The Butler Did It or Did He?

The Scots lion was on its knees, wounded but still breathing. Who was to blame? How did RBS find itself at the centre of the financial crisis.

Sir Fred now found himself back to plain old Mr. Goodwin, the removal of his Knighthood has led many to heap all the blame on the unfortunate Mr. Goodwin. But Mr. Goodwin may have been the leading man in the RBS tragedy but there were many supporting actors. The Financial Services Authority played no small part in this tragedy. Section 2 of the Financial Services and Markets Act 2000 (FMSA) outlined the regulatory objectives of the FSA as being:

• “Market Confidence
• Financial Stability
• Consumer Protection
• The reduction of financial crime”

The report on the failure of RBS was released in December 2011 and concluded that among the contributing factors were the poor decisions made by RBS management including the ill-fated ABN Amro acquisition, their weak capital levels as well as their over dependence on short- term funding.  However the failure of FSA as a regulatory body is also acknowledged as Alan Turner, FSA chairman refers to how “the Report concludes that the FSA was too focused on conduct regulation at the time and its prudential supervision of major banks was inadequate.”

 Lord Turner of the FSA : Regulation was simply wrong.

A toxic mix was present in the form of poor management, poor regulation and poor decision making added to the mix was the fact that the required capital and liquidity levels that banks had to hold was also proven to be starkly insufficient. With Basel III proposed as the solution to this issue and a new approach to regulation surely avoiding such a failure will be an aim galvanising regulators and bank management alike.

This is surely is the only hope for the future. But we must remember that our Scots lion didn’t roam the world alone and was accompanied by other hunters, hunters which some view as even more dangerous; the lions of politics. The bank world operates within society, and is just as subject to political machinations as the rest of society. Mr. Brown, Blair, Balls and Darling and their belief in light-regulation and their ham-stringing of the FSA played no small part in the fall of the Scots giant. The fall of RBS was not just a financial tragedy but also a political scandal.

Old Lady Saves Scot while Knight Leaves the Stage

2008 found the storm clouds of a financial tempest closing over RBS. A massive six billion pound loss finally forced Goodwin to face the reality of the unfolding tragedy and act. RBS needed new capital and it needed it fast. Sir Fred sought the aid of the shareholders, attempting inorganic capital raising. The storm was too great and actions too small and too late. RBS now saw itself cut adrift on this violent sea, the markets seized up and other banks turned away, refusing to lend to the struggling institution. Goodwin was quickly running out of options as the share price fell. Fear stalked the financial landscape. October 6th 2008 saw the largest withdrawal of deposits the bank had ever witnessed when a large oil firm withdrew its funds, there was even talk of the dreaded bank run.

Were we witnessing the death throes of the world’s largest bank, was this Scots tiger really going to die? The Chancellor of the Exchequer Alistair Darling, himself a Scot was shaken; he made his feelings clear, stating:  “The prospect of the world’s largest bank shutting its doors was not one we wanted to contemplate.” Darling was well aware that if RBS fell the contagion effect could destroy the entire financial system.
RBS had gone from the pride of British banking to a canker in danger of spreading and killing the British banking system itself. With all avenues closed there was nowhere to turn except to the Old Lady of Threadneedle Street herself. Goodwin now looked to the Bank of England to throw a financial life buoy as the lender of last resort,

But could the Old Lady help? The Bank of England felt that the RBS ship was capsizing and was too close to insolvency to provide the emergency funds to help.  RBS needed to hold a higher level of capital. The life boats weren’t being deployed yet and RBS was able to recapitalize.  Subsequent to the recapitalization the Bank of England was able to provide the aid required.  The Scots giant was humbled; RBS was forced to accept a £20 Billion tax payer funded bailout, with the British tax payer now owning 84% of RBS.  How ironic that an institution founded to ameliorate the effects of the Act of Union would now be owned by the State that act created. So what of our Knight of the Realm? Sir Fred was forced to leave the stage albeit with a reduced pension of a paltry £342,500.

Bubbles, Boxes and Tragedy

There is an unfortunate, fatalistic thing with bubbles; it’s in their nature to expand until they meet their demise. The American housing bubble met its fate in late 2006. Our untouchable friends now found themselves in financial deep-water unable to make mortgage repayments, with rocketing interest rates. The sub-prime market was imploding, but surely RBS was safe, their hands were clean at least that’s what Sir Fred had assured the City.

With the US housing market in turmoil, you’d think caution would be the watch word but RBS wasn’t cowed by uncertainty, they were after all the Scots takeover tiger. RBS now had its eyes on a Dutch target, the poorly run, ABN Amro. In RBS’s corner were Spanish giant Santander and Fortis, facing them were Barclays.  Amid the usual mire of takeover controversy RBS staked 27 billion euros for their share in the world’s biggest bank takeover, but had eagerness blinded this hunter as they failed to carry out due diligence, would this prey be poisonous?

The financial jungle was about to become a very dangerous place. The doomed sub-prime liner was about to hit an ice-berg or should it be a rock, to be precise a Northern Rock. The British bank Northern Rock found itself the target of the dreaded bank run, with queues of depositors withdrawing funds. Fear stalked the markets. For RBS things were to get a whole lot worse. The clean hands of RBS were about to become very dirty.

In a shocking example of upside down thinking, the books of ABN Amro were about to be opened for the first time, following takeover. ABN Amro’s books turned out to be a proverbial Pandora’s Box, loaded with sub-prime investments which were becoming toxic, this prey really was poisonous.

The words of UBS banker John Cyran must have haunted Goodwin. Cyran had visions of the Greek tragedy contained in ABN’s books warning Goodwin “There is stuff in here we can’t even value.”  The sub-prime toxin was spread through the veins of RBS; losses became the word of the day. RBS’s Core Tier 1 capital ratio fell to risky depths of 4%.  The video below from Marketplace explains the significance of this measure to banking health. 

The Greek tragedy was playing out to its’ dramatic, tragic end. Would Goodwin act now, or would he continue to deny the need to raise new capital and force the bank to its knees?

Dancing with the Untouchables

With NatWest now in the fold RBS continued to grow. Five years post NatWest and with a raft of further acquisitions we find RBS still unstoppable, ranked according to some measures among the top five biggest banks globally. The insatiable appetite for growth and expansion still hadn’t been satisfied and much like the early pioneers RBS was to take the advice to “Go, west young man!”The USA was now in their sights.

With their US arm Citizen giving them a bridge-head in America it was time to advance further into what they hoped would be the road to further fortune. Mellon Financial became the first target of the Scots giant and was duly captured, but this was only a prelude to what was to follow.  The main battle plan was actioned with a massive $10.5 billion takeover of Charter One. RBS had now extended its’ reach into the lucrative Chicago market and had gone from a regional UK entity to the 7^th largest bank in the USA.  What could possibly go wrong? Was the sun ever going to set on this doyen of the banking industry?

This massive 30 billion shopping spree by RBS had taken its toll and all was not well, perhaps the sun was beginning to at least dim. There were dissenting voices in the city and those that felt that RBS had overpaid for Charter One. The doubters contributed to a drop in the share price. The RBS lion was on the defensive and would have to fight back.

RBS looked to Greenwich Capital which they had inherited with NatWest to provide a path to recovery. They acquired huge bundles of mortgages and loans from banks and other lenders across the USA. The bundles were then packaged up, sliced and diced and sold on to investors. The state of the US housing market must have given hope at this stage, with real estate experiencing a boom and realising extensive profits. There was an in-built weakness with this strategy as there was a negative relationship between time and the number of people the bank could lend to. This weakness forced the bank to foray into what now appears as the high risk world of sub-prime lending which involved lending to those who in more cautious times would be termed financial untouchables, borrowers with issues, Gorton (2009) characterises them as those with:

“(1) insufficient funds for a down payment on the house; (2) credit issues, either no credit history or prior problems repaying debts;(3) an inability to document income; (4) a lack of information or erroneous information.”

 This dance with the untouchables was viewed as incurring a high level of risk but as long as the mortgages were paid the investors would reap the rewards. This risk initially appeared to pay off as the City recovered its belief in RBS and resulted in a share price increase.  Sir Fred Goodwin appeared either to be ignorant of this strategy or else wholly embarrassed by it. In the Annual Report for 2006, Sir Fred referred to RBS’s “longstanding aversion to sub-prime lending, wherever we do business.”  Was this a case of hear no evil, so no evil, or did this knight of the realm allow himself to be blinded by profits despite massive risk? It would not be long before this house of cards would fall.

Fallen Knights and Tartan Tigers

Bankers, bonuses, knighthoods and politicians, for RBS this has been a rather toxic mix. The bank has found itself at the forefront of public scrutiny recently due to the annulment of the former Sir. Fred Goodwin’s knighthood and Stephen Hester’s reputed bonus. The phrase “How the mighty have fallen” comes to mind. It seems a long way from the heady although controversial days of the Natwest takeover. Some at RBS may wonder how what was once, one of the world’s biggest banks has reached such a hiatus and I’m sure our former knight of the realm must query this himself.

Twenty shilling banknote of the Royal Bank of Scotland,1727

It seems altogether ironic that the roots of RBS lie in a scheme intended to avoid negative financial consequences from the Act of Union of Scotland and England. The Scots found themselves in receipt of compensation for agreeing to bear a proportion of the English national debt and were exposed to costs from the failure of “The Company of Scotland”.  The Scheme bore the name “The Society of Equivalent Debt”, becoming “The Equivalent Debt Company” in 1724 and after the first foray into banking, “The Royal Bank of Scotland” in 1727. Given the cost to the taxpayer of RBS some in England must surely be wishing that the Act of Union never took place.

Despite the Union, RBS could hardly have been called a UK bank in its early years as it remained strong in its’ Scots identity and focused on expansion north of the border and the issuing of Scots bank notes. But ambition can’t be held at bay forever and the rich pickings beyond Scotland couldn’t be ignored. The Scots lion had to be sated. The US bank, Citizens fell to the tartan giant in 1988. The millennium saw the appointment of the ill-fated Fred Goodwin as chief executive. Despite the acquisition of Citizen, RBS still felt like a big fish in a small pond and remained anxious to expand into the City, a feeling shared by their old Jacobite rival, “The Bank of Scotland”. Gordon Pell, RBS Retail Markets Executive put it thus “They both took the view that they had to jump to something bigger to avoid dependence on the Scottish economy”

The subsequent, hostile takeover of NatWest was deemed by RBS to be such a success that they soon developed further cravings for growth. As human nature prescribes Goodwin and RBS wanted more! Some must have wondered what could stop the Scottish juggernaut.

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