Monday 10 October 2011

The Big Bang and Thatcher Caused Credit Crisis

Big Bang's shockwaves left us with today's big bustEverything changed when the City was deregulated in October 1986. Today, 25 years on, we are living with the consequences

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Heather Stewart and Simon Goodley The Observer, Sunday 9 October 2011 Article history
Traders on the London Stock Exchange watch the screens in the post-Big Bang 1980s.
Photograph: Tom Stoddart Archive/Getty Images

Back in 1986, as the City broker L Messel was being acquired by a fast-expanding investment bank called Lehman Brothers, a young, ambitious financier was parachuted into London from Wall Street and put in charge of European expansion.

That man was Dick Fuld, who later achieved notoriety as the captain of the investment bank as it went down with all hands, but even in the mid 1980s he was demonstrating a deftness of touch.

At an early meeting, Messel executives told their new thrusting boss that if he was serious about achieving his aggressive growth plans, they really needed to supplement the London office with another in Frankfurt.

"No way," fired back the earnest American. "We're never going behind the iron curtain!"

Many of the Messel staff present have dined out on that one ever since, but it is only one of many anecdotes about the events leading up to what will forever be known in the City as the Big Bang.

This month marks the 25th anniversary of that radical Thatcherite reshaping of the City, a period in which the Americans arrived to snap up ancient City institutions for huge premiums, leading to the clubby atmosphere of the Square Mile being replaced with the rapacious, bonus-grabbing culture of the investment bank.

"Nobody could quite believe how much the Americans wanted to pay," recalls Adam Pollock, now head of corporate broking at Panmure Gordon, then a banker at Lazard. "It brought with it a renewed vigour and enthusiasm, with everybody working a lot harder. But that ended some traditions. It used to be de rigueur to have a big lunch."

The Big Bang was partly about modernisation – ensuring that the City used up-to-date technology such as computers. But it also dismantled the barriers between the separate, narrowly focused firms in the City, the stockbrokers, advisers and "jobbers" who created the markets in shares. Afterwards, all these services could exist under one roof and ultimately, some would argue, it led to the catastrophe of the credit crunch, whose effects the UK is still living through. "Big Bang was the start of investment banking in the UK," says Tony Dolphin, chief economist at the Institute for Public Policy Research.

With the Glass-Steagall Act, separating investment banking and deposit-taking, still in force in the US, Britain's laxer regime brought an influx of US firms, with their chinos, booze-free lunch-breaks and bumper bonuses, helping to bust open the old City cliques.

With them, argues City veteran Tony Greenham of the New Economics Foundation thinktank, came deep-seated conflicts of interest.

"On the plus side, the Americans brought a more meritocratic culture," he says. "But they also brought the idea that, instead of being client-based, it was a transaction-based business. You change from long-termism to short-termism, from looking after the long-term interests of your client to making the biggest buck out of today's deal."

When a company is considering a float or a merger, for example, its bankers will both advise it on the deal and sell the shares to investors, taking a cut on every side, meaning that their interest lies firmly in encouraging the mega-bucks transactions that came to characterise the champagne-popping culture of the City in the mid-to-late 80s, the late 90s and the early noughties.

"What happened in the old days was that the company would engage a financial adviser and they would shop around for a stockbroker," says Greenham. Now "the same company, even the same team, are advising investors and companies, and that's just a ridiculous conflict of interest".

And if the bank is involved in proprietary trading, the controversial practice Barack Obama is seeking to outlaw with his "Volcker law", it might also be risking its own money on the deal.

It is partly this tendency to omnipresence that prompted one commentator to call Goldman Sachs a "vampire squid".

Some say this observation has always been more than just a nice soundbite. Over the years, as investment banks developed increasingly sophisticated financial instruments, they became involved with one another in an ever-expanding web of bets and counter-bets, making them almost inextricably entwined. It was precisely that problem that sent shockwaves through the world's markets when the Fuld-led Lehman Brothers collapsed in September 2008.

Professor Karel Williams of Manchester's Centre for Research on Socio-Cultural Change (Cresc) argues that the Big Bang did not just unleash the forces of capitalism, it also created powerful vested interests that have shaped British politics ever since.

"Deregulation allowed the City to construct long lines of indebtedness, which are completely beyond technical regulation and, as we see with the eurozone crisis, beyond political management."

In After the Great Complacence, a book recently published by Oxford University Press, Williams and his colleagues argue that City firms treat regulations as "bricolage": instead of being constrained by regulations, they build them into their day-to-day activities.

"What have the markets spent all summer doing, except wittering on asking for political leadership, which is [code for: Angela] Merkel should listen to them and not the German electorate. But in a democracy, the prime responsibility of a political leader is to the electorate. Deregulation created a sectional interest in finance, which is beyond political subordination."

Many economists also argue that the growing dominance of finance, accelerated by the Big Bang, helped to bring about profound changes in the UK's economic model. George Osborne bemoans the imbalances in an economy far too focused on finance and debt, and with too little emphasis on Britain's former strengths in industry. But others argue that the Tories' deregulatory spree in the 80s could have done as much to bring about that out-of-kilter economic model as the forces of globalisation, which helped to undermine manufacturing.

Dolphin says: "People talk about comparative advantage as if it's God-given and just emerges, but we know that's not true. Big Bang was important in cementing Britain's advantage in finance.

"The fact that we had this growing financial industry did attract a lot of capital. Those capital flows, other things being equal, would have pushed sterling up, and therefore will have accelerated the decline of manufacturing."

Dolphin points to the fact that, as the power of finance grew, Britain consistently ran trade deficits, year after year: "It produced a casualness about the decline of manufacturing and the collapse of all competing sectors which is really quite jaw-dropping."

In the other camp is – predictably – Lord Lawson, who introduced the reforms as Margaret Thatcher's chancellor. He insists they were as much about strengthening the London Stock Exchange as slashing red tape; as much about regulation as deregulation.

"It was absolutely essential, because it was a way of bringing the stock market into the 20th century, and in particular making sure it was adequately capitalised," he says.

"The Financial Services Act, which did regulation of the stock market, was the first time that it had been put on a statutory basis. It was an act of regulation, not deregulation."

Instead, he blames Gordon Brown, more than a decade later, for handing the supervision of individual banks over to the shiny new Financial Services Authority in its Canary Wharf headquarters, while leaving the Bank of England in charge of overseeing the stability of the financial system. "The individual banks are the system," Lawson says.

He concedes that some conflicts of interest may have emerged as investment banking evolved but says: "Nobody at the time realised that if you put everything together, there would be a problem."

Britain was not the only country to unleash the money-spinning potential of the bankers, of course, but Thatcher's ideological convictions of unleashing the power of the markets put London in the vanguard — and Brown did nothing to fetter the masters of the universe.

Twenty-five years on, Lawson is unrepentant, insisting that the benefits of the Big Bang far outweigh the disadvantages. But even he admits to a certain nostalgia for the old City: "The Stock Exchange was run as a kind of private club: no outsiders could come in and it was riddled with restrictive practices. It was a very charming club – I rather liked it – but there was no way in which it could be a strong player in that business in the modern world."

That would be the modern world of 1986 – the one whose geography Fuld would soon become acquainted with.

City veteran Brian Winterflood, founder of Winterflood Securities, began work in the Square Mile in the 1950s

I loved being on the trading floor, so that coming to an end after Big Bang was a hell of a wrench. It was for everybody.

One thing I like to remember was the wonderful nicknames: Cruella de Vil, Anne Boleyn and Super Bum – and that was just the women. The classic is the war memorial in the exchange, which had two famous names: one bloke won a Victoria Cross and his brother won a Military Cross. He was forever known as "the coward".

The amount of money raised with IPOs, nationally and internationally, has been phenomenal. Vast amounts have been raised for industry. The City is a cleaner, neater place now. But I do get slightly worried about the amount of instruments one can trade in these days. The underlying concern is that they are so sophisticated. If you scratch the surface it is an awful worry about what is going on down there. Which is what Warren Buffett said - it's a time bomb. There is nothing that greed and avarice won't overcome.

The other thing that worries me is poor old Sid – the everyman from the British Gas privatisation adverts of the 1986. Every financial instrument that comes out doesn't benefit the blokes right down the bottom. They need educating. The Sids with the gas flotation became Sidneys, but the Sids that remain don't have anything else. None of the things are for the man down the bottom somehow.

I don't think it was different pre-Big Bang, but you'd have thought, the way we've progressed, that we might have brought up the rest of them. It's the unfortunate face of capitalism.

The Big Bang hasn't altered the dividing line. It seems that, whatever we're doing in this world, the gap between the haves and have nots gets wider and wider. We should understand better the reasons for that. I do find it a bit hard to accept.

Then there are bonuses. Where did this word "bonus" come from? Everybody expects a bonus. All it was really was a reward for effort. We didn't all get one. But now it's written in, isn't it? Golden handcuffs and parachutes and what not. That's what I'm saying: one end of the spectrum is all right and the other end … I'm not so sure.

Interview by Simon Goodley

What was the Big Bang?
A package of deregulatory measures introduced by Margaret Thatcher's government, which broke up many of the customs and practices prevailing in the City of London, implemented on 27 October 1986. To some, the move signalled an end the end to "gentlemanly capitalism"; others saw it as the dismantling of an old boys' network, allegedly rife with market manipulation.

What were stockjobbers?
Before the Big Bang, trading stock-jobbers were institutions that made a market in shares, acting as intermediaries between stockbrokers. Stockbrokers, in turn, carried out trades on behalf of clients but were not allowed to act as market makers themselves. The professional divide was abolished, allowing all City firms to become broker/dealers.

What was open outcry?
Unlike so many other types of revolution, the Big Bang was characterised by the disappearance of screaming crowds. The practice of share trading being conducted verbally, face-to-face, on one market floor was replaced with computer and telephone communications between dealing rooms spread across the City.

Who benefited from the Big Bang?
Changes were deliberately designed to open the City's doors to overseas companies, encouraging a new generation of banks to import practices prevailing on Wall Street.

How did the City culture change?
The new spirit of openness and meritocracy was accompanied in some quarters by a celebration of greed. The bowler-hatted reserve that had previously characterised the City was replaced by a new breed of traders, hungry to compete for bonuses. Simon Bowers

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