It has been two painful years since that mid-September weekend when the collapse of Lehman Brothers jolted the world into a stark realisation – the high-rollers of the investment banking fraternity had threatened the very foundations of capitalism. The big risks that bankers had taken in the boom years, and the big bonuses they had been paid on the back of that, had come back to haunt us all.
For a while, a few signs of moderation were evident on Wall Street and in the City of London. But the show of humility appears to have been short-lived. This week, hackles rose among British politicians as one of the world’s highest-paid investment bankers, Barclays’ Bob Diamond, was named as the UK group’s next chief executive, and it emerged that the rival HSBC was also considering elevating Stuart Gulliver, its investment banking chief, to CEO.
“Mr Diamond illustrates in a particularly graphic way what happens when you have an extremely high-paid head of an investment bank taking over one of these major international banks,” said a clearly peeved Vince Cable, business secretary in Britain’s Conservative-Liberal Democrat coalition government. Lord Oakeshott, a fellow Lib Dem, said Barclays was “sticking two fingers up” at the government.
So has nothing changed? Are rampantly profitable banks returning to their old arrogant ways? And if so, will it spark a dangerous populist backlash?
Regulators insist there is no chance of the old risk-taking culture taking root again. Sunday brings a crucial meeting in Basel, Switzerland, when the likes of Jean-Claude Trichet, president of the European Central Bank, and Ben Bernanke, US Federal Reserve chairman, will gather with other senior regulators to approve tougher capital ratios – part of a plan, in the works almost since Lehman failed, to change the profile of the sector and pre-empt another crisis.
Reformers say the new rules should rein in the worst excesses, cutting banks’ profitability and providing a natural brake on pay levels that should be more effective than politically inspired taxes on bonuses.
But the overhaul, which will be phased in over a decade or more, will do nothing to calm populist anger, which many worry could erupt again soon – particularly in the US.
For now, as one banker puts it, the mood in the US is “the calm after the storm”. Having been cast as the ugly, overfed face of capitalism and the principal culprits in the financial crisis, Wall Street executives are enjoying a rare time out of the spotlight. With the country in campaign mode ahead of midterm congressional elections, discourse has centred on the stalling US economy, the stubbornly high rate of unemployment and the stance of President Barack Obama’s administration on taxing the rich.
Politicians on both sides of the Atlantic claim some credit for that, citing big advances in dealing with banks’ worst excesses. In June, Mr Obama hailed “the toughest financial reform since the . . .aftermath of the Great Depression”.
Within days of the president’s fine words, however, the administration was forced into an embarrassing climbdown on the so-called Obama levy, abandoning the $19bn tax on banks’ balance sheets in order to ensure the bill sponsored by Con-
gressman Barney Frank and Senator Christopher Dodd secured Republican backing. Lobbyists also prevailed on whether the largest “too big to fail” institutions should be broken up.
But they mostly lost the fight to overturn the “Volcker rule”, named after Paul Volcker, a former chairman of the Fed, which will force publicly insured institutions to close their proprietary trading desks, which deal in the bank’s own money. Other battles, such as a tussle over which kind of derivatives should be put through clearing houses, have yet to be settled in the rulemaking that follows the passage of the bill in July. The same applies to the nature of a new consumer financial products regulatory agency. Some fear it will become a lightning rod for continuing negative public sentiment towards Wall Street.
Bankers have lobbied against the expected appointment of the firm-minded Elizabeth Warren to the job. “For the time being the populist wave is over, because it has been crystallised in the Dodd-Frank legislation,” says Scott Talbott at the Financial Services Roundtable, a lobby group. “But we are watching closely how the consumer agency develops. That is a key concern to our members.”
Britain’s political moves against the banks have, so far, been less extreme than those in the US. The only concrete measures have been a one-off bonus tax, imposed by the previous Labour government last year, and a US-style levy under its successor. If the Lib Dems have their way, however, the overhaul could be far more extreme than in America.
The first page of the government’s coalition agreement is full of plans to avoid a repeat. The coalition promises to tackle “unacceptable bonuses” and reduce risk in the sector; it suggests a break-up of the biggest banks by demanding more competition; it wants the banks to increase lending to business. A government-appointed commission on banking, led by Sir John Vickers, has begun a year-long analysis of whether risky investment banking activities should be split from safer high-street operations.
But the change at the top of Barclays reignited the debate about what the coalition is doing to honour its promises. For the Lib Dems, Mr Diamond’s appointment is a chance to turn up the heat on the banks. Nick Clegg, the Lib Dem leader and deputy prime minister, believes his party can stake out a clear identity in the coalition by leading a populist campaign against bank excess.
George Osborne, chancellor of the exchequer, is no fan of Mr Diamond but gritted his teeth when told of the appointment. Before the May general election, Mr Osborne said Mr Diamond’s remuneration package in the aftermath of the financial crash “beggared belief”. But now installed at the Treasury, the Conservative Mr Osborne is keen to normalise relations with the banks and to cool tensions. Although the government wants to “rebalance” the economy in favour of “real engineering, not financial engineering”, it needs a buoyant financial sector to pull the country out of recession.
Mr Osborne’s £2bn levy on bank balance sheets – announced in his June Budget – is on the low side of City expectations and his aides say he has no plans to increase it. New rules are in place to link bank bonuses to long-term performance but Mr Osborne has no plans to repeat the Labour government’s one-off bonus supertax.
Although the Treasury is trying to secure international agreement on a “financial activities tax” on remuneration, privately Mr Osborne’s team sees no such deal on the horizon. On splitting the banks, Mr Osborne takes a softer line than the Lib Dems and there is a growing expectation that the Vickers commission will propose something more subtle than a retail/investment banking divide.
Mr Osborne is being warned forcefully from the City not to push his luck – or banks such as HSBC, Barclays and Standard Chartered could move their headquarters abroad.
Meanwhile Mr Osborne and Mr Cable have so far failed to squeeze the banks into lending more to small companies – an issue of significant tension between politicians and banks around the world, but particularly so in the UK. Mr Cable is among those who think the banks are escaping lightly and that the coalition pact envisaged more robust action to rein in bonuses, increase lending and reduce risk. But even he this week moderated his criticism, talking of “better ways” of dealing with retail and investment banks being under one roof than a “crude break-up”.
People close to him say conversations with Stephen Green, who announced this week that he would stand down as HSBC chairman to become trade minister, persuaded him of the merits of a more measured approach. With Mr – soon to be Lord – Green also set to sit on the Treasury committee that will decide in a year’s time how the commission on banking’s reform proposals should be implemented, radical structural change now looks less likely.
For all the signs of moderation, however, sentiment towards the banks could yet ferment into a toxic political brew, particularly in February and March when the banks start paying out their bonuses. If banks reverse this year’s trend – in which the compensation ratio that relates bonus pay-outs to profits fell to a little over 30 per cent, compared with previous levels of about 40 per cent – that could inflame both politicians and the public.
In the US, the touch-paper for populist tension could come sooner, as midterm campaigning ramps up. Many believe public opinion could turn on a dime – generous bonuses or another financial scandal could reignite a widespread popular anger against those Mr Obama once referred to as “fat cats”. In an Oval Office meeting last year, he warned America’s top bankers that his administration was “the only thing [standing] between you and the pitch forks”.
Roger Altman, chairman of Evercore Partners, a private equity group, and former deputy Treasury secretary, says that in all his years in business he has never seen such a gap between Wall Street and the rest of America. “That gap has not been bridged – nowhere near. My guess is that the populist sentiment against Wall Street is only dormant and could easily return in the next few months.”
Additional reporting by George Parker and Francesco Guerrera