Monday, December 22, 2008


Dear all, your Chairman and Board are happy to report our best investment returns again this year as ever - despite remaining well diversified in terms of concentration risks and to maximise our market turbulence gains, with zero exposure at any time to the wrong side of price peaks, or to any bursting asset balloon bubbles. Our investment strategy is not that of Berkshire Hathaway's fundamental values, but always firmly based on market prices. This is never a straight line expectations business, always steadily up by stages before finally zigzagging down fast. Ours is a chairlift & super-G giant slalom strategy (Alpine). We made good money on shipping stocks and gold in '07 and first half '08, swapped out and then shorted commodity shippers after June. In line with our Madoff principle that if we cannot explain how we make our steady but excessive returns you should not invest with us, we are happy to explain this year's strategy. The signs that this could be our best year were clear in late 2007. We leveraged and borrowed heavily, doing everything experts have been telling everyone has been the ultimate cause of the credit crunch. We borrowed stock to short-sell financials and other predictable fallers. We sold the company's and our shareholders' art collections. We did not engage in any complex hedging strategies, relying instead on business confidence survey data for our main leading edge indicators. As you all know we sold all our property portfolio in 2006 except for what was leased out at fully secure long term rentals. We sold shares and bought US 10 year and longer maturity AAA bonds gaining 62%. On UK gilts we made 64%. In the first half we did carry trade deals, borrowing in Yen and depositing in Australia, making 75%. We also rode the MSCI BRIC Index and the MSCO World index, making 38% and 72% respectively. We continued to short the S&P making large gains on 90% of deals. We bought oil futures taking 50% profit at mid-year when we sold, recognising that this had peaked as soon as Goldman Sachs made a simple straight line trend prediction. It was obvious at that very moment that oil was bound to fall and the dollar would peak rapidly. We next sold oil short making over 70%. Our offshore operations remained strongly in cash, while onshore was heavily borrowed. Once the commodity and emerging markets bubbles looked fit to burst in the second half, we got out of foreign equities and shorted whatever the excellent US retail statistics told us to. Certain stocks remained good value, however, such as Tunisa, some Central Asian stocks and Far East stock temporarily based on news, and any stocks with smallest free-float like Volkswagon and Hermes, making over 100%. The easiest bets were shorting the S&P and the FTSE in the third, and into the fourth quarters. During the year with sterling clearly over-valued, we rode the dollar as funds fled back to it, making 28%, and then shifted into Euro for another 20% gain, before liquidating all positions and buy long dated treasuries for a quiet Christmas and to lock in our 500% aggregate gains for the year including a final 12% gain on shorting the dollar in recent days, having recognised that it would not cross the long term 90 resistence level. Thanks to our buying several large shareholdings in banks that we very successfully shorted (either with derivative puts or CFDs according to the rules prevailing at the time, and never holding or going short more than 1% of any stock, a healthy, and perfectly legal, market practise) we are happy to announce that we have purchased more tax loss than required to offset all tax liabilities for this year, and that our current tax account is therefore showing a large three digit percentage profit. We also have a raft of 3yr corporate bonds from solid blue-chips paying 9% and similar bond holdings with banks where the bonds are guaranteed by Government. I am happy to report that shareholders have voted their full confidence in the re-election of the full Board and a vote of thanks to our esteemed Chairman, everyone's favourite Bank Manager, Mr Gale Gordon. All that remains therefore is for Hindsight Investment Securities Inc. to wish you all a prosperous 2009 when we fully expect the beneficial investment climate to continue for at least the first three quarters much as we have enjoyed the same in 2008! The US recession is already 1 year old, the UK recession about 6 months and we expect both to last another 9 months, possibly 12! Staff and managers and any shareholders who have signed the new zero funds withdrawel and 100% profits reinvestment clauses are welcome to join us at the company chalets at Val d'Isere, Gstaad and Wengen.

Friday, December 19, 2008


"On the thirteenth day 'fore Christmas my true love sent to me thirteen institutions voting, twelve funds dismembering, eleven registrars counting, ten shareholders leaping, nine directors dancing, eight managers bonusing, seven brokers selling, six citizens complaining, five legal rules, four billion puts, three commission judges, two governments fighting and a Bank of Scotland in a Bear Tree."
On that day, last Friday, of the HBOS shareholders’ meeting in Birmingham, just over 1% of shares changed hands in both Lloyds TSB and HBOS, enough for their prices to fall by 17% and 23%? HBOS attained the same price as that contemplated on the same day by the Scottish Government for a new bridge over the Forth! How to reconcile such equations in our dysfunctional economy? Obvious, we can’t! A natural response to the events of the past year, credit crunch, then recession everywhere, is to say, as many commentators have said in various ways, that irresponsible hubris has been unmasked and now we face the unpleasant truth of fundamental realities. But, that is like imagining there is something more true about the wreck of a car crash than the dangerous driving that caused it.
In the morning of Friday a truck was careering on the M6. This caused three other trucks and a car to crash. Several people were seriously injured and traffic backed up for many miles in both directions. The M6 was closed outside Birmingham for over 9 hours northbound and 13 hours southbound! How many shareholders were unable to make it to the meeting we cannot know. It may have made no difference to balance of the vote, since that had been managed, counted and receipted days earlier.
When the six stalwarts of the Merger Action group lost their appeal case over competition law on Wednesday and gallantly decided it was now up to shareholders to carry on the fight for the bank, they may not have realised the vote was already in the bag. Nearly all the voting was booked before the 12th. 46.5% of all shareholders voted for, 8.8% against, the takeover merger. Votes collected on the day were less than 1%. Nearly 45% of shareholdings failed to vote at all? Possibly half of the bank’s missing votes were shares loaned out, voting with their feet by selling the bank short in the markets! That was the amount on loan in June and July when the bank’s share price plummeted at the time of its botched share issue. There is now a much larger issue open over Christmas, but this time underwritten by Government. When shares are about to be diluted by new issues, it is a glorious time for short-sellers - traders who prodit on price falls. Stock markets have fallen all year, misery for investors, but for short-sellers it has been Christmas all year long!
Stock lending may in normal times of orderly markets be useful for reasons other than short selling. But, in a long falling market, stock lending is overwhelmingly for short selling. This is when stock is borrowed by one trader for a few days and sells into the automated markets where FTSE index funds and last week’s short-sellers are buying. When the price falls enough that day or next day, the trader who borrowed can buy it back for less than he sold it, keeping the profitable difference. We do not know how much of trillions wiped off share prices are short-sellers’ profits, mainly gained by hedge funds. We can surmise it is substantial!
Imagine all the giving and swapping of Christmas gifts as if a loan that cost more before Christmas than you would pay for the same in the January sales. If you have the receipts, take them back to the shops in January, and maybe you can buy something more or something better for less and make a profit. Short selling depends on the ease and low cost of stock borrowing for short periods of a week or a month. Borrowers require lenders. Stock lending is a practice with 200 years of history. It is over-the-counter dealing, which means it is not transacted via exchanges. It used to be an honourable business of a bilateral agreement between two parties. In recent years it has increasingly become a marketplace brokered by intermediaries, a divisional profit centre with banks and fund managers sweating their assets, like blinkered racehorses blind to others. Investment funds appear comparable to landlords renting out buy-to-lets for a month only to get them back trashed, costing far more to repair than the rent and deposit!
All we know about stock-lending is part guesswork. We know it can account for more than half of trading on the LSE and other exchanges. We also know that lots of small sell orders can move a share price far more than one big sell order. The FSA’s code and ban on ‘naked short-selling’ is a sick joke. In Europe and the USA there may be nearly $20 trillion of securities owned by investment funds that are available for lending for a short time, a week say or a month, for a small percentage fee. As we saw on Friday, it takes only 1% of shares to be sold for the share price to fall twenty times this! Shareholdings of 3% or more have to be published. The FSA requires short positions of 0.25% in bank stocks to be reported to it, but will drop this requirement on the 19th January. Such restraints on short-selling are a joke to all involved! More serious embarassment awaits the stock lneders if the FSA publishes its report about them. This may not happen, however, since the funds are busy remontrating with the FSA to drop the publication idea for fear of exposiing their (or more likely that of the custodians and collateral holders) stock lending 'strategies' - surely another egregious joke at impoverished shareholders' expense.
Another compelling report would be about shareholder meeting votes and how these can be very effectively 'managed' by the banks' board. There are rules for restricting the voting by funds where there is cross-ownership. This is especially importan in takeover situations such as Lloyds and HBOS. The few institutions (about ten) who voted more than half of the votes registered at the Lloyd TSB and HBOS shareholder meetings all have small 1-3% holdings in each other. This is one reason why financial authorities in Europe and at times in the USA too do not like bankassurance groups like Lloyds TSB with Scottish Widows or HBOS with Clerical Medical where a bank owns insurance fund subsidiaries, whose capital may count in the parents tier 1 capital and yet can also risk this while also trading, including stock lending and borrowing of its parent’s shares. If small shareholders and the general public were to become truly aware of the cabalistic machinations available to, and practised by, large financial groups in organising the result of shareholders’ votes… sorry must go catch and stuff the turkey, happy Christmas to all, and a prosperous… and so on.

Wednesday, December 17, 2008


I write this listening to Sir Victor Blank on Radio4 blaming American sub-prime issues by Investment Banks for unforgivable irresponsible behaviour, not banks like his. He says his banks lending is only in the business of lending to those who can repay. He does not mention his bank's loans to American Special Purpose Vehicles who managed and issued the sub-prime and other securitisations. This is followed by William Haig and David Cameron breathlessly and wholly unrealistically attacking the Government for the chaos in the housing and financial markets. Victor Blank had said the first quarters of next year will be especially difficult and house prices are expected to fall another 10%. This sounds like a short and sharp recession. All these are matters examined and accounted for in banking regulations, especially Basel II. A long term friend and colleague, in Brussels, commented that FSA 'waivers' (regulatory licenses approving compliance with Basel II, CRD etc.) for banks, fund managers and insurers can be granted like backstage passes - nodded through by the theatre impresario, not perfect, much more work still needing to be done, risk still a silo culture, not yet fully imbedded in banks, for many a bridge too far etc. An underestimated issue is how everyone understands banking finance and risks graphically or pictorially. However well we define matters in words and mathematics, as every architect knows, ultimately we need pictures too.This got me thinking, beginning with a J.S.Mill view that may be obvious: conditions necessary for our everyday freedoms also facilitate private enterprise crime. We need our human, democratic and libertarian rights etc., to protect us from government and corporatist caprice. But, this is also a balance between public sector and private sector 'criminal behaviour'. David Cameron, Conservative Leader, is doing his best to be populist about credit crunch recession, most recently to lead the mob baying for criminal arrests and punishment of "irresponsible bankers". Madoff's pyramid of $50bn losses is a symbol of symbols for this. But he was not irresponsible; he was criminal. He banked his reputation, trust, confidence, status and created a discrete but massive business alongside his two (or more?) other alternative investment firms. The $50bn reputedly lost in his fradulent non-investment scheme ranks alongside Drexel BL, LTCM, Enron and Worldcom if few others as the world's biggest white-collar crimes, with numbers one associates with the losses of Citigroup, UBS, Lehmans and a host of other banks. MADOFF pretended he could operate in the top decile of hedge fund performance, but proposed instead to only deliver modest but steady returns, and not to charge a fixed fee. He was in fact far below the very bottom decile oh hedge fund performance? How the money was 'lost' remains a mystery. Was it all paid out back to investors as performance returns? Madoff falls into the category of rogue trader or fraudster or operational risk. He is not representative of so-called irresponsible bankers, that epithet belongs to the professionals who invested in him without full due diligence. They can however use the excuse that the SEC's regular due diligence did not uncover the truth either! Fraud and credit crunch do overlap when it comes to misprepresentation. There have been about 300 FBI arrests in the USA so far connected to mortgage fraud and credit crunch matters including at Bear Stearns and other substantial major firms. The main crime is insider trading fraud; saying one thing in public or to clients and something else to friends. There are hundreds of major lawsuits based on 'knowingly giving false assurances and advice'. Little approaching this scale is happening so far in UK or EU. Yet, the Capital Requirements Directive (BaselII regulations) in the EU are law. Not just firms are culpable for breaches, directors and other key individuals in banks and other financial firms are personally liable for breaches of the law. Checking lists of banks' risk officers from only a year or two ago, one can see that in the last year many have either been moved, fired or resigned. CEOs, Chairmen, FDs, other directors and heads of structured finance etc. who have 'gone' is not a short list. If hauled into court, as in the US, they may appeal on the grounds that the accounting systems didn't work or the regulatory supervisors gave them a green light or it was all too much for anyone to fully understand and be responsible for. Just as they transferred credit risk they know how to transfer blame. Solid prosecutions may require 'smoking guns' and hands caught in the cookie jar? We have yet to see anyone arraigned for not complying strictly with regulatory reporting rules. The pace too at which bank officers were moved around without sufficient desk time in any one job to be culpable, not least given the amount of discretionary interpretation allowed in key aspects of Basel II (Pillar II especially) means that prosecutions will be harder to achieve, costing cost a lot of time and money (halcyon years for corporate lawyers) and for this reason alone may not come to court.
The Bank of International Settlements, the author of Basel II, headquartered in Basel, Switzerland, heroically built a wonderful set of regulations (many thousands of pages, hundreds of papers) with a mind-boggling pedantic thorougnness and intellectual brilliance (I say this as one of very few who know and understand most of it). But, compromises, trust and confidence in the managerial and intellectual competence of banks and their accounting systems, have inevitably allowed many degrees of freedom, latitude to game the regulations. But gaming regulations is the elastic least of it. Gaming regulations is a complexity that exists in all markets and around all tradable instruments. Failures in the quality of markets is possibly more to blame for the present crisis than irresponsibility of financial firms, banks and hedge funds and so on. That nearly all of capital markets is over-the-counter i.e. not transacted through fully regulated data reporting exchnages, that equity markets have been shredded, that credit derivatives, stock lending, short-selling, dark pool, internal and external crossing networks, hedge funds and 'shadow banks' are all well hidden from public scrutiny. Basel II and its related regulations do not address regulatory rules and reform of how financial markets function, not directly, only the financial resilience of individual banks, retail fund managers and insurers. How market functions is the responsibility of exchanges, and or exchange members, and other 'stakeholder' authorities can have strong influence.An important aspect of all this is how to understand the extremities of risk. Last week at a gathering in Zurich, at the Swiss Federal University of Technology (ETH), Einstein's alma mater, we listened to mathematics professor Paul Embrechts who, in the regulatory context, is one of the most impressive risk experts in the world. His close colleague Alexander McNeil is professor at Heriot Watt, Edinburgh. Over the past decade they have progressively succeeded in convincing leading banks to rely less on mechanistic maths and fixed assumptions when analysing and calculating risk values. Their thinking and that of Claudio Borio at BIS will become more central central to the further evolution of Basel II (EU's CRD), Solvency II, and IFRS, rules and regulations - displacing Black-Scholes inspired formulae, discredited when LTCM collapsed, and direct descendants that assume a fixed or symmetric or Gaussian shape to increasing and decreasing risk. If you want the detail trying googling or wikipedia. What can be represented with clean two dimensional precision in mathematics is of course more complex in human-centred, stochastic and probabilistic, not like natural science or enginering realities, that are repeatedly reproducible. Essentially, the bell-shaped Gaussian image of risk ranges from highest return in normal expected conditions to embarassing losses in extremely unexpected conditions. When interdependence is important, the pattern represented as a Gaussian normal bell curve with thin tails may be contrasted with empirical observations of fatter tail risk events - at first glance, this may obtuse, abstract, and not very important, as the two curves shown here do not appear to be that different. But on closer scrutiny, there is an enormous difference. The “tails” of a fatter tail curve — the regions to either side that correspond to large fluctuations — fall off slowly in comparison with those of the Gaussian bell curve. These so-called fat tails imply that large events take place far more often than one would expect on the basis of “normal” statistics. In the case of market fluctuations, for example, the bell curve predicts a one-day drop of 10 percent in the valuation of a stock just about once every 500 years. The empirical fat tail statistics gives a very different and more reliable estimate: about once every five years, and 'unexpected' risk becomes 'expected' 100 times more often.
But, for the sake of factoring in guman subjectivity, let's go further. Replace the abstract curves with another more mesmerising set and you come closer to what bankers see when they focus on short term profitability attractions leading to irresponsibly ignoring the tail risks, the unpredictable risks of instinctive and reactive legs and feet, say? Banking is part of the economy. It is a machine and a system, but also red-blooded people-centred, and rarely especially politically-correct. There is only so far that risk analytics can go mathematically. Capital buffers, risk margins, are required to cope with the unexpected. But at the same time banks have to deal with competitive pressures and market prices. These can become dominated by short term profit-takers over long term investors - a an enormous conflict. Short term risk trusts in liquidity changing very little; the speed at which one can buy is the same speed at which one can sell. When the world was clamouring to buy asset backed securities (ABS) investors did not check whether selling would be just as easy. The ABS markets grew phenomenally market as a seller's, but were never tested by a buyers' market, by a downturn, a loss in confidence until suddenly in 2007. The rapidity with which what could be bought and pledged as collateral, was suddenly followed by a market in which no-one would buy except at enormous discounts. Markets can under-price risk. However sensibly banks manage their risks they are at the mercy too of markets behaving less than rationally about the totality of the quality of the maarket. Where major firms and reputable traders go,many others blindly follow. This too is what Madoff relied upon, his 50 year long reputation as a sharp cookie and a market insider's insider. The ethos of financial regulation in recent decades has been to say fix all we can but "let markets decide the rest"! This vests a lot of trust in those who are the hard-core of market traders. Can financial services firms be blamed for trusting in the ideology of markets and market-traders know best for igniting their own nuclear winter or are they victims too? It is one thing to understand banks as individual firms, with all their subsidiary business and profit-centres and individuals within them, quite another to understand them also as part of a total financial and economic system with all the interdependencies between banks and other financial service firms. Copula definitions, principles, warnings and prcepts can be simple or complex and are not yet commonplace in financial economics textbooks. The simplest kind critiques by Embrechts and McNeil and others are a stationery distribution of expected and unexpected risk along the bell-shaped curve that attempts to account graphically and fully for correlation covariances among risk factors determining the outcome of financial exposures. It also has the advantage of actually admitting that there are unexpectedly extreme shock events than (Gaussian normal) underlies Black-Scholes, by admitting the stylized fact that all asset markets exhibit "fat tails" or kurtosis, i.e. in an area beyond where normal risk cover is available - to produce suddenly far larger losses than any firm is prepared for (other than when market and economic conditions are near normal and not 'disorderly', panic-driven or 'turbulent' to use another now common expression). Copulas need an economic cycle dimension. It turns out, these are quite insufficient to deal with the multi-interdependency links driving the events of the last two years, with most funds and banks getting into trouble and losing on average twice their reserves to paper losses and at least one times total reserves to net economic losses. One of the Zurich conference participants was an econophysicist, Didier Sornette, who runs the "Observatory of Financial Crises." He made some not quite accurate forecasts (see "Econophysics and Economic Complexity," at, but described the problem of Gaussian bell-shape curves applied to individual transactions, and banks' portfolios: they don't take into account of 'herding' responses, which is where traders and investors follow the market in directions that do not fit with fundamntal risk analysis. Herding effects are why risk models, however used, did not predict the liquidity crisis or that a 10% fall in a market could happen not just on one day, but three days in a row. Crashes are predictable, but not long persistent repeating crashes. So again, another defence for the 'guilty' irresponsibles is that risk models, even the best, weren't up to the job of a 1 in 100 crash. Prof. Alexander McNeil makes some important corrections to the story I offered above:
1. The influence of the academic gnomes of Zurich in promoting the use of copulas is overstated. Paul Embrechts and I would consider our role to have been in showing the problems associated with applying Gaussian thinking in a financial world that is manifestly non-Gaussian. One problem of Gaussian thinking is an over-reliance on the concept of correlations for describing dependencies. In our hands copulas were tools for revealing the fallacies of Gaussian thinking and the pitfalls of a reliance on correlation.
2. They have a role in building models for particular financial modelling applications, but were never viewed as any kind of panacea.
3. I would say that we were surprised to find copulas being adopted in the world of
[Collateralized Debt Obligations = general term for banks' Asset Backed Securities]CDO valuation, particularly as the copula which came to dominate market practice was the Gaussian copula. In CDO valuation the use of copulas is purely for reasons of convenience.
Professor McNeil usefully also draws my attention to the difference between copulas and copulas, something I confess to having neglected hitherto:-
4. Best not to conflate copulas and cupolas. The former were originally
objects in grammar, verbs like 'to be' and 'to become' that perform a specific linking role. Likewise, in the theory of probability distributions, copulas perform a linking role - the maths is actually pretty simple. Cupolas don't need further elaboration but do carry unfortunate connotations of bell shapes and, by extension, Gaussianity.

This at last explains why I do not find cupola graphic charts in McNeil & Embrecht papers! Now back to Bernie. Bernard Madoff, former chairman of the world's second biggest stock exchange, NASDAQ. Bernie (bailed for $10m) was turned in by his sons, Mark and Andrew (also arrested) on Thursday, one of whom was the compliance officer. His hedge fund, Bernard L. Madoff Securities LLC, was declared insolvent with estimated losses of $50bn and bernie is charged with 'securities fraud'. This reflects badly on the Securities & Exchange Commission, SEC, which has u-turned a couple of times on hedge fund transparency. The SEC did seek more reporting oversight but was frustrated over a year ago in Federal Court. Madoff did not have to cheat anyone, least of all with so much funding (1-2% fee plus 20% of profit). He produced modest, steady returns for clients, claiming to be profiting by trading in S&P’s 500 Index options, and closing all positions prior to mandatory reporting dates so that investors had no window into the fund’s holdings. To professional examiners, the steadiness of the returns should have been a clear warning! Betting the index would have meant sizeable short term derivatives contracts on the Chicago Mercantile or other comparable options exchanges. The S&P500 has been volatile. It should have been easy for any financial professional exposed to Madoff's fund to check on that? Banks in UK, Spain, France, Switzerland, Italy, Belgium, Netherlands and other countries have potentially lost $billions. They loaned money on the strength of collateral in the form of Madoff certificates. Madoff also managed funds belonging to charities and was quite charitable to good causes himself, apart from just himself. Apart from individuals, charities and numerous "funds of funds" investing in hedge funds, banks such as HSBC Holdings PLC (ADR: HBC) and Banco Santander SA (ADR: STD), lent $billions to investors participating in Madoff's fund, secured only by holdings in th fund. SEC failed to protect investors. To some commentators it is shocking but not surprising that the losses could be so much as $50 billion, given the excessive growth of hedge funds. But, it is shocking and surprising to me. Everyone knows that hedge funds have not been reliably great performers. In 2002 returns were in small single figures and many have struggled ever since then. It is surprising that it was possible for any experienced investment manager to lose so much. It may be less surprising that major investors were trustingly naive. Madoff could be very convincing after over 50 years of winning other people's trust. Investors trusted him more than they would anyone else of their country or mid-town club set teeming with investment advisors. It is expected that charities should be unworldly and easily seduced by a great sales pitch. But, actually charities and their advisors can be as hard-nosed as any. The main investors were other hedge funds, who bought off screens analysing hedge fund performances using data not publicly available or full audit-checked. This raises a daunting question: how savvy are the big hedge funds? Modern-Day Ponzi (pyramid-selling) Schemes are a well-known (like the innumerable boiler-room scams) and the SEC has great experience unravelling them. But like all internet frauds, they are like Japanese knot weed; for every one closed down several more pop up. It is an endless and disheartening task to stamp them out. Ponzi schemes are fairly easy to detect by any reasonably suspicious professional. If offered an investment opportunity you simply keep asking questions of the promoter until you are absolutely confident about how the money is made. This may seem technically obscure, however, in the case of market indices. After all, Nick Leeson was able to fool his bosses at Barings and thought he could full the floor of the Simex about arbitraging the Nikkei index. I cannot believe that what Madoff was doing, if he ever did buy derivatives contracts would not have been known to others on the exchanges including the many Chicago 'own traders'. The rule should be if you can’t figure it out, you don’t invest, and take advice. Finance is an area in which there should be no impenetrable mysteries, and none to experienced and competent professionals. It is also worth noting that no-one has consistently profitable insight into a whole market index - why no-one on the floor of the Simex believed leeson and took him to cleaners. Leeson exposed his own bank's management incompetence. Madoff has exposed a swathe of similar incompetence among many banks, hedge funds, other investors and finance and regulatory professionals who ought to have been trained to know better! In the emerging capitalist markets of 1990s Eastern Europe, pyramid schemes were a known hazard. Victims were deluded about how capitalism worked and regulation was weak. The MMM scheme in Russia collected $1.5bn, Caritas in Romania collected $1bn, and in Albania in 1997, the banking system and government collapsed under a $1.2bn pyramid fraud. In the West, Enron and others operated in effect similar schemes insofar as they created circular ways of artificially inflating their profits and disguising their debts and losses. There have been thousands of cases of mis-selling and of dumping proprietary losses into client accounts and of preferring bigger clients over smaller clients. These can be described as partially-Ponzi. Two groups of investors appear vulnerable - rich club member types who trust in personal “connections” – and another type beloved of Swiss private banks whose dubious, criminal or tax evasion money is handed over on the strength of conspiratorial assurances by people who neither understand nor care about how investment returns are generated or whether they are relatively high or average or low. They avoid professional experts and specialists and buy 'mickey mouse' retail products from people whose “connections” appear to provide an “inside track” not unlike ractrack tipsters. Madoff, as a former chairman of NASDAQ with a charming personality, was qualified to appeal to gullible rich. Charities and others who don’t pay enough tax can be readily seduced. Ponzi schemes were enormously boosted by derivatives growth in the '80s and '90s. Even if clubbable investors, those with power of attorney and trustees have some idea how bonds or stocks work, many, even financial professionals, mentally cloud over when derivatives and trading strategies are described. Madoff was able to blow smoke'n mirrors. Private partnerships do not have disclosure rules comparable with public investment funds, and did not have to disclose trades or show accounts of any details about his trading methods. This does not explain or thereby excuse the gullibility, even culpability, of professionals managing hedge funds and “funds of funds,” or loanbooks who loaned to Madoff's victims or invested in his schemes. These people who are themselves inordinantly well paid perhaps believed excessive management fees buys superior investment, but they are no better than boiler-room scammers. They should be sued for failing in duty of care. It is not enough either to blame the “get-rich-quick” gold-rush fever or epidemic of 13 years of easy money and lax regulation. Professional investors and advisors failed in “due diligence”. They deserve to be sued for failing in fiduciary duty. If investing their own money, they deserve to be pilloried for crass stupidity and incompetence.

Sunday, December 14, 2008

The Decision & the Consequence

Terry Murden, in an otherwise excellent comment ("Now the HBOS deal is done, the anxious wait begins for job cuts" Scotland on Sunday, 14 Dec.), states what may seem plain fact that "the real alternative to Lloyds TSB was the complete failure of HBOS." But, it was never that simple. It is not a view of the accounts, not even given the loan defaults in 2008. These are only 1.5% of the bank's assets,half of which should be recovered. "Failure," commonly understood, means 'bankruptcy'. But, there are no hard facts supporting this. Lord Dennis Stevenson said the bank was brought low by a liquidity problem. Wholesale funding is expensive, but so is it for most banks. The interbank market is lop-sided, borrowers outnumber lenders, hence the Bank of England's interventions. HBOS has substantial drawing rights at the Bank of England and the offer of a large Government stake (1). Its balance sheet is better than others. It could have stayed independent. But, after a botched share issue and attacks by short-sellers that still continue, management panicked and agreed a firm deal with Lloyds TSB, brokered by the Prime Minister. Decided in haste, this will be repented at leisure.
The consequences are 20,000 - 40,000 job losses, sell-off of HBOS busines assets, (some possibly to firms that Lloyds has dealing with and investments in), more severe book writedowns and integration of both banks operational systems. Of the 145,000 staff of the two banks voluntary redundency will see about 14,000 go. Another 8,000 or so jobs will go possibly with the sale of HBOS subsidiary businesses. But, on top of that it is conceivable thre will be 20,000 involuntary redundancies!
For more on the decision and the consequences see
(1 ) £38bn available as draw-down funds. At the time the Government's recapitalisation was announced - £37bn of taxpayer funding for HBOS, Lloyds and RBS - the Government said it would make another £25bn available next year to the clearing banks. On 18 Nov. 2008, the eve of the Lloyds TSB shareholder vote on 19 Nov. in Glasgow, when 95.8% for the takeover of shareholders voted for the takeover, the Government (Chancellor Darling) concentrated minds by firmly stating that the merger is a condition of Lloyds receiving £5.5bn of state money and HBOS £11.5bn, and this also days before RBS shareholders vote on its £20bn bail-out (and this was also when Barclays was under the stress of stinging rebukes from its shareholders for having preferred more expensive foreign sovereign investors to UK Government investment.)
Partly to avoid referral to, or blocking by, EU Competition law and single market principles, The statement spelt out how any new bank bail-out will be more punitively priced than the existing deals. The preference share element of the recapitalisation will "be based on prevailing market conditions, with due regard given to the rate at which eligible institutions have announced the issue of such instruments most recently". The coupon on Barclays' preference share instruments was recently priced at 14pc, plus a substantial fee, compared with the 12pc for the state rescues of HBOS, Lloyds and RBS. The Treasury added that any new capital raising would be done at a discount to the current share price and that the discount was likely to be more punishing than the 8.5pc in the agreed deals.
The Chancellor said: "To the extent that HM Treasury is asked to underwrite an offering for ordinary shares, the price would be at a discount to either the market price or, if applicable, the placing price agreed on October 13, whichever is lower. The percentage discount would not be less than the percentage discounts applied in transactions already announced." When HBOS and Lloyds seek to raise new equity from shareholders and refuse some of the offer, this will be bought at substantial discount by the Government as effectively the 'underwriter'. This likely to be so and leave the new Lloyds Banking Group more than 50% owned by the Government. Lloyds' circular in advance of its own shareholder vote warned that, should the merger deal be blocked, the Financial Services Authority would require it to raise £7bn, and HBOS would need to raise £12bn as a standalone entity.

Saturday, December 13, 2008

Death of a bank: the downfall of a Scottish institution and how it happened

INEVITABLE, and shocking. Overwhelming, and shocking. Humiliating, and shocking. At 12:40pm yesterday, the last of HBOS's shareholders threw in the towel and voted to accept the takeover bid from Lloyds TSB. And less than an hour later, at 1:30pm, I cast my own vote of sorts. I made my last cash withdrawal from the Bank of Scotland, as we know it.This was more than a gesture for me. I have had an account with the Bank of Scotland for 53 years. My father took me to the local branch of British Linen and opened an account in my name. That was a day of pride. Yesterday was a day of infamy.I had never thought, over that half-century, that I would ever outlive what was always more than a bank. It was part and parcel of being a Scot, and of Scottishness. And when I moved to London, I banked with the Bank of Scotland in Threadneedle Street. I loved its tradition and its "differentness". I wrote its cheques with pride. So yesterday, for me, was more than the loss of a bank through a merger. It was the loss of a constancy and the passing of an identity that had outworn and outlasted and endured through all the different phases of my life. I feel sadness. Millions of Scots will feel that. But I feel, too, a great shaft of anger.It is not Lloyds that has stolen the bank. It was lost on our watch and through lack of vigilance. It was lost through some of the biggest and most ruinous misjudgments made in the history of Scottish banking.In the scramble for mortgage market share, the leveraging up of the loan book, the crashing through of long-standing ratios of debt to income and loan to value, the concentration of corporate lending in building and property development and, through all this, an insouciant insistence that full provisions had been made and that it was only the stock market that had got it all wrong, the result is not just a capitulation but a Culloden. Yesterday brought a trading update revealing a near doubling of bad-debt provisioning in less than three months that was nothing else than utterly shocking.It is hard to recall that, less than ten years ago, the Bank of Scotland had one of the best reputations in British banking. Under Bruce Pattullo, it expanded and innovated but maintained throughout a firmness of vision and purpose. There was no diversification into estate agency or stockbroking or whatever passing fad had ramped up the prices of these trophy assets at the time. Pattullo saw through all that. And the analysts, fund managers, shareholders and customers deeply respected him for it.Under his stewardship, the Bank of Scotland was the first to raise a rights issue without any prior underwriting in place – such was the confidence in the bank's record, its management and its clarity of purpose. Yesterday, we handed over the wreckage of the ensuing nine years. With that trading statement and the vote that followed went 300 years of Bank of Scotland history – through wars, European revolutions, depressions and booms. The bank could manage those. All of those, in fact, except the vainglorious pride of today's generation of executive bankers and a bonus system that lit the road to ruin. Seldom has a board of directors left the platform of a public company with such a trail of devastation behind them. And seldom has the word "sorry" been used so cheaply. Sorry doesn't cover a fraction of the havoc these people have wreaked, and the institution they have destroyed. Were the directors victims of an epochal storm that few ever expected would hit global finance? Up to a point. But not all banks have been brought to their knees in such a humiliating manner as HBOS. Its shares have collapsed by 90 per cent. The collapse has been intense, and the speed terrifying. But seldom has a board of bank directors grown more slowly wise to the enormity of the crisis that hit them. Andy Hornby, the chief executive who presided over this catastrophe, is to be retained by Lloyds on a salary of £60,000 a month. Have we totally lost all sense of humility and shame? This surely, is a contract that will live in infamy. Now, with the bank's balance sheet shot to blazes and its shares plunging further, it deigns to tell 2.1 million shareholders: "Sorry." It is beyond despicable. After all this, ownership by Lloyds should be a relief. Ironically, its conservative banking culture is reminiscent of that of Pattullo at his best. But that did not make this day any better or easier or more acceptable. Sorry? That's the very least I feel today.


HBOS's 5.4 billion shares are owned roughly 30% by 10 institutional investors, notably Legal & General, Schroders, M&G (Prudential) and Standard Life with 3% or over. Only about 300 people turned up at the general meeting. There was a major traffic accident on the M6. To account for this, the meeting's start was delayde by half an hour, though this was hardly long enough delay for the hundreds or thousands of motorists delayed for hours. If these were mainly small shareholders, even if they had all turned up, their votes on the day would still have been too small to make a difference, even when a holder of 100 shares counts as 10 million shares for the purpose of determining the simple majority of shareholders.
Overall, 56.5% of shareholders voted, most online and by proxy. The rule is that at least 75% of shareholders who vote their shares must approve the board's resolution on the takeover by Lloyds TSB and there must also be a simple majority of share owners. About 84% of the 56.5% of individual share-owners voted yes and 98.4% of all shares that voted. This means that the takeover and its consequences were voted for by 55.6% of all shares and by 47.5% of all share-holders. It is perhaps surprising to most readers, given the importance and the publicity attaching to this vote that almost half of all shares and less than half of all shareholders have not bothered to vote! If the rule had been that more than half of all shareholders and 75% of all shares had to vote yes to allow the bank to be sold, then the board's resolutions would have been lost!

Friday, December 12, 2008


HBOS say 98.4% voted for the takeover, comfortably above the 75% it needed for the capital raising although for the takeover it must also win support from a simple majority of shareholders as well not just weighted by their shareholdings. Before the meeting opened the bank received indications and proxies indicating it had 56% majority for a YES vote.
For an indication of how sensitive share prices are, both banks shares fell steeply, by 23% and 18%, on just over 1% of each bank's shares changing hands. The share price fell mostly in the morning even as HBOS reported it would win approval for the takeover by Lloyds TSB. Just over 1% or 3m and 80m shares of the 2 banks, enough for HBOS's price to fall 23% to £3.65bn at 67.5p per share and Lloyds TSB shares fell 18% to 129.9p. By market close the revised bid HBOS shareholders will be offered 0.605 of one Lloyds share per HBOS share is worth 78.6p. Yesterday the offer was worth 95p.
The bank's early statement was "HBOS welcomes preliminary voting indications received from HBOS shareholders ... (which) show overwhelming support for the transaction," HBOS said it would publish final voting figures before the weekend.
At around 15:30pm the general news reports confirmed that shareholders overwhelmingly agreed the takeover at the rain-sodden general meeting in Birmingham's conference centre. Voters could only agree YES or NO. But with large shareholders all in support and it seems most small shareholders too, the leafletting by UNITE trade unionists were aimed more at reminding shareholder of that there are thousands of jobs at risk.
HBOS shareholders also approve the £11.5bn taxpayer-funding. Based only on votes cast before the meeting in Birmingham, YES was supported by an 84% of individual shareholders, or 98% by the value of shares voted. This forecast was based on proxy votes received - the highest ever for an HBOS shareholder meeting - representing over 56% of the bank's issued share capital by value, but not by voting power. STV reported that all resolutions were passed by a majority of 99%? It too reported that the bank's results were a "surprise" to the City. Hardly, I should say, not a surprise to anyone ! The chairman of HBOS apologised for the bank's plight. Dennis Stevenson said the board was sorry about the crisis and he is "neither happy nor proud" - the world is in "the most pronounced financial crisis since the Great Depression" and, he said mournfully, HBOS faced conditions "frankly more difficult by the day". He added (in implied reference to MAG)"I cannot say too strongly that your board looked at every possible solution... we do not cede our independence lightly."
HBOS shareholders will have just a fifth of the new bank. Of the Government's banking rescue, Mr Stevenson said, "Overall, I applaud the intervention of the UK Government... it was the right thing to have done."
Andy Hornby, the much derided chief executive of HBOS Plc, not least for his £3,000 per day consultancy fee once the new bank forms, told the meeting that the Lloyds TSB deal was the best option for shareholders. "I would like to say sorry for the anxiety our shareholders have felt during this exceptionally challenging period for HBOS." That is the least he could say and the least to be said. He outlined three reasons why the takeover "made sense". First, shareholders will benefit from the synergy of the combined HBOS and Lloyds group. Does this also mean its dominating market share? Second, there will be greater financial stability as a result, and third, access to wider funding services would be available. This does not follow as a factor of size, but of course instantly the £10bn loan to HBOS from Lloyds and whatever other loans and obligations both ways between the banks are immediately vapourized, 'saved', internalised. He continued, "The large group expects to have excellent breadth and balance. This breadth of business is a vital attribute especially in the increasingly uncertain environment. In summary, we believe that the Lloyds acquisition will be in the best interest of our shareholders. We are proud of the heritage of our company and its individual brands.
The last 12 months have been an exceptionally difficult period for HBOS but we believe the Lloyds deal provides the best solution for the shareholders
." How often in how many banks have shareholders heard the same assurance and not trusted one word? My word is s my bond has become my word is only as good as my asset backed securities. Questioning the panel, a shareholder. Mr Peter Hapworth said he was "appalled" at how HBOS had been run in recent years. "Let's face facts, it is a bank like yours along with a number of other banks that have caused the crisis in the first place. You all went dashing for short-term gain to fulfil bonuses and salaries."
He said the banks are trying to hide behind "the crisis that they had caused... The banks have taken out money on profits which were fallacious. I cannot believe that you as chairman, the directors, non-executive directors, did not know what was going on. If you did not understand what was being passed around in parcels of debt you were not acting very well in the interests of shareholders or doing your jobs properly."
He asked the panel if the money paid in salaries and bonuses would be put back into the company? Mr Stevenson replied, "I understand why you made these observations. I do not agree with all of them, but I can understand because it has been completely horrible for shareholders not just in our banks but virtually all banks in the world and it is wholly reasonable to examine us and hold us to account for it." Hmmm, I can think of a few banks like HSBC that seem to have performed far better! Stevenson said HBOS is a business in which executives had received bonuses on "real profit"; executives had put money from bonuses back into company shares. "Our weakness has been our access to wholesale markets which is not about capital but about liquidity. It is liquidity that has been our problem not capital. I am not proud or happy to be where we are." This confirms what I and others suspected that especially when the share price is falling faster than other banks, or the accounts are suspicious, it become harder and harder to borrow from other banks at an economically efficient price. Stevenson said the board had focused on "nothing else but the best solution for the company's shareholders". Well, this was surely not so after September 16 and the firm agreement to be taken over by Lloyds TSB. All they have done since is say and do the minimum beyond defending that decision! Shareholder Mr Malcolm Cheshire asked why the name of the new group did not reflect the acquisition of HBOS, which we may surmise is a matter of pride in Yorkshire as much as in Scotland. Mr Stevenson said HBOS had no direct control over the name of the new group.
A few HBOS employees (out of only 300 attendees) may have been inside the meeting. Many employees are shareholders, but most would have voted online (assuming they understood this to be totally confidential) as I doubt they'd have got the day off to go to Birmingham? As a small shareholder with over 100 shares, according to HBOS's voting rules that counts the same as 10 million in the takeover vote, or so I'm told! And, I cannot believe HBOS employees overwhelmingly voted yes?
HBOS shareholders met in Birmingham to vote on the takeover deal with Lloyds TSB. Ahead of the meeting, Halifax Bank of Scotland said it was operating n "increasingly difficult market conditions" and bad debts were rising. What a daft statement - everyone knows that and every other bank is experiencing that too. Why say it unless you want to force the vote by another hit on shareholder value - and sure enough the totally unnecessary gloomy outlook sent HBOS shares tumbling 20% in morning trade. They may be back up by teatime, but in the meantime this gives shareholders another kicking to ensure they do what management advise them to do after the takeover deal has already been backed by Lloyds TSB shareholders, and most analysts fully expected HBOS shareholders to follow suit. In its trading update, HBOS said that bad debts and losses on assets had risen to £8bn ($11.9bn) in the first 11 months this year, up £3.2bn since end-September (only 0.5% of assets and general defaults of only 1.3%), hardly dramatic in a recession and indeed better than others - just par for the course. And why not add that as normally expected we will in time directly recover more than half of these current losses, or how about we expect recovery before end 2009, or we are at, or near bottom and from here on in the way could be up. Or, non-performing and impaired loans fall well within our expectations at this time and well within our reserves (let's not forget a £37bn drawing facility available from the Bank of England just for HBOS when needed!). Bad debts on corporate loans jumped to £3.3bn from £1.7bn. Anyway, shares in HBOS fell 17.4 pence, or 20% , to 70.2p in morning trading - how convenient. The management state, "Global market and economic conditions, UK recession and increasing unemployment will continue to present a particularly challenging operating and credit environment." Goodness me! Every statement by every bank says this. It has the same weight as "past performance is no guarantee of future performance" etc. Prof. Stephen Hawking's computerised speech machine sounds more warmly human than this! The 'spineless' management whitter on in the bank's last public outing as an independent force (no words for 313 years of history ("A friend for life"?), in fintech-speak "However, through the injection of capital and liquidity facilitated by the UK government, both currently and going forward, HBOS remains confident in its ability to navigate through this difficult period, as it becomes part of the enlarged Lloyds Banking Group," so that's alright then, another hackneyed phrasing.
I read an inspiring piece weekas ago in The Scotsman about how vital our banks are to the cultural as well as the business life of Scotland. Looking at HBOS management and their statement, who'd know? The takeover was personally brokered by the Prime Minister Gordon Brown (and LLoyds TSB Chairman Victor Blank who insisted on no referral to the Competition Commission or "no deal"). Government therefore green lighted the takeover ex-referral (officially unofficially for weeks and then finally only truly officially on 31 October) after Baron Mandelson found a moment the previous afternoon to consider the matter 'thorougly' without 'fettering' by any other decision-takers or decisions-taken, while outside his window thousands of women demonstrators called for equal pay, and bad news came in on the wire from Russia (troop movements into S.Ossietia) when he had just been 4 days in Moscow trying to mend fences and stop this kind of militarism, and then too while all the day personally answering thousands of Dail Mail readers' emails and faxes before going on to the Guildhall for speeches, including one by him, and dinner. In some interlude snatched from between all this he asked Humphrey and Bernard if all is as it should be and where do I sign? The decision had long been made for him, even specially legislated for only a week earlier. What else could he do but sign. Why bother asking any searching questions like what else could be done? Anyway, as he said, "preserving the stability of the financial system" outweighs any potential anti-competitive effects. The stability won will be the creation of a banking giant with 145,000 staff and 3,000 branches that is hopefully too big to fail once the new 30-40% of UK banking bank dispenses with somewhere between 20,000 and 40,000 diligent or at least innocent employees - all in a day's busy busy Yes, Minister world.
UNITE the giant trade union representing many or most of the 145,000 bank staff involved protested at the LLoyds TSB shareholder meeting demanding they are recognised as 'stakeholders' too and appealing to shareholders to consider more than financial consequences. Similar protests are expected in Birmingham today, but so far news of that aspect is not getting out and about? For protesting voices at the Birmingham meeting see:

Wednesday, December 10, 2008


First in short order:- MAG's case painted a wholly convincing picture of a Secretary of State who can only have believed he had no other choices but to do anything and everything not to refer this merger of banks to the Competition Commission. No evidence at all was offered to prove that he could or did at any time consider alternatives. Government evidence admits that all opinions on the matter received by Lord Mandelson pointed one-way only (except a hint of scenarios by the FSA of how HBOS could prosper without merger). This 'all one-way only' and 'only option on the table' etc. one-dimension by itself, however, undermines the Government's defense while appearing at first sight to support it. Why, because it is impossible that there are no alternatives, and without them the Secretary of State cannot balance his judgement as he is legally (morally) bound to do. MAG's case failed, but if subject to the same tests so too should the Tribunal Judges's reasoning fail similarly. If the Secretary was not mentally 'fettered' he was surely logistically 'corralled' into a one way system! You can read of all this below in detail and at such length you better conclude that life is not too short for this, or that the fate of 20,000 employees and Scottish and other public interest warrants that you need know more. A 40 pages of Judgment was handed down caveated many pages in to remind us this judgement concerns lawfulness and not correctness of the Secretary of State's decision not to refer the merger of the banks to the Competition Commission. The result of that is a defeat for the appeal, which those of a more cynical persuasion than I may not be surprised at. What was the basis for M'Lordships' judgement?
It turned on the flexibility allowed to the Secretary of State in determining public benefit, the new public interest consideration under section 58 of the Enterprise Act 2002 as laid before Parliament on 7 October, House of Lords 16 October and the Commons on 22 October. It came into force on 24 October.
It is not the credibility or plausibility of MAG's case that can be doubted, and must seem so too to anyone who has followed this case - the remoteness of the possibility of such a purely lawful mind of Lord Mandelson - that is the story favoured by Milords' judgement - that MAG's case "fails" for contrary evidence that all was as should be, absolutely - rather than what seems more realistic, simply concluding "case not proven", assuming there can be such choices of verdict. But then, the Tribunal's job was to fully securitise and insure the Minister's assets by finding proof-positive that the Secretary of State had behaved lawfully absolutely, and not merely to judge if MAG could or could not either prove or merely persuade them otherwise. The OFT's firm and legally binding judgement that referral to the CC is necessary hung over the case like the political shadow of a hangman's noose. So the Tribunal had to find positive absolute evidence of the Minister's fully lawful behaviour and process, nothing less. But to do so required a long stretching of spectacular quantities of credulity not to see the overwhelming obvious fact that the Secretary of State was out on a limb where if he had two choices the difference between them were extreme and personal, his political life or death, and the clock ticking! How much imagination does it require to see that a decision to refer the merger to the CC would have invoked the pitiless wrath of Lloyds TSB and HBOS boards, political bosses, and who knows who else, the newspapers certainly (the scope for derision of a minister passing a law one minute to do x and then next minute deciding to do y, how funny), maybe the markets might decide another short-selling spree, or maybe, just maybe, some voices might think 'oh, a man of sound principle', while others would scream 'government confusion, Nero fiddles, Rome burns!" Of course, the man was fettered, and indeed QC Forrestor acting for MAG said so, and felt some sympathy for his awkward position, any other view is just nonsense! The judges conclude that MAG's evidence fails to be sufficient for not being absolute, a standard of proof that would be reasonable in a capital murder case, but not in the circumstances here. This is where the Tribunal's logic fails - so far as I see it, but I'm a banker not a lawyer.
MAG's case was that this order should not be applicable retrospectively to a merger bid that is conditional on non-referral to the Competition Commission (CC) agreed to weeks earlier and so adamently and publicly supported by the PM & Chancellor since then that it is inconceivable that Lord Mandelson was not 'fettered' in his 'Decision', which only he is entitled to make and only if the report of the Office of Fair Trading (OFT) allows him some latitude to do so, which it could not until the Enterprise Act was amended to specifically include financial stability as a public interest benefit, an amendment brought in just for this one case.
Milords found their way to a judgement that the flexibility allows the Secretary of State an unbounded latitude in defining public interest benefit sufficient to resist the OFT's opinion because it did not in any specifics address the matter of financial stability to balance that against competition issues, which is stretching into practical & legal extremes, so that this could include retrospectively applying the law, but anyway Lord Mandelson did not take his Decision until October 30 and has said or written nothing to prove he was firmly biased (fettered) to pre-judge the matter. MAG's case is perfectly plausible. If the Tribunal judgement was merely saying MAG's case is plausible but fails only because of standard of proof, fine. But, they go further than this to say they accept positive proof to the contrary that the Secretary of State did not behave unlawfully in thought or deed when that proof is no less circumstantial and much less substantial, also for being less independent, than MAG's evidence. If any inolved at all in this case ask themselves 'do I believe this?, in absolute ministerial rectitude to balance two sides of an argument when only hearing one side? Can such a political bird exist? The Judges refuse to concede the very strong probability that MAG is right and insist instead on MAG needing to find absolute proof (and indeed in their judgement they use words like 'absolute' and 'wholly') that Mandelson could decide something being a politician merely to please by agreeing with his political bosses, the PM & Chancellor, so as not to embarrass them, and thereby the whole Government, especially not after rushing in a new law through both Houses of Parliament specially so he could do just that. The basis for the Tribunal judges' verdict teeters on quite flimsy conditions of proof. Despite the very short time available to prepare, the judges require something more than however many compelling examples of circumstantial evidence; this is unreasonable, just as it is unrealistic if not laugh-out-loudable to ascribe to Lord Mandelson the wisdom or integrity of Solomon not to be swayed, fettered, biased, pre-judging, believing in only one-way. If the Judges need a smoking gun in the hand of the defendant standing over the victim and saying to more than one independent witness yes, fair cop, I don' that an' good riddence too, I meant too an' all! - well do we not have that in that there is no shtred of evidence to show that the Government at any time sought or received evidence as to how HBOS independence could be secured. The Government's evidence confirmed by the Tribunal judges is that all the information considered pointed only one way. This is technically so unrealistic as to HBOS's true circumstances, as it would be even for a bank in a truly parlous condition, which HBOS is not, for there to be no possible ways and means of saving the bank's independence (and thereby 20,000 jobs and their families and other dependents). Sir Burt, Sir Matthewson, and I could introduce any number of bankers who like myself, would agree that of course the bank can survive and be viable with the same temporary help Government is supplying to all the banks. It seems from the evidence however that HMT & others advised Lord Mandelson probably verbally that not only is the merger bid conditional on non-referral to the CC, but the government's aid to the bank is conditional on the merger - an aspect emphasised by The Chancellor publicly on 18 November - if ever a hellish circle of manicled logic this is it, and therefore how is it at conceivable to imagine the Secretary of State's mind was not made up for him by others, and not least of all when he mistakenly imagines, stating so in the House of Lords on 16 October, that reference to the CC could result in a review lasting years. My Lordships in their judgement stretch reasonable credulity past breaking point. If the Secretary of State is the person the Tribunal judges say he is, truly I take my hat off to him and say he is the finest living gentleman in all England with the batting style of W.G. Grace. What are the specifics of the judgement verdict? For that now read on.
But key to this is the report required from the OFT as to whether the evidence it received showed that public interest benefits outweighed the loss of competition. The OFT stated clearly, "any relevant customer benefits in relation to the creation of the relevant merger situation concerned do not outweigh the substantial lessening of competition and any adverse effects of the substantial lessening of competition, and it would not be appropriate to deal with the matter by way of undertakings under paragraph 3 of Schedule 7 to the Act." The OFT found that reference to the CC was warranted in respect of three out of the dozen or so areas of overlap between the businesses of the merging companies (i.e. personal current accounts (“PCAs”), banking services to small-and medium-sized enterprises (“SMEs”), and mortgages). These are very substantial areas." The Judges conceded that the OFT does not have to be certain about this, merely believe in the probability. This would be tested by the CC. That is the one properly ccoked ingredient, pasts al dente. From that point on the spaghetti starts to get soft, forked and caked with sauce. One the one hand, the judges did conclude that the OFT is not remitted to adjudge the public interest benefit in weighing the balance between competition issues and public benefits, but may do so, but did not do so in its report. This is somewhat disengenuous since the detailing could involve confidential business information such as the 'secret dossier' (see previous essay below for more about this)? Then too, the Secretary of State, say the judges, is obliged to refer the merger to the CC if the OFT advises him to do so, which it did! On the other hand, the Secretary of State's consideration under paragraph 45 has two counter-balancing matters to be weighed in the balance:
45(4)(c) one or more than one public interest consideration mentioned in the intervention notice is relevant to a consideration of the relevant merger situation concerned; and
45(4)(d) taking account only of the substantial lessening of competition and the relevant public interest consideration or considerations concerned, the creation of the relevant merger situation may be expected to operate against the public interest.” and
45(6) provides: “For the purposes of this Chapter any anti-competitive outcome shall be treated as being adverse to the public interest unless it is justified by one or more than one public interest consideration which is relevant.” and The Decision states that the new public interest consideration contained in section 58(2D) of the Act, namely the interest of maintaining the stability of the UK financial system, is relevant to this case.
There then follows about 6 pages concerning the standing of MAG as 'aggrieved person' finding that they do represent such persons. Next there follows the question of the legality of the Secretary of State's decision insofar as the decision had been made for him already weeks earlier, overlapping with irrelevance of advice from the FSA and the irrelevance of other considerations when conditions have changed, such as the EU Commission's permissioning of state aid and the EU general law principle of proportionality. The judges noted that MAG was not seeking considering of the specifics of competition issues or HBOS's financial difficulties, and MAG accepted that under the Act the Secretary of State is entitled to intervene on the grounds of public interest. It follows that neither the Secretary of State’s decision to issue the Intervention Notice, nor the decision to introduce the new public interest consideration, nor the Order by which such consideration was inserted into section 58 of the Act are the subject of any challenge.
MAG's challenge had a broad aspect ('over-arching') and a narrow one. The latter is that Lord Mandelson was 'fettered' by statements made by the Chancellor and the Prime Minister (when they committed to the merger). That this idea is debatable may appear a surprise to those who consider all politicians in high office are fettered and would have immense difficulty even to convince themselves otherwise. Perhpas the legal minds find it improbable that the fate of banks, not least one called 'Scotland' might be politically state-sensitive and thereby also strongly fettered? But, the judges noted that MAG could not give as evidence any statements by Lord Mandelson himself indicating that he was so 'fettered', and given that only he can make the decision not to refer the merger to the CC on his discretionary balancing of public interest benefits. But, surely he could not judge at all with any confidence what referring the case to the CC might do to the two banks. No-one can know that. Opinions would be finger-in-the-air, back-of-envelope, speculation, guesswork. Ask me as a banker who can look at the published accounts only and I'd say it's not a problem; the banks will be fine. They have robust valuable businesses and I cannot find signs of toxic assets in sufficiently large amounts or potentially mounting losses that either bank should not be able to manage these given the breathing space afforded by Government aid to do so. And that is something I am an expert on and can pronounce about with no false confidence and more than usual aplomb.
Mr Forrester, for MAG, had put its case in two ways: first, the over-arching argument that government preordained by-passing competition rules (something that was a condition attaching to Lloyds agreement to bid for HBOS, by the way!) regardless of whose responsibility it was to take the Decision, and this must have fettered how the Secretary of State analysed the Merger. Unfortunately for MAG, Lord Mandelson is not known to have said (or written) anything himself that showed this. This also I suppose means so far no leaks either from inside Whitehall to prove otherwise?
Mr Forrester relied upon statements attributed to the Prime Minister and the Chancellor of the Exchequer, in particular remarks made by the Chancellor when interviewed on BBC Today Radio 4 on 18 September. Mr Forrester also argued that the Prime Minister and the Chancellor were not legally permitted to waive the competition rules as they indicated they would on 18 September 2008.
MAG's narrower point was about how Lord Mandelson framed the Decision. In this regard it was argued that he should have taken account of the OFT's concerns in his formal Decision instead of failing to refer to them and relying for competition input on inappropriate other sources (e.g. the FSA asked to validate the financial stability benefit but not assess the competition disbenefit), and that one-sidedness or bias was a manifestation of the fettering effect! The Government team produced evidence from a civil service advisor to Lord Mandelson describing the process they followed. Some cases are sites concerning lawfulness and correctness definitions at law. But most of the cases were not under Scottish Law, a problem solved by the opinion of the judges that Scottish legal precedents would seem to be similar. These cases all lacked the political dimensions of MAG v. Mandy and be questionable on that score? Unfortunately Walter Scott's invocation of the 1707 Treaty of Union in defending the rights of the Scottish banks in 1826 was not recalled by Forrester. The Treaty is a constitutional right that would oblige Lord Mandelson to specifically determine that the merger is in the interests of the people of Scotland, something perhaps he assumes to be so is is this not all one and the same whether Scotland or UK? The OFT and the Enterprise Act, and even EU Competition Law, can and do consider geographical areas smaller as well as bigger than member states. The cases boiled down to making a distinction as to whether legitimate considerations were ignored or excluded rather than whether the considerations were considered wrongly or inadequately. And while outside pressure may be proved, it also has to be proved that this pressure did indeed influence the decision-taker to fetter himself, which is hard when Mr Forrester could not argue that the Secretary of State did or said anything to fetter his own discretion. Reliance is placed upon remarks by the PM and Chancellor in the nature of spoken, unscripted statements. But what about when spoken means statements to HC, and who says these are unscripted e.g. statement to HoC by the Chancellor on 6 October 2008, "In September, we amended the competition regime to allow the interests of financial stability to be considered in the merger between Lloyds TSB and HBOS. We took this exceptional measure because financial stability had to come
before normal competition concerns.”
Somewhat puzzling, since the Enterprise Act 2002 does not seem that unobliging in this respect? But the law was adduced to needing amendment by introducing a new public interest:- “The order specifies the maintenance of stability in the UK financial system as a public interest consideration under Section 58 of the Enterprise Act 2002 – a new public interest consideration. This will enable the Secretary of State to intervene in those mergers in order to be able to make the final decisions based on the vital public interest of financial stability, alongside the competition issues." This is not then a matter of cabinet responsibility to consider raising the balance of other public interests such as the premiership division football stadium's worth of employees and their families who will lose jobs in a deep recession? Quite damning too, on the face of it, were interviews with PM and Chancellor and also a press briefing by the Prime Minister’s Spokesman on 30 September when the Spokesman stated, “Our role in this was to make a commitment to introduce legislation in order to facilitate the takeover and we stood by that commitment.” It beggars belief that after specially introducing legislation to ensure non-referral to the CC was allowable in this very merger case that the Minister would not then do that, but actually refer it to the CC? To have done that would have severely politically embarrassed both the PM and the Chancellor. The problem here surely that if you do what your boss says should be done are you following orders or freely making up at your own perfect discretion your own mind on the matter that just happens to coincide with what your boss has told the nation should and will happen? Politicians may not script a policy, but it can be surely as good as when enunciated not once but several times to millions of voters? It is a bit like asking whether a jury has been influenced by media comment during a trial. The law does not normally assume that persons can remain indifferent to such influences, not sufficiently that we can have perfect confidence in perfect discretionary judgement, and least of all when it is a one-person decision? But all this line of thinking was not pursued - thoughn might be a plank for appeal?
However, the civil service evidence was that stability issues were considered right up to 30 October, "“[On the afternoon of 30 October], the Secretary of State met with officials to discuss the advice and submissions he had received and to reach a decision. At our request, officials from HM Treasury were also present in case the Secretary of State had any specific further questions about the evidence of the Tripartite Authorities relating to the implications of the merger for financial stability. Having satisfied himself that all the evidence and options had been fully examined, the Secretary of State reached the decision, in line with our recommendation and on the basis of the arguments set out in the submission dated 28 October 2008, not to refer the merger to the Competition Commission.” We are not told how long this meeting was or what kind of analysis was undertaken, or why civil servants should not also feel 'fettered' by the public commitments of their political masters? While the tribunal cannot consider whether the stability of the financial system was adequately considered, there is an issue if it was in reality not really considered at all in some rigour? But in Lord Mandelson's statement to the House of Lords (16 October) he said explicitly that he had not yet evaluated the financial stability issues. "The order will allow us to make careful and urgent consideration of financial stability an additional part of our assessment process, and as a result, support our work to help millions of UK businesses and families get through these very difficult times. It is a critical addition to the public interest considerations specified in the Act and I commend it to your Lordships" and also, "This will include advice from the Treasury, the Bank of England and the FSA, which make up the tripartite authorities. I am sure that your Lordships would agree that swift, decisive action is needed to give investors the regulatory certainty that they need and to send a clear signal to the market about the proposed merger between Lloyds TSB group and HBOS." To any normal reader this would surely look as though a view had already formed and would not change unless subject to challenge. Every such decision has opposing arguments. Did Lord Mandelson ever receive from anyone a considered view that the merger was not essential to the UK's financial stability? Did he read the secret dossier, if so when? Lord Mandelson also stated in the House of Lords, "The caveat is this: the order that we considering [sic] is brought forward to allow for the careful consideration of financial stability as part of our assessment of the proposed merger between Lloyds TSB Group and HBOS. This debate, therefore, is not about the assessment, which I have yet to undertake. I will do so following receipt by me of the OFT’s recommendations as to the competition and public interest issues which are due by 24 October. I have an open mind to both the competition and the public interest considerations...Therefore, I do not envisage a one-, a two- or a three-year review following whatever decision I take on the merger in due course. I will not be drawn on conditionality in advance of my decision, but I assure your Lordships that, should a decision be taken for the merger to go ahead, we will not relax our vigilance at any time when it comes to the proper protection of consumers.” There are two weaknesses here, one that the Government can on an ongoing basis guard the rights of consumers under competition law (without resorting to the Competition Commission ex-ante, only ex-post) and two, Lord Mandelon had a prejudicial view, perhaps based on someone else's advice, that reference to the CC could involve a review lasting 1-3 years! An exaggeration surely? There is political time, legal time and other people's sense of time, but here is a Faustian pact; sacrificing the long term for the short term, kicking the ball into the long grass. It would surely require the most heroically principled and independently-minded of all politicians not to feel a fettering on every side in this case just as MAG asserted, an argument for which surely reasonable doubt is sufficient rather than absolute proof as the judges appeared to require? The judges noticed that there was ammunition here for MAG, which Forrester declined to load into his guns. The judges wrote in their judgement, "the conclusion would be that the Secretary of State’s statements to Parliament, the process of instructing the OFT to investigate and report to him, the receipt and consideration of representations from other bodies including the Treasury and the carrying out of the processes described in Mr Saunder’s witness statement were little more than an elaborate sham designed to deceive Parliament and others and achieve a preordained result without the exercise of the independent decision-making required by the governing legislation. Mr Forrester avowed that his clients’ case attributed no personal reproach to the Secretary of State, but concentrated its fire on the decision, which he said contained manifestations of a readiness to waive the Merger through without a reference to the CC – a readiness which could only be attributed to the fettering effect of the government’s statements." We now come to the THE CONCLUSION.
According to MAG are 3 manifestations of the alleged fettering. FIRST, instead accepting the OFT’s binding analysis balancing competition and other public interest consideration, TWO, a “tinkering”, a “denigrating” or a “discarding” inconvenient parts of the OFT Report and relying on other sources, and twisting the sumamry of submissions including about short and medium term perspectives, “In the medium to longer term Government would have withdrawn its support, leaving either a fully independent HBOS once more, or an HBOS in the hands of a “no overlap” purchaser: the Stage II counterfactual. In these circumstances HBOS would also constitute a significant player in the market place in the medium term.” (paragraph 85 of the OFT Report)and the prĂ©cis in the Decision:
“In the medium term, once stability had returned to the markets, the Government would sell HBOS on to a new owner or owners.” (paragraph 18 of the Decision). the judges find there is absolutely nothing in this point; the drafting neither diminishes the OFT finding nor indicates that the Secretary of State was failing to treat that finding as binding. The judges also found that the second manifestation of the alleged fettering also relates to the section of the Decision where the Secretary of State summarises submissions made to the OFT by interested parties. MAG had pointed to the fact that in the submissions by the FSA to the OFT there is mention of the competitive strengths of HBOS under different scenarios, and that the Secretary of State mentions the FSA’s submissions in his summary in the last three sub-paragraphs of paragraph 22 of the Decision. MAG's view that this showed the Secretary of State going to the FSA for competition analysis rather than to the OFT,
as evidence of the fettering effect, is concluded by the judges to be wholly without merit. The submissions of the FSA do concern the consideration of maintaining the stability of the financial system, and are summarised in a section of the Decision which is expressly dealing with that consideration and not with the OFT’s competition concerns
. What the judges miss here is that HBOS's stability is not the stability of the financial system (currently unstable for reasons not to do with any one bank of which HBOS may be a wholly innocent victim). The FSA is not competent to judge the stability of the financial system, only the resilience of individual banks, and they do say there are scenarios under which HBOS can thrive and remain independent? The judges conclude too that nothing in Lord Mandelson's Decision or anywhere else suggests that he has done anything other than treat the OFT’s findings on competition as binding, or that he has treated the FSA’s submissions as diminishing those findings. MAG's third vice also in the Decision concerns the FSA’s submissions. Those submissions are said to contain an error of law relating to the effect of the State aid provisions of the EC Treaty upon a banking institution. By referring to this in his summary of submissions made to the OFT the Secretary of State is said to have incorporated the error of law into the Decision thereby vitiating it - perhaps merely a technicality? The FSA’s views are said to differ from those which the OFT put forward in the OFT Report, and the latter are belittled by reference to the former. “EU State aid rules preclude a government-owned entity from competing aggressively with private sector banks”. In support of a contention that this is wrong in law, Mr Forrester for MAG referred to the Commission Communication on state aid to financial institutions in the context of the present global crisis that the Commission’s recently modified approach meant that there would be little if any constraint on the competitive ability of a recipient of State aid. This is so, although there is an obligation to make this aid costly. The judges had heard from the Government's Mr Lasok’s argument that the position is rather more complicated than Mr Forrester indicated. For example the Communication makes it clear that companies in receipt of State aid by way of guarantees must expect to have imposed on them behavioural constraints and restrictions on their commercial conduct which could limit their competitive effort as the price of the aid (see paragraph 27 of the Communication). However, the judges concluded "we do not need to decide whether there was or was not an error by the FSA: suffice it to say that at the level of generality of the FSA’s statement we very much doubt if their remarks could be criticised. Moreover, those remarks are not so very different from the comments of the OFT on the effect of the State aid rules which the Secretary of State also cited in the Decision. The OFT said “While [bringing HBOS into partial or full public ownership] may have led to the imposition of restrictions on the scope of HBOS to compete in the market (to comply with EC law on state aid), a publicly owned HBOS would continue to exert some competitive pressure in the market though it would be potentially a significantly weaker force in comparison with conditions prior to the current financial crisis.” Therefore both bodies took the view that the State aid rules could have a dampening impact on competitive efforts of a recipient".
In any event, the judges say, the Secretary of State was doing no more than reciting the submissions received by the OFT, not agreeing or adopting them, and therefore this is a hopeless point.
As to the MAG’s contention that the PM's and other government ministers’ statements led Lloyds TSB not to offer any undertakings to the OFT, Mr Forrester conceded that this was not itself a separate ground upon which the validity of the Decision could be impugned; but it was, he said, a manifestation of the unlawful and regrettable consequences of a Government acting too categorically when it lacks the power to do so i.e. a result of fettering. This was strenuously disputed by Miss Davies on behalf of Lloyds TSB. Anyway, the judges concluded this issue is irrelevant.
In the light of all that, the judges considered MAG's contention fails on the ground that the discretion of Lord Mandelson was fettered by statements of the Prime Minister and the Chancellor of the Exchequer.
MAG's contention that Lord Mandelson closed his eyes or paid little attention to the availability of government bailout package for banks, which in MAG's submission
presented a real alternative to the Merger in order to save HBOS, the judges say Mr Forrester did not really develop this in his oral presentation, which was almost entirely taken up with issues relating to the fettering point. However, he did say he was maintaining the argument that, in view of the fettering, Lord Mandelson’s attention was elsewhere, so that he paid insufficient attention to alternatives (the recapitalisation scheme announced by the government on 8 October 2008) and overmuch on the Merger and FSA’s views in regard to HBOS’s ability to be an effective standalone competitor should the Merger not take place, as opposed to the legally binding views of the OFT. The judges concluded the main problem with this is that it is unsustainable in the light of the evidence. Well, here of course, we have the problem again of what is and is not in the 'secret dossier' about which there is no reference or any comment by the judges of what if anything they concluded from it, a document only they could see? An appeal might suggest this amounted to 'fettering' of a siilar sort, or also of another sort insofar as not seeing this fettered MAG's case? The judges' view is that the question of the need for the Merger to go ahead in the light of the government rescue package was discussed by the Secretary of State during the House of Lords debate to which we have referred. In the run up to the Decision the he received representations from several sources as referred to by the civil servant statement and the HMT/ BoE/ FSA view that recapitalisation is complementary and not alternative to the Merger and, accordingly, that the Merger was necessary notwithstanding the recapitalisation programme. This is a very curious view and could certainly be challenged, and frankly the idea of 'complementarity' here makes no technical sense other than if the recapitalisation is conditional on the merger going ahead? Here is another fettering of a most pointy stick kind! Milord judges say, "Further, this very issue was specifically considered in the briefing note dated 28 October 2008 prepared for the Secretary of State by his officials. This note is referred to by Mr Saunders at paragraphs 24ff of his statement. The evidence is therefore all one way and there is simply no basis for the allegation that the issue of the continuing need for the Merger was not properly considered by the decision-maker. Nor, for the reasons already given, is there any substance in the claim that the Secretary of State wrongly took account of the views of the FSA on the competitive strength of HBOS in preference to the position of the OFT, or failed to have regard to the Commission’s latest position on state aid. It follows that these points, whether under a label of irrationality or failure to take account of relevant considerations or some other label, also fail." I'm sorry to be objectionable here, but I do not see a clear logic here. The words which undermine the any possible logic is to say all the arguments are one-way! That by itself shows that the evaluation was biased. It is impossible for there to have been no practical strategies whereby HBOS could retain its independence!
The judges sum up, "For the reasons given above, the Tribunal unanimously decides as follows: (a) The Applicants are “persons aggrieved” within the meaning of section 120(1) of the Act (b) The Applicants’ application under section 120 of the Act is dismissed." The Merger Action Group tonight said it was disappointed to lose its legal challenge against the Government's decision to ignore competition law to push through the Lloyds TSB's proposed takeover of HBOS. But the group was heartened that the Competition Appeal Tribunal [CAT] found they were right and proper people to bring the action which had been raised under public interest concerns. At the end of the two day hearing, the MAG team expressed considerable confidence, believing they had got the better of the arguments before the three judges. Of course, the elephant never left the room, the Government, and it had a large secret dropping for the judges to consider in camera, the one (or is it two) secret dossier!
Immediately after the tribunal ruling, MAG said it was considering its position over whether it would appeal the tribunal's decision to the Court of Session in Edinburgh. and its decision of whether or not to do so will be reported here as soon as possible! The MAG leaders said,"We have said from the start that, on behalf of many ordinary and concerned shareholders, account holders and employees, we felt we had to contest the decision to “rip up” competition rules in order to facilitate a takeover over which growing numbers of people – ordinary members of the public, bank customers, shareholders, businesses and politicians from across the divide – have serious concerns and doubts. We are all glad to have made the stand we did, and will continue to stand up for what we believe in. It remains our belief, shared by many, that allowing this proposed merger to go forward without due and proper consideration by the Competition Commission, sets a dangerous precedent. We did not embark lightly on this task. It has been onerous and at times highly charged, ranged as we were against the combined might of the Department of Business, Enterprise and Regulatory Reform (BERR), HBOS and Lloyds TSB. We pay tribute to the strength, determination and skill of all those who have taken part so far, who have made representations on our behalf and to the many shareholders, customers and business who have offered their support".