Then it fell apart

“I’ve seen so much in so many places
So many heartaches, so many faces” – Moby Extreme Ways

Inspired by Marc Rubinstein, who I used to work with before he went on to big hitting hedge fund manager – I thought I’d write about my memories of the 2008 banking collapse. 
For me it started in early 2007, in Bergen halfway up the coast of Norway. Working for Societe Generale, the French bank, I was meeting a fund manager later in the day. But had a call early in the morning to say that HSBC had put out an announcement to say their profits would disappoint, due to losses in their US subprime mortgage book. HSBC management had previously told a story that this lending business was low risk, because although they lent money to low income groups, they had over 100 phDs working in their risk management department.
Soc Gen was not a great place to work, because analysts were given so many contradictory goals. “Publish more sell notes on companies” – but “persuade those same companies (who don’t like sell notes) to go on corporate roadshows with you”. It used to take me a month to publish a research note, because so many people got to edit and change what I had written, by which time what I had written was out of date because the share price had moved or new information had come out.

One time a colleague told me “You know Bruce, you write really clearly” – as he scribbled out the entire executive summary at the front of the note and completely rewrote it. Then he resigned to become a partner in a Financial PR firm.

After the Full Year results HSBC Finance Director, Douglas Flint, called all the analysts in to tell us:
“Look I know you think we are really dumb for losing money – but at least we know that we have lost money. All the other people who have bought these credit derivatives backed by subprime mortgages don’t even know that they’ve lost money yet.”

My words, not his – but that was the gist.

Extreme places I didn’t know

The next thing I did was go on a skiing holiday to Turkey. While in a valley in the Ala Dag mountain range, my boss was desperately trying to get hold of me because Royal Bank of Scotland, Santander and Fortis had announced that they were bidding for ABN Amro the Dutch bank. Fortunately I didn’t have a mobile phone signal, so all the questions left for me on my voicemail had answered themselves by the time I picked up the message.  Later Barclays management decided to bid for ABN Amro too, causing a bidding war.  This seemed an odd thing to do if banks had lost huge sums of money, all the banks were behaving as if HSBC didn’t know what they were talking about.
While I was on holiday, Soc Gen hired two analysts from Dresdner Bank to do my job. Which seemed weird because a couple of weeks earlier they had paid me a healthy bonus and told me that I was doing well. But now they’d hired these guys, they were telling me that instead of UK banks which I specialised in for the last 7 years, I could cover Icelandic banks, which I knew nothing about.

I would stand in line for this

I decided to leave and join Pali, which was a small broker in Mayfair owned by a couple of US billionaires. The bidding war for ABN Amro lasted through the summer, with the consortium prepared to pay a higher price than Barclays. Almost as soon as I joined Pali in June 2007, Northern Rock warned that their profit growth would disappoint. I suggested that the bank was in real trouble, and over the coming months this turned out to be correct.  Northern Rock’s main problem was the wholesale markets refusing to fund the balance sheet.  The retail run on the bank, with long lines forming outside the banks came later, after Robert Peston, the BBC journalist had broadcast that Northern Rock needed emergency support from the Bank of England. There were other, better paid, more successful, analysts who were still positive on Northern Rock in September, when it should have been obvious the bank was failing.

So many dirty things

One memory sticks in my mind from August 2007. The Finance Director of HBOS resigned. I sent out an email to clients saying that there were rumours of large trading losses at a UK bank (other than Northern Rock) but I didn’t think the two things were related. The HBOS Investor Relations phoned me up and went ballistic: how dare I write that. He threatened to launch legal action against Pali unless I issued a retraction. I pointed out that the email said that I DIDN’T think that two were related, but he said I shouldn’t even have mentioned the rumoured trading losses and the FD resigning in the same email. I should publish a public retraction.
I asked a colleague what to do. He answered with a cunning smile
“Oh yes. You should do exactly what the IR asks. Most people don’t read emails – but they will definitely read an email with “RETRACTION” in the title.”

So I re-sent the email, making clear in an ironic way that I didn’t think the rumoured trading losses and the resignation were related. The irony was that I actually thought HBOS would be OK – it hadn’t made a large risky acquisition, 70% of the loan book was low risk UK mortgages. After what went wrong with Northern Rock, it seemed pretty obvious that the Bank of England would provide liquidity support to other banks, to prevent any other bank runs.

This analysis was factually correct but dead wrong. The problem with HBOS was not that it was a mortgage bank with 70% UK mortgages, but that the balance sheet was £666bn and the other third of the balance sheet (corporate and international) was more than enough to sink the bank. The second problem with HBOS was that the bank had been securitising and selling on high quality UK mortgages to other banks. At the same time it had been buying credit derivatives backed by fraudulent US mortgages and keeping the toxic stuff on their balance sheet. In other words it had been selling good quality assets to other people, while buying shite assets from other people.  This was clearly dumb.  I just had no idea at the time that intelligent people with MBAs could make such mistakes. I met someone with a mathematics degree from Oxbridge who worked in HBOS Treasury Department doing clever stuff with derivatives, and he was convinced that the bank’s book was fine.  I don’t think he was lying, he genuinely believed this.  And that was the third problem with HBOS: management believed that they were fine, and that their share price and credit spreads were being manipulated by short sellers, who had started rumours that the bank was in trouble.

The FSA launched an investigation into these short sellers with great fanfare. Then quietly dropped the investigation and never published their findings. I suspect whatever they found they didn’t like.

You wouldn’t even believe

It was around this time that Barclays Investor Relations took me out for lunch and told me that I was being far too negative. They politely told me that they had much more information than me (which was true) and things really weren’t that bad (which wasn’t true).
The stock market in the second half of 2007 climbed higher. The two guys who Soc Gen hired to replace me arrived for an afternoon then promptly resigned because they had been offered more money by BNP Paribas, Soc Gen’s arch rival French bank. I suggested to someone in Soc Gen management that perhaps losing a bidding war might be a blessing in disguise. Same goes for Barclays losing the bidding war for ABN Amro.

It wasn’t clear to me what would happen next. At this point James Ferguson at Pali was a great help. James had seen the Japanese banking crisis first hand. He told me that banks would need to raise more equity, and only then would they be able to recognise the size of their losses. I wasn’t convinced. I pointed out to him though that unlike Japan, disclosure requirements in the UK had been tighten up after Enron and its auditor Arthur Andersen failed. Management who presented fraudulent accounts would got to prison. There were also strict rules about making false claims and disclosing information in a capital raising prospectus, precisely to protect investors from companies lying to raise money.

I had to close down everything

Again this was all factually correct – but turned out to be wrong. In fact I think the legal action of the rights issue prospectuses may still be going on. James kept telling me that I could not trust the numbers the banks were reporting, and that things were a lot worse than they were saying. Then Bradford and Bingley, another mortgage bank needed to raise money. By this stage I thought it was all nonsense and agreed with him. The guys who had been hired to replace me at Soc Gen, and then moved to BNP Paribas had Bradford and Bingley as their top pick for the year. They didn’t care though, they had reportedly been guaranteed millions of pounds for getting things so wrong.

I had to close down my mind

I went to the pub on Friday afternoon with the insurance analyst next to me. In an hour or two I built an “embedded value” type model, to flex the assumptions that would be needed to show Bradford and Bingley was bust. I published this and the next week had a call from the Bank of England Financial Stability people who asked me to send through my model. I was also interview by Paul Mason who then worked at the BBC Newsnight – but he didn’t use the interview, I expect because journalists had been warned not to publish anything that might cause a panic.

Later I met up with the Bank of England, and I admitted that I had built the model in a couple of hours after a few pints in the pub. She said:

“Oh actually, we all really like your model. It’s so simple. So useful. Everyone builds complicated things that they don’t understand. Whereas no one argues about your model, we can argue about the assumptions going into it. But no one can say that the numbers it churns out are meaningless.”

My words, not hers. But that was the gist.

In 2010 the accounting firm PriceWaterhouseCoopers was paid over a million pounds to value Bradford & Bingley shares.  They concluded that the shares were worthless.  Not surprising.  But nice work, if you can get it: valuing a bank after it has failed.  Sad that analysts like me, who published research beforehand warning the shares were worthless can never expect to be paid that sort of money.

Then it fell apart, it fell apart

After the 1999 internet bubble analysts were rightly criticised for publishing positive research notes on worthless companies. The regulators were very keen for analysts to tell the truth – except they hadn’t thought about the implications if there was a banking crisis, and banks didn’t have enough equity.
The weird thing was that after raising money Royal Bank and HBOS credit default spreads were still showing signs of trouble. James Ferguson confidently asserted that the banks would have to be nationalised. My former colleague who had left to work in Financial PR also suggested the same thing. About this time the Icelandic banks collapsed.
So I published a note, looking at Nordic and Japanese banking crises, suggesting the banks might need to be rescued by the government. Then I lost my job. Pali was losing money, and the billionaires that owned Pali were also losing money. I hadn’t realised that billionaires often are only billionaires on paper, and actually they are often more leveraged than us, less wealthy, folk.  It was partly my fault though, because I pointed out to a saleman who was convinced that Bradford and Bingley was bust, that all his Buy to Let new build properties that he owned would be the next shoe to drop.  He then was promoted to be my boss and fired me.

Then it fell apart, it fell apart

I got another job in September 2008, but had to take a 70% pay cut. And then published a research note saying that banks would need to shrink their balance sheets, that there were more losses to come. I was right, but everyone was annoyed with me. I put an 18p price target on Royal Bank (implying the value would fall by 70%). I was wrong the price actually fell below 10p.
Then Evolution, my new employer decided to hire a huge team of people from Dresdner Bank – which was closing down. So for the second time in 2 years a team from Dresdner Bank had been hired to replace me.  This didn’t make a huge amount of sense why these Dresdner Bank people were so valuable, because the bank seemed to lose money hand over fist. 

I was fed up.  So I decided to go skiing in March 2009.  Before I did I decided to buy shares in Legal and General – as a sort of insurance policy against being out of the market. Then share price halved, because people thought it would fail. I didn’t think that you could have a run on an insurance company, so I bought even more when the share price fell in half. I trebled my money in a fairly short space of time, but actually I sold too early and should have held on to the shares.  This did give me the confidence that perhaps there were easier ways to make money than being a banking analyst though.  And that trying to predict a share price with an excel spreadsheet and price target is dumb.  Things are often far more extreme than that. It’s better to find companies with stories that makes sense, and buy shares in them that can increase in value by 5x or more over several years like L&G did.  And to avoid shares like Royal Bank, HBOS, BB and even Lloyds which all fell 90% in value over a few years.

Like it always does, always does

Marc concludes his post on the collapse with these words:
“Something quite like it is unlikely to happen again in as unexpected a fashion. But the basic story of excess is an unchanging human one. Ten years ago my work required me to look in the right places at the right time. Next time, it will be different people looking in different places. It will pay to heed them.”

That seems a good conclusion.  I suppose stories help us understand different people and different places and apply it to our own thinking – like James helped me understand what was going on in 2007-8 with his experience of the Japanese banking crisis. So that’s why I’m sharing my story from 2007-2008.  

Photo by Dean Rose on Unsplash

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