Subscribe to this blog's feedMichael Lewis, author of Liars' Poker, wrote this long piece on the subprime business - describing with gusto the mistakes involved and tracing the rot back to the decision by John Gutfreund to take Salomon Brothers public back in the 1980s.
He and the other partners not only made a quick killing; they transferred the ultimate financial risk from themselves to their shareholders. It didn’t, in the end, make a great deal of sense for the shareholders. (A share of Salomon Brothers purchased when I arrived on the trading floor, in 1986, at a then market price of $42, would be worth 2.26 shares of Citigroup today—market value: $27.) But it made fantastic sense for the investment bankers.From that moment, though, the Wall Street firm became a black box. The shareholders who financed the risks had no real understanding of what the risk takers were doing, and as the risk-taking grew ever more complex, their understanding diminished. The moment Salomon Brothers demonstrated the potential gains to be had by the investment bank as public corporation, the psychological foundations of Wall Street shifted from trust to blind faith.
No investment bank owned by its employees would have levered itself 35 to 1 or bought and held $50 billion in mezzanine C.D.O.’s. I doubt any partnership would have sought to game the rating agencies or leap into bed with loan sharks or even allow mezzanine C.D.O.’s to be sold to its customers...
This is far from the first time I've heard the suggestion that partnerships - or other forms of employee ownership - might be the way forward for the financial sector. The UK's mutual building societies spent decades being humdrum, unexciting, unambitious - and solvent. Then they all demutualised, as more than one recent conference attendee from a major bank pointed out to me, and what happened to them? To Abbey National, Bradford & Bingley, Halifax, Midland, C&G, Alliance & Leicester, Woolwich, and, of course, Northern Rock? Bought up or shut down, almost to a man.
And the Co-operative Bank is still the ninth largest in the country - and seeing rising profits and minimal writedowns, not to mention rejecting bailouts.
I'm not trying to write off the public limited company altogether. But which lines of business are still dominated by employee-owned companies or partnerships? Lawyers, doctors, dentists, undertakers - all areas with little physical capital, but where human capital, trust and reputation are key.
Where you need physical capital - in manufacturing, for instance - tapping the equity market is indispensable. But isn't it now becoming increasingly obvious that easy access to vast amounts of (apparently) freely flowing capital -through the equity or the wholesale markets - has in fact been a huge temptation, rather than a boon, for banks?
I was joking when I described the original TARP (now of course completely changed) as "Mr Paulson seizing the means of production". But I'm now coming round to the view that a bit more of "the common ownership of the means of production, distribution and exchange" might not be such a bad thing for the financial sector.
UPDATE: the Economist describes "banking as it used to be" with reference to the Airdrie Savings Bank:
Ten self-selecting local businessmen and professionals act as trustees, forming the board... There are no shareholders: Airdrie Savings Bank’s customers own it. The reserves, bonds, and deposits it keeps with other banks are its core capital, which amounts at present to about 30% of its liabilities, says Mr Lindsay. That is more than three times the increased capital demanded of British banks since the recent bail-out. A modest across-the-board bonus is paid to all staff when conditions merit it.
“Risk” seems almost a swear word at Airdrie. The bank does not issue credit cards, only debit cards. “We don’t have any currency risk,” says Mr Lindsay. And he arches his eyebrows at the folly of the Barnsley Building Society, which rushed into a merger with the Yorkshire Building Society last month after discovering that £10m of its assets were locked up in tottering Icelandic banks. Airdrie’s bad debts in 2007 were just £53,000, against loans of £33.5m, four-fifths of them to local businesses. “We’d only be in trouble if the whole British banking system collapsed,” says Mr Lindsay. “But then, everyone would have a lot more to worry about than us.”
Comments (1)
Your comment about the restraining influence of employee ownership is well made.
In another sector of the economy, the John Lewis Partnership remains a flagship retailer, one of the few to have survived independently since the beginning of the last century. Why? I think for two reasons. Firstly, the staff are motivated and genuinely do care, so customers are happy and loyal, and, in retailing, customer loyalty drives profits. Secondly, they are conservative. They deny themselves access to the capital markets so all growth and development is self-financing and organic. It's not stopped them innovating with Waitrose and Ocado, but you would not find them going off on acquisition frolics in the USA, for example.
Of course, both Lehmans and Bear Stearns were 30% employee-owned so employee ownership is not a panacea. I guess it's all a matter of degree. When you earn $1m in salary and cash bonuses, and enjoy a very comfortable Manhattan lifestyle, you care less about the other $1m of your bonus that's locked away in deferred shares, and have every incentive to bet the farm.
I maintain an index of the share prices of public companies that are more than 10% employee-owned, and it consistently outperforms the market.
Posted by LM | November 17, 2008 3:01 PM
Posted on November 17, 2008 15:01