication system, supports the possibility that this had been going on for several years and had become common practice and even path dependent.

The BarCap compliance function was notified about LIBOR issues three times in 2007 to 2008 but did not take effective action. Not having the appropriate or effective systems of control, as was admitted by the top Barclays management (Melvin and Shotts 2013), is a specific example of absent management.

Between November 2007 and October 2008, Barclay employees notified the British Bankers Association, central banks and regulators that the LIBOR submissions for United States dollar were artificially low. Some commented that all the banks, not just Barclays, were submitting low rates. The New York Federal Reserve, one of the most important central banks in the United States, issued a report raising questions about the LIBOR setting process. The New York Federal Reserve contacted the Bank of England with recommendations for improvements to the process,

which the Bank of England in turn made to the British Bankers Association. After a review, the British Bankers Association decided to retain the existing process (Rose and Sesia 2014). However in 2017 the United Kingdom regulator the Financial Conduct Authority communicated the intention to transition away from LIBOR to alternative reference rates by the end of 2021, with the expectation that this will be a development to be led by the financial markets and its various associations. The Euro benchmark currently used to price €24 trillion of derivatives, loans and bonds is planned to be replaced with the new €STR benchmark based on submissions from 50 banks by the beginning of 2022. The introduction has already been delayed by two years.

It would be possible to consider many other banks for possible absent management both before, during and after the 2008 financial crisis. The Icelandic and Irish banks are examples of banks that experienced such great losses that they are more likely to have had no management at all than management so bad as to have caused such horrendous losses to themselves, their shareholders and their countries. The Payment Protection Insurance miss-selling scandal in the United Kingdom, which has so far involved payment of over £34 billion in compensation to customers, may also show absent management by banks if it was considered from this angle.

It has been traditional to view banks incurring large fines as evidence of either very badly managed or deliberately manipulative banking practice. Once a fine is imposed, the evidence for poor management is often easy to accept. Proving deliberate manipulation by the top leadership has been much more difficult. The ability of top management of fined banks to remain in their jobs or walk away unpunished, and sometimes with their stock options and even recent bonuses, has contributed to the criticism of banks and even the whole financial and capital system.

The argument here is not bad management, it is no management. The cost to the bank of its actions are so detrimental that to manage so badly would be irrational. Neither is the argument that the bank management was so arrogant that it thought it could get away with its management. Bankers have certainly displayed ample evidence of arrogance, but again the detrimental effects are so great that arrogance itself is an unlikely explanation. Deliberate manipulation, and its potential legal implications, is best left to the courts. Regulators may have been satisfied that a combination of large fines and limited damage to the banking system was preferable to a successful criminal sentencing.

The argument that seems more persuasive is that a large fine is a strong indication of absent management. When banks had become complex, were managed by producer managers more focused on production than management and were path dependent because this is how we have always done it, there is no management. The LIBOR scandal in Barclays and other banks is a very large and recent example of absent management. The chief executive officer of BarCap from 1997 to 2009 and later chief executive officer of Barclays from 2009 to 2012 was quoted as saying that culture was how people behave when no one is watching. With regard to LIBOR in Barclays that may have meant that when no one was watching, bankers were producing but not managing. That is a culture of absent management in banking.

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