| The recent financial crisis has been humbling for many | | | | disconnect. When Peter Norris, former head of |
| stakeholders. It has been particularly embarrassing for | | | | Barings, was asked by the House of Commons |
| regulators who failed to learn from past mistakes or | | | | Treasury Committee if there were members of the |
| even heed their own warnings. | | | | board of Barings who were knowledgeable about |
| Case in point is former US Fed Chairman Alan | | | | derivatives trading, Mr. Norris responded with an |
| Greenspan. The man who coined the phrase | | | | astounding, “No.” That basic lack of |
| “irrational exuberance” in a speech to the | | | | knowledge and understanding was a key contributor |
| American Enterprise Institute in December 1996 not | | | | to the failure. |
| only failed to act on his own concerns but | | | | It was widely believed at the time that the Barings |
| encouraged the conditions which allowed the tech | | | | failure would send a clear warning to the industry to |
| bubble to grow and then burst. | | | | improve on its risk assessment and management |
| Later, on July 16, 2002, giving evidence to US Senate | | | | procedures. This has turned out to be a forlorn hope. |
| Banking Committee in the aftermath of the Enron | | | | Fast forward to Lehman Brothers. Its risk committee |
| and Worldcom scandals, Greenspan said: | | | | reportedly only met twice annually in 2006 and 2007 |
| “Why did corporate governance checks and | | | | – the years when Lehman’s crisis was |
| balances that served us reasonably well in the past | | | | brewing. Not unusually, few of the board members |
| break down? … An infectious greed seemed to grip | | | | had any actual financial industry experience. |
| much of our business community.” | | | | For far too long, boards have simply acted as |
| Greenspan clearly had not seen the link between the | | | | sounding boards and rubber stamps for management |
| two factors. He compounded matters further | | | | with little accountability to shareholders. One of the |
| through his belief that the new derivative | | | | more extreme examples was the meteoric rise of |
| instruments, becoming more widespread, would | | | | the now deposed CEO of the Royal Bank of |
| reduce risk overall. In 2004, he said: “Not only | | | | Scotland (RBS), Sir Fred Goodwin. An accountant |
| have individual financial institutions become less | | | | with no formal banking qualifications, Goodwin grew |
| vulnerable to shocks from underlying risk factors, but | | | | RBS from a middling UK bank to one of the |
| also the financial system as a whole has become | | | | world’s top five in the space of only eight or |
| more resilient.” | | | | nine years. This was achieved by an acquisition spree |
| The writing was on the wall long before the | | | | in which RBS bought some 26 banks in seven years |
| sub-prime mortgage meltdown, but few bothered to | | | | and ruthlessly cut costs through staff reductions. |
| read it. When banks, mortgage companies and others | | | | Consequently, Goodwin earned the nickname |
| realized how much they could make, they created | | | | “Fred the Shred” and lamentably the uncritical |
| specialty products to “help” people achieve | | | | trust of his board. The wheels came off at the |
| the “American Dream” of home ownership, | | | | height of the boom in 2007 when he led a |
| fuelling the housing boom. We ended up with a | | | | consortium (RBS, Fortis and Santander) to acquire |
| situation where even the financial professionals | | | | ABN Amro. His main target was La Salle bank in the |
| didn’t fully understand what they had created or | | | | US, which would have consolidated RBS’ position |
| the risks inherent therein. More dangerously, many of | | | | as one of the largest banks in the States. When this |
| these new financial products were so complicated | | | | deal was thwarted by the ABN Amro board, he |
| that government regulators did not understand them, | | | | pushed ahead in any event, undeterred by any |
| didn’t have the resources to investigate them | | | | opposition. |
| and left it to the market to police. | | | | The consequence was a record loss of £24 billion |
| It is now widely recognized that the current crisis had | | | | for 2008 of which, £16.8 billion related to write |
| much to do with excessive risk taking spurred by | | | | downs arising from the ABN-Amro acquisition |
| inordinate compensation in the form of | | | | together with huge losses on CDOs via RBS |
| multimillion-dollar bonuses. When the lure of big profits | | | | Greenwich Capital. RBS had to be bailed out by the |
| is too great, senior executives are liable to act in | | | | UK government and is now 86% owned by the |
| ways that are not completely rational – they | | | | British taxpayer. |
| disregard internal warnings and only hear what they | | | | The worm has turned |
| want to hear, a common human failure. | | | | There is some evidence that the bankers are |
| “The fish rots from the head” | | | | beginning to “get it”. In February 2010 |
| While regulators round the world (with the honorable | | | | Marcus Agius, Chairman of Barclays, said that the |
| exception of Canada) have been much criticized for | | | | bond of trust between banks and their stakeholders |
| their failings, others equally if not more culpable, have | | | | has been significantly weakened by the events of |
| got off more lightly. What is abundantly clear (again) | | | | the last three years and that the vital task of |
| is that there were serious failures of board oversight | | | | rebuilding that trust will be based on banks |
| in the financial institutions involved. | | | | acknowledging the mistakes they have made. |
| Where were the boards of directors who were | | | | The focus of attention is swinging towards the |
| supposed to be guarding the shareholders’ | | | | excessive levels of senior management remuneration, |
| interests? All too often, the answer is that the board | | | | and not only in banks. Aviva, a very large UK |
| was supporting the company’s CEO rather than | | | | investment manager, announced on February 26, |
| asking the hard questions. The boards of financial | | | | 2010 that they expect executive salaries and |
| giants such as Lehman Brothers, Bear Stearns and | | | | bonuses to be “prudent, aligned to business |
| AIG were paid large sums to oversee the activities | | | | strategy and performance over the long term”. |
| of their firms and protect the interests of the | | | | The sorry episode of Wall Street in 2008 was more |
| shareholders. Instead, they looked on while the CEOs | | | | than just a massive failure of common sense, |
| ran these companies into the ground. | | | | regulation and leadership. It was a failure of corporate |
| Stories abound about incompetent board members. | | | | governance. There is a great need for boards to be |
| When Barings Bank, the oldest merchant bank in | | | | held accountable for the overall risk control, and for |
| London, collapsed on February 27, 1997, after losses | | | | those who fail, to pay an appropriate penalty. As |
| in its future trading business in Singapore of $830 | | | | Warren Buffett said in his 2010 Shareholders letter: |
| million, it had lost an amount equal to more than | | | | “CEOs and, in many cases, directors have long |
| twice its capital base. Until the collapse, Barings | | | | benefited from oversized financial carrots; some |
| management in London believed that the trading | | | | meaningful sticks now need to be part of their |
| conducted by Barings Futures Singapore was | | | | employment picture as well. |
| essentially risk free and very profitable, a staggering | | | | |