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Editor’s letter: Bonfire of the vanities

When a Republican administration effectively nationalised half the US
mortgage market by bailing out Freddie Mac and Fannie Mae, many people clearly
thought (judging by the surge in share prices) that some sort of nadir had been
reached. It couldn’t get any worse than this, it seemed, because there simply
wasn’t anything else as big as this that could go wrong.

Not quite right. If Fannie-Fred was the biggest plate to fall off its stick
and go spinning towards the ground, it sure as hell wasn’t to be the only one.
The Fed chose to catch this one, because – and here’s a phrase that will get on
your nerves – they were deemed too big to fail.

Those of us in the UK less familiar with the whole concept of Fannie-Fred can
but shake our heads in amazement at what appears, with perfect hindsight, to
have been a fundamentally warped mechanism – entities created by Congress to
support the US housing market, yet having private shareholders and a Wall Street
listing. Heads I win, tails you lose.

The biggest debate regarding Lehman Brothers wasn’t whether it could be
rescued by the market (it couldn’t) nor even whether it should be rescued by the
US government (it shouldn’t), but whether it’s pronounced ‘Lay-mans’ or
‘Lee-mans’.

One newspaper columnist wrote about how ordinary folk watched tearful bankers
with something akin to “horrified delight”. As one Daily Telegraph
reader put it, who are the Masters of the Universe now? Economist Diana Choyleva
of Lombard Street Research told Newsnight that it was good news that the
American authorities allowed Lehmans to fail, and that seems about right. It
would have come as a real shock to them, though, given the earlier rescue of
Bear Stearns. Tough.

AIG – another one that was too big to fail – is probably best known over here
as lead sponsor of Manchester United (which reminds me: office rhetorical
question of the week has to be, why is Her Majesty’s Government continuing to
give taxpayers’ money to Newcastle United so that they can sew Northern Rock’s
logo on their shirts?). It’s an unholy mess, intricately entwined in the
sub-prime shambles by way of its insurance contracts that pay out when sub-prime
mortgages go phhht. Nobody reckoned on almost all of them going
phhht.

The downfall of our own HBoS – an organisation that, at heart, ought to have
been a big old-fashioned paternalistic building society and a dour, conservative
Scottish bank – is ironic, given the business is being rescued by a combination
of a clearing bank (Lloyds) that lost its shirt in Latin America 25 years ago
and a one-time mutual organisation (TSB) that came undone when it waded into the
business of the Square Mile by acquiring merchant bank Hill Samuel.

The veteran commentator Christopher Fildes – one of just a handful of people
who consistently makes sense, decade after decade – is fond of saying that
giving capital to a bank is like giving a gallon of beer to a drunk. You know
what will come of it, but you don’t know exactly which wall he’s going to do it
against. Latin America, dotcoms, hedge funds, pre-Depression Wall Street
speculators – take your pick. I think of bankers as people who forget, but never
forgive. They make the same, greedy mistake and burn their fingers time and time
again, but each time on a different stove and with increasingly impressive
degrees of sophistication.

But it’s still the same mistake. It’s the mistake of thinking that their own
greed can be sated. It can’t, so they keep lusting for more. It’s the mistake of
thinking that making money is easy. It isn’t, as any FD in any real world
business will tell you. It’s the mistake of thinking that once risk is squared
away on a rocket-science spreadsheet then there isn’t anything else to worry
about. There is. And it’s the mistake of being so vaingloriously arrogant as to
think that, if you make a big enough mistake, then you will be in the luxurious
position of simply being too big to fail. Don’t count on it.

A few years ago, we asked HSBC finance director Douglas Flint what was the
cleverest question ever put to him by an institutional investor. He thought for
a minute and said, “What are you doing today that we won’t see the benefit of
for ten years?” It prompted us recently to think up another few questions: How
are your dominoes laid out? How do they connect to everyone else’s dominoes? And
what’s going to make the whole lot tip over?

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