The great financial crisis of 2007-8 still leaves questions to which no wholly satisfactory answers have been offered. One concerns the fact that top management in the largest banks consisted of intelligent and hardworking people. They may have been greedy, writes Christian Dinesen, a former management consultant who spent a decade from 2002 straddling the crisis at investment bank Merrill Lynch, but it is difficult to believe that they could manage so badly as to have caused so much devastation to the global economy while sabotaging their own banks and reputations.
In this book, Dinesen argues that it is possible for all banks to fail in a crisis, as happened in the 14th-century plague in Europe. But while financial crises may have multiple causes, in most of them management is the ultimate determinant of which banks fail and which survive. If it is unfathomable that anybody would manage so badly as to lose more than $50bn as he suggests Merrill Lynch did in 2008, then what is the explanation? His answer is that the fault lay in “absent management” compounded by flawed incentive structures.
Looking back selectively through history, the book identifies the reasons for absent management as an inability to cope with complexity. At the Medici bank, in the early 15th century, banking products were few and simple: bills of exchange, lending to individuals of high social standing and taking deposits from the rich. Under Cosimo de Medici, famous for his keen judgment, the bank prospered.
Complexity came with expansion into foreign parts, which required an understanding of local conditions and an ability to control foreign branches with appropriate incentives for managers. As Europe’s biggest bank grew, and Cosimo’s heirs failed on this and other scores, it became unmanageable. A high-spending grandson, Lorenzo the Magnificent, neglected an increasingly troubled institution to focus on politics. The bank was closed down when the Medici were expelled from Florence in 1494.
Fast forward to the 20th century and the complexity story becomes about deregulation. As Dinesen writes, regulation does not cause banking crises but provides parameters within which banks are allowed to operate and fail. In short, deregulation gives bankers more rope with which to hang themselves.
In this context it means the introduction of morally hazardous limited liability through the retreat from partnership together with the liberalisation of markets before the 1929 Wall Street crash, and again in the 1970s. That was when governments unwound the draconian controls of the 1930s such as the Glass-Steagall act, which prevented deposit-taking banks from dealing in securities.
There were no major financial crises between the 1940s and the early 1970s. Deregulation then unleashed dramatic banking growth and concentration through mergers and acquisitions, along with explosive innovation in derivative instruments and securitisation. Growth, writes Dinesen, creates a need for management. Yet, with the help of case studies garnered mainly from Harvard, he shows that at numerous banks, from the megalithic Citigroup at one extreme to the much smaller S G Warburg at another, growth was unmanageable.
How helpful is the label “absent management”? It is a loose categorisation and the dividing line between absent management and plain mismanagement is not always clear. Dinesen applies it to Citigroup’s Chuck Prince who in 2007 told the Financial Times that “as long as the music is playing, you’ve got to get up and dance”. Yet this was surely also a response to short-term capital markets and institutional investor pressure — rather than flawed corporate governance, which is not something the book much explores.
Dinesen concludes that a historic mistake has been made in the regulatory response to the financial crisis. He argues that, in contrast to the response after the Depression, policymakers decided broadly to regulate banks as they were, with an emphasis on capital adequacy, rather than simplify them to make them more manageable. The analysis bears thinking about, though many will find the prescription uncomfortably radical.
The reviewer is an FT columnist
Absent Management in Banking: How Banks Fail and Cause Financial Crisis, by Christian Dinesen, Palgrave Macmillan, £89.99, 305pp
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