When trying to decipher the mess that is the financial crisis it can be all too tempting to concentrate the blame on the City or Wall Street, hedge funds, investment banks and other high profile representatives of the finance industry. Vince Cable wrote an article for The Guardian doing just this back in December. His narrative was a tale of finance as a good industry with a few “rogue institutions”. The truth, as always, is somewhat murkier.
Engelen et al, in After The Great Complacence, make a compelling argument for the way elites used storytelling to convey neoclassical economic ideas to the general public in an easily understood way. These informal stories offer ‘broad brush, commonsense accounts in a vernacular easily comprehensible to politicians and lay people.’ Many official responses to the crisis have carried on this tradition and given us easy to understand stories of high finance run amok while the ‘good bits’ of banking and finance have been carrying on in their steadfast manner.
Mr. Cable’s article was just one example of this phenomenon. He made some good suggestions with regards to the problem of investment banking – and there is a problem – however we ignore the all too clear problems in wider financial services at our peril. Mr. Cable maintains that although the pensions and insurance industry has its share of problems it doesn’t pose the same risk as the investment-banking sector. This may be news to A.I.G, the U.S insurance giant that had to be bailed out with funds totalling over $180bn by the summer of 2010.
Not all finance related activity is immoral and not all in the industry are greedy risk takers. Most people who work in the finance sector don’t earn huge amounts of money and many independent financial advisors are highly qualified professionals who want the best for their clients. But there is often a culture of greed and risk-taking running through many organisations that it isn’t purely confined to The City. Mr. Cable mentions the Equitable Life scandal but ignores the rest. If he’d mentioned all the crises that have hit the finance sector in recent years, what sort of picture emerges?
The Equitable Life scandal was serious but there have been many others, most notably the pensions debacle. Between 29 April 1988 and 30 June 1994 many members of the public were advised to take out personal pension plans when they were already members of an occupational defined benefit pension scheme. In doing so, many lost out financially resulting in a huge scandal estimated at a cost of over £11 billion. The Financial Services Authority also ordered a separate review of the sales of Free Standing Additional Voluntary Contribution (FSAVC) plans. This review covered the sale of FSAVC policies made during the period 29 April 1988 to 15 August 1999. Again many were made worse off by being advised to invest their money into plans with insurance companies rather than in-house schemes.
Those that avoided being mis-sold pensions may have been caught out in the With Profits fiasco. With profits bonds were especially popular with some financial advisors. Gavin Lumsden of Citywire argues that it was the substantial commission available that drove the trend rather than the superiority of the investment vehicles:
“Sure investment bonds have their use in tax planning but as savings and investment plans they are generally outclassed by ISAs (individual savings accounts) and other forms of pooled investments, notably unit trusts and investment trusts.”
In 2004 the FSA fined Bradford and Bingley for its dubious selling of precipice and with profits bonds. Bradford and Bingley would later become one of the high street banks to collapse following the mortgage crisis.
With Profits bonds weren’t the only investment vehicles to cause problems, the other With Profits policy to get a bad name was the endowment plan. Way back in 2002 The Telegraph reported that the endowment mortgage crisis was ‘threatening to eclipse the pension mis-selling scandal…according to figures released by the Consumers' Association.’ Many were left unable to pay off mortgages at the end of the life of their policies. Over confident performance predictions had again left a hefty bill, ultimately, with the public, while the profits were safely banked.
Both of these crises occurred during decades when numerous smaller scandals were ongoing. It can be argued that these were all a result of the orgy of deregulation that laid the groundwork for the ‘big one’, the finance scandal that nearly brought the whole system down; the sub-prime mortgage fiasco.
When discussing sub-prime mortgages the issue of story telling and narratives, used by an elite to set the parameters of debate, once again become important. Some like to paint a picture of an innocent industry, betrayed by a lot of feckless borrowers who ‘used’ banks to gain easy credit. The reality comes much closer to what would in most industries be called systemic criminality. Many firms, particularly in the United States, were alleged to have purposefully sold mortgages to those unable to pay, including people who were unemployed and with zero assets. So called “ninja” mortgages, to people with “no income, no job or assets” were rife in the US and, to a lesser degree, the UK. These bad loans were then wrapped up with good loans and presented as triple-A rated. For the ratings agencies involved, where do their incentives sit – providing impartial advice on the quality of a loan book, or keeping their paying customers happy?
The FBI, during their investigation into the sub-prime financial crisis didn’t mince their words, stating; ‘It’s a bull market for financial fraud.’ They are investigating organisations from across the financial services industry, from mortgage lenders to investment banks. Even more alarming, a study by Ran Duchin and Denis Sosyura of the University of Michigan looked at the U.S. Capital Purchase Program (CPP), whereby banks were bailed out, and found that banks in receipt of funds were more likely to make risky investment decisions going forward. They noted; “Overall, the analysis of banks’ investment portfolios suggests that CPP participants actively increased their risk exposure after being approved for federal capital.”
This list of scandals past and present wouldn’t surprise many who’ve worked in the industry at one time or another. The idea that all products and advice must be in the best interests of the client is contradicted by a hugely pressurised sales culture. Those who don’t hit target are often viewed as failures and can face disciplinary measures or lose their job. For those at the sharp end the day can become all about the bottom line and hitting target. When your job itself is on the line then the pressure to sell can become intense. Many industries of course have targets and incentives but surely that contradicts the idea of impartial advice, given by a qualified expert?
Indeed when Which Tested out Natwests supposedly impartial advisers back in 2009, they found that only four out of twenty branches provided the impartial advice advertised. Later in an undercover investigation during 2011, Which found that only five out of thirty seven advisers gave good advice. Even more worryingly eighteen of the thirty seven seen claimed their advice was free, when in fact most products sold pay advisers commission for recommending them.
Last year Money Marketing reported on the Which? Banking Commission in London. The comments below the article are illustrative of the problems at hand, with some contributors feeling they are pushed to sell products regardless of whether it’s in the best interests of the client. The contributors mostly chose to remain anonymous, not surprising for a comments section in a trade paper. One anonymous commentator states; ‘I am currently working in branch… The pressure to sell fee paying accounts along with Mortgages, Credit Cards, Home and Motor Insurance is VERY stressfull.’ There is clearly still pressure being exerted with the threat of dismissal being used for failing to achieve targets. It seems just as banks that are bailed out take more risks, the industry as a whole may also have become even more pressured when it comes to volume selling.
Mr. Cable and others are being naïve when they frame the issue as purely being about regulation of The City. The litany of mis-selling through the decades makes it clear there are systemic problems, problems inextricably linked with a target driven culture and the drive for profit trumping professionalism and codes of conduct. Of course these problems are inherent within neo-liberal capitalism itself but due to the way finance funds the wider economy they are more dangerous within the financial realm - on both a macro and micro level.
If you’re mis-sold a mobile phone or a DVD player it isn’t the end of the world; it might be if you’re mis-sold a pension. Have enough people mis-sold a pension and you’ve got a multi-million pound crisis on your hands - one the state inevitably picks up the tab for. Finance has increasingly been used to plug the gap left by a decreased welfare state as people are forced into private provision for pensions and income protection. At the same time credit has had to fill the gap left by stagnating wages resulting in an explosion of debt vehicles. The increase in the number and complexity of financial services products makes proper regulation even more vital. This is clearly lacking if banks feel free to take on more risk after being bailed out than before. Until these deeper problems and contradictions are addressed, there will be more crises and more bailouts.