The day banking died

There’s been a lot of discussion about what killed RBS, some of it crazy-talk, but some of it both interesting and insightful.

For me, it was “Originate to Distribute” that killed RBS. For some, this may seem obvious. For others, it’s meaningless. But bear with me.

Securitisation used to be an agency business. That sounds like gobbledygook, but what it means is that we used to arrange huge and complex loans to companies.

The loans were complicated because the companies wanted to pay a miserly rate of interest, and since they weren’t all Microsoft the only way they could get away with it was by having something the lender could take off them if things went wrong. It’s exactly the same principle as mortgaging your house when you borrow the money to buy it – and in the same way, the more the house is worth (compared to the loan), the happier the lender will be and the more prepared to shave a fraction off the interest he’s charging you.

Instead of a house, these large corporate borrowers had cashflows – sums of money someone else would be paying them in the months or even years to come – and it was these cashflows that they promised to use to pay off the loan they’d taken out. The cashflows could come from almost anything. Leasehold payments from office-block tenants or shopping mall retail outlets. Royalties from music publishing rights. Ticket income from football grounds. Most commonly, the payments from a whole host of mortgages – yours and mine – that the borrower had loaned out in the first place.

So we used to arrange these huge, complex loans. Some building society or property company or football club would get in touch and ask us to get them some money. And we’d talk to the lawyers and the rating agencies and the accountants and a whole host of others and we’d come up with a “bond”, which is basically a form of loan. And finally we’d talk to a bunch of “investors” – the ultimate lenders, the guys who were putting the money up, generally insurance companies and pension funds and anyone else with an enormous pot of cash and a need for a steady, reliable return. The investors would hum and hah and they might ask us to change this or that, and then they would tell us if they were prepared to lend and at what interest rate. If enough of them said yes at the right rate, we’d all shake hands and sign half a million documents and, as we used to say, ‘the money would flow’.

We didn’t do the lending, though. We just sat in the middle and took a fee for setting the whole thing up. We were brokers. That’s what being an agency business means. It was in our own best interest to get a good deal for the borrower, otherwise no one would appoint us to arrange a deal for them in the future. And it was in our own best interest to get a good deal for the investors who loaned the money, otherwise they wouldn’t look at the deals we brought them in the future. We got our fee, and made sure no one got ripped off, and it might not have made mega-bucks but it did just fine and everyone was happy about that. Where the bank did lend, it worked (for the most part) with good clients, clients with strong fundamentals, and it was a straightforward, traditional relationship. For everything else we were an agency business and our balance sheet was our own business.

Until the day banking died. Every department in every bank started to die on a different day, but for us it was the day we were told that being an agency business was all well and good but (as our American competitors and our own clients had shown us) there was a hell of a lot more money to be made by being a principal.

The idea was simple, really. Instead of arranging the loan, we were to lend it. And some time later we’d fiddle around with it and “refinance” it, selling it on to all those pension funds and insurers who were so desperate to throw their cash around. Instead of getting a fee, we’d make a profit. We’d buy low and sell high – sometimes literally, buying up huge blocks of mortgages and bundling them up into a bond to sell to the investors. We weren’t brokers any more, we were told. Now we were traders.

And like all traders, that meant carrying inventory.

And when the investors suddenly weren’t quite so desperate to throw all that cash around the inventory couldn’t go anywhere. It sat there on our books like a big fat Camembert, so full of promise and deliciousness back when it had first arrived, but now getting smellier and smellier so that at first it was just that no one was interested in the Camembert but bit by bit it got that no one wanted to go near the shop, and even the fresh stuff wouldn’t sell.

In a way it was the inventory that killed us. But we should never have been carrying it in the first place.

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If you liked this, take a look at some extracts from my soon-to-be-published novel Without Due Care here.

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5 comments

  1. The death of money and banks is written into its DNA. For money is effectively a Ponzi scheme, and all such scams collapse in the end. It’s a bit like musical chairs, and you were standing when the music stopped. Those CDOs and CDSs you didn’t mention should never have existed, and definitely should never have been bundled as they were (or is it a CDO/CDS cubed, now?). Nor should anyone ever have taken ratings agencies at the word, because they were being paid nicely to say nice things about dodgy deals.

    I feel sad for humanity when so many of its most intelligent members waste their time and energies on such grubby scams as money, and can’t even see it for what it is.

    1. Thanks Jay. You won’t expect me to agree with all of that but I think you’d be surprised by how much of me is nodding along thinking “he’s got a point, you know”.

      1. Pricks like me often have a point (a painfully sharp one, too, occasionally) although I’ve long since given up expecting anyone to agree with my diagnosis of lancing the boil on humanity that is money. However, if you didn’t surprise me from time to time, I doubt I’d read your blog as avidly as I do. Linguistic virtuosity alone doesn’t cut it for me any more. Life, for all its colour, would be so dull without debate, so keep ‘em coming. I certainly enjoy your posts more than anything the Royal Mail delivers. (My Feb 14 mail haul ain’t what it used to be.)

  2. I don’t really understand money, it makes me nervous. I’m currently trying to read Milton Friedman. But I think I enjoy your exposition more than his!

    1. You’re very kind, thank you!

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