What did you learn from the crisis, and has it changed the way you view the system and the way markets work?
John Keynes said, “Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.” Many banking executives and policy makers went into the crisis with a mental roadmap which simply didn’t fit the crisis. I’ve been fascinated by how many eminent individuals got it so wrong. Before the crisis, the majority of the academic community had very little regard for the credit channel’s own dynamics. We have learned a lot from the crisis, and many aspects of financial reform make sense, but there is still insufficient focus on the holistic system. We are still feeling our way through the process of the understanding of a stable system and macro-prudential policies.
That’s probably the number one thing I’ve learned: just how many people got it wrong. The whole point about being an analyst is to question whether the market has got it right and to have the courage of your convictions when you think it hasn’t.
Number two would be about how superficial the regulator’s collective understanding was of the financial system as a whole. Many parts of the system were simply not focused on as risks accumulated. We failed to learn enough from the lessons from prior emerging market crises. It echoes the 1930s in that it actually confronted the paradigm people were in.
Do you think the level of debate is high enough and informed enough on reforming the financial services?
The overall programme of financial reform is generally pointing in the right direction – making banks safer and more resilient through better capital and more matching of funding; making it possible that banks can fail so taxpayers never again have to step in in quite the way they did; ensuring that the infrastructure works; and making sure that the rest of the financial system is sensibly designed.
Those basic objectives, robustly implemented, will make for a safer system. The areas where I have concerns are: first, that the interests of one national regulator can be very different from another so there is a risk of a much more balkanised financial system with lack of consistency in the application of regulations. Given the relatively slow progress in some areas of international cooperation, it makes sense for a national regulator to protect themselves. But while that protectionist instinct is understandable, it also means that capital will flow a lot less freely across borders, particularly to countries which may need it most.
What we’ve learnt from the financial crisis is how complex the financial ecosystem is. In a perfect world, we would make it a lot more simple, but simple solutions aren’t always the right answer. Take something like a leverage ratio – if the intention is to have relatively simple banks, providing a flow of mortgages to customers and funding to corporates – a leverage ratio regulatory solution actually works against that, even if it is a well-intentioned policy.
And then the third issue is about calibration. Even if the general direction of regulation is correct, the calibration in some areas may not be. It’ll take some time, but I believe with some iterations we will get to workable solutions.
One area which we’ve done quite a lot of work on is the issue of who is going to fund long-term assets in society. So, if banks are disincentivised from offering long-term lending, then who’s going to fund infrastructure developments such as social housing? And to add to the problem posed by bank rules, unfortunately the insurance rules, called Solvency II, also disincentivise insurance companies from making these sorts of investments.
Are you optimistic?
It depends what the question is! If we take the European financial landscape, I was arguing two years ago that we were in a Bermuda Triangle of sovereign risk, bank deleveraging and stress in funding markets for financial services. Through the actions of policymakers, and partly just by the passage of time, over the last year we’ve started to head out of that Bermuda Triangle.
I think what [European Central Bank President] Mario Draghi in particular did around OMT (Outright Monetary Transactions) to try and stablisie the system was incredibly important because it’s very difficult for corporations, let alone banks, to make decisions if they don’t know if the Eurozone’s actually going to exist in its current format.
So I think we’ve got plenty of signs of rehabilitation, but it’s going to take some time. Economic growth is still well below the trends we got used to. I feel more optimistic today than I did one or two years ago, and I see opportunities, but there’s a lot of hard work ahead.
In financial services, there appear to be a lot of forces at work who aren’t really particularly well informed trying to shape something that’s incredibly complicated.
Do we have to accept that it’s always going to be a grey area?
The banking system needs to be safer and more resilient and the taxpayer should never have to put quite as much up to support the financial system. So it’s completely appropriate for voters and politicians to be very clear about the objectives that they would like to see in a reformed financial system, such as seeing bankers being punished for acting irresponsibly.
It’s also appropriate for politicians and voters to hold the regulators more to account for their actions, but we probably do need to have technocrats and policymakers calibrate how best to meet the public’s objectives in redesigning the financial system. And we should be ambitious. There will be compromises and there will be disagreements, but that doesn’t mean we shouldn’t be relatively ambitious about how far we can reform.
One issue which is not being discussed with enough vigour is the capital markets solution. If more capital raising comes from markets then less comes from bank balance sheets, the banking system becomes relatively smaller and safer. Social housing projects, for example, could go direct to the bond markets. Many more companies could go direct to the bond markets. That’s actually a more pluralistic, and likely to be a safer, system. There is strong evidence that without the bond markets providing finance during the recent crisis, plenty more companies would have had issues than actually did.
The issue is that it raises the question of who’s regulating the providers of bond finance, who is monitoring and controlling the investment community? In Europe there is a lot of concern about what has been called shadow banking. It may well be that one consequence of the regulatory reform programme is that the banks are safer and sounder, but smaller, and that a lot more business is done outside the banks where it isn’t so well regulated.
Inevitably, there is still a lot of distrust of bankers by policymakers. It will just take a very long while – possibly as long as a generation – for this to work through. The banks need to make money to make sure they’re stable institutions, but they also need to act as model citizens in terms of making sure they’ve got the right culture and are doing the right things.
You have worked as a management consultant, have an MBA and studied politics, philosophy and economics. Has this given you a different perspective on investing?
To be a good investor or analyst, you need to be interdisciplinary because you need to understand the macro environment, you need to understand what’s motivating the companies’ management, you need to understand your facts and figures. So coming from an interdisciplinary background can help, but it’s more about making sure that you keep your curiosity as high as possible. It’s largely about having an open and inquiring mind which can help you improve the odds of any investment judgment.
Your curiosity must be highly developed, because you have been prescient on a number of events over recent years.
We’ve got some things right, but some things wrong as well. Where we’ve got things right is by questioning why something is the case. Why was Northern Rock growing as fast as it was? Why were the Icelandic banks growing like weeds? Why was there such a build-up of structured credit?
You need to have the nose for a good story like a journalist, you need to have the forensic accounting abilities of a really high-calibre financial analyst, but you also then need to have the judgement of where this piece fits in the overall puzzle. And sometimes you get it right, sometimes you get it wrong, but it’s making sure you can see the wood for the trees and be humble if you make mistakes to ensure you change tack and learn from the mistakes.
I like to think that if you are a sell-side analyst, effectively your clients are the smartest investors in the world. The standard for our team is: can we tell a smart, well-informed investor a thing they don’t already know or join up the dots in a way they might not have seen? The mission statement hanging in our meeting room is to “help clients think or make money – and preferably both”.
So it is important to ask questions, but also not to be cowed by authority. There are any number of CEOs and chairmen who told us that we are wrong. With that kind of heavyweight pushback from the companies you cover, you need the courage of your convictions.
That comes from making sure you’ve done enough work so you make sure you improve your odds. You do as much work as is humanly possible to try and work out are you more likely to be right than wrong? Then you stick with it.
Did you have doubts?
Every day one has doubts. As Keynes said, if facts change, change your mind.
What is important is to keep yourself fresh and keep looking at problems in different ways. I started off being an analyst covering diversified financial services and the strategy of European banks. I then covered all the investment institutions, worked for Morgan Stanley and eventually came back onto the sell side, covering all the banks.
Banks are always geared plays on the economies, but the overlapping sovereign and banking crises has meant we’ve worked ever more hand in glove with our economists and credit teams.
I’ve tried to make sure that I don’t get stuck in a rut. That would be fatal.
What’s nice about the investment world is there’s a direct feedback every day with the movement of the stocks on whether you’re right or wrong. If you have a buy on a certain stock and it goes down in value, you’re confronted every day with the realities of the price. Now, you may think the market’s got it wrong, and it may have it wrong for a period of time, but it’s about the numbers on the board – did you get it right, or wrong?
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