We want new banks.
Just one US industrial company, General Electric, has been in the Dow Jones index from its inception in 1896 to the present day. All the others (who now remembers the Distilling and Cattle Feeding Company or American Cotton Oil?) have either perished or been absorbed into other organisations in a healthy process of renewal. By contrast, banks seem to last forever.
Financial institutions have, of course, amalgamated over the past century, but rarely has a new entrant muscled its way on to the scene. In Britain, Barclays has its roots in the 17th century; Lloyds was founded in 1765. HSBC in this country is a thinly disguised Midland Bank, another Victorian colossus, while Royal Bank of Scotland dates from the Hanoverian dynasty.
This longevity has bred an unwarranted sense of entitlement. Large banks seem to believe that they have a right to exist because they have been around forever. This attitude was on view in the US recently, when bankers from Citigroup and Bank of America appeared on television to assure the public that they were going to pull through this recession because the government was lending them money for nothing and they were passing it on at a much higher rate of interest. No one should worry, the bosses chortled, as they were making billions of dollars in profit. The Brits have shown a similar want of awareness. Who can forget that unsavoury blob Victor Blank, chairman of Lloyds, gloating over the Lloyds-HBOS merger largely, presumably, because its anti-competitive nature would allow him to raise his prices?
It is time to prick this delusion. There's no good reason for us to care two hoots whether Lloyds or Bank of America come through this recession. Of course we don't want them to collapse chaotically, taking our savings with them. But that shouldn't happen now that the taxpayer is standing behind the depositors. Just as the Distilling and Cattle Feeding Company was eclipsed when other more vital companies supplanted it, surely our old banks should face a similar fate if they are too full of toxic assets to do their job effectively. After all, it is only the lack of competition that is forcing us to restore their finances.
What we need now is new banks with sound balance sheets that aren't constrained by the errors of the past and can lend to us at reasonable rates. Even better, we need ones that can bring in new management to replace the incompetents that got us into this mess. Who could set up such a bank? Some have suggested the Post Office, but this is not an organisation known for fresh thinking or flair. A better bet might be an entrepreneur—someone like Richard Branson, who looked into taking over Northern Rock. A more boring option would be Tesco, which is said to be looking to expand into banking. At the end of the day it doesn't really matter who does it, but someone should. Otherwise we will be left in the less than capable hands of the big four (or three, as further amalgamation is likely) for another 200-odd years.
Black box investing
One of the simpler lessons of the recent stock market and credit bubbles is this: if you don't want to be ripped off by a dubious but doubtless plausible fund manager, manage your money yourself.
At the opposite end of the spectrum to this sane approach—to self-manage—is what is called black-box investing. This is where you delegate all decisions over your money to an individual or a computer program. Not only are you in the dark about the strategy that this individual or algorithm intends to employ, but you are told that it would actually be harmful to your interests to find out. That is because if you knew, so might the competition. And if rivals knew they would swiftly arbitrage away the returns.
It was at this end of the spectrum that Bernie Madoff lay in wait with his unexplained "split-strike" investment method, which produced its steady stream of high returns. No one knew how it worked or could replicate his results. But the returns? Well, who could argue with those?
We now know that Madoff was a crook on a grand scale. But his path was greatly smoothed by a culture that encouraged people to hand over their money without any real idea what was going to be done with it. This credulousness didn't just infect the "dumb" retail investors but the professionals too. After all, Nicola Horlick, a self-promoting fund manager, handed lots of money to Madoff, as did Man Group, ironically one of the City's oldest and most successful black-box fund managers. At root, these highly paid professionals of today were little different from the investors who punted on the famous South Sea bubble company, whose prospectus stated that it was established "to carry on an undertaking of great advantage but no one to know what it is."
But unlike the banks, which remain entrenched, if crippled, incumbents, black-box investing may have had its day—for a while at least. There's no danger of any moral hazard at least because the taxpayer isn't going to bail out anyone who punted and lost on a black-box scheme. Madoff, of course, has gone to jail. But even honest firms like Man have suffered. Its share price has fallen by 65 per cent over the past year even though its funds have outperformed the stock market.
Perhaps it should think about opening that black box.
