Time to protect bidders from their greed?
There is a comprehensive account of the government’s diagnosis of what went wrong with the financial system in a speech given last night at the Smith Institute by the City minister, Lord Myners.
It doesn’t contain anything particularly new. But, as it happens, I don’t recall any minister attempting this kind of overview.
Myners makes three substantive points:
1) Markets are a good mechanism for distributing capital, goods and services, but not a perfect one – so we must recognise that those who worship a deified perfect market are worshipping a false god;
2) It’s unfortunate that wholesale and professional lenders to the likes of Royal Bank of Scotland and HBOS, and even providers of putative risk capital, were bailed out by taxpayers – because it proved that these banks could behave irresponsibly and more-or-less get away with it, thus undermining any incentive for them to behave more responsibly;
3) There has been a systemic, long-running failure of institutional investors to exercise their ownership rights over companies in a rational way, to prevent those companies – especially but not exclusively banks – from taking actions that damage the interests of owners.
To most of which – I would guess – there would be a wide degree of assent, from the leaders of the opposition parties and from many of you.
But beyond the bloomin’ obvious – such as that banks must be forced to hold considerably more capital to protect against losses and to increase their stocks of genuinely liquid assets as insurance against runs – we are still a long way from consensus on the appropriate prescriptions.
On the issue, for example, of how to make sure that banks don’t take crazy speculative risks now that it has been proved beyond doubt that taxpayers will bail them out, Myners makes slightly contradictory suggestions – though it’s probably wrong to single him out for criticism, since these contradictions are inherent in most of the remedies suggested by assorted governments.
First he extols the virtues of living wills, or a proposed new obligation on all banks to have detailed, practical plans to hive off their retail operations in a crisis. The aim of such measures is to prove to the world that only those retail bits – which look after the vital interests of households and businesses – would be bailed out by the state in a crisis.
The hope would be that banks’ more speculative activities – their investment banking operations in the main – would be seen by their creditors as inherently more risky. And that these creditors would have a powerful motive to prevent those banks taking dangerous risks.
Which is good in theory. Except that if a Goldman Sachs or a Barclays Capital went kaput today, it is inconceivable that it would not cause horrific contagion, both to other financial institutions and to the economy (if for example asset prices collapsed or the rug was pulled from under important non-financial companies).
So unless and until these investment banks can be massively shrunk in respect of size and scope, there would probably still be state protection for the more speculative activities of universal banks such as Barclays or Royal Bank of Scotland.
So Myners and the British government also favour some kind of Obama-style insurance fee to be paid by banks, such that the costs of any bailout would be met by bank and their owners, not by taxpayers.
But there’s a problem with creating a blanket insurance scheme of that sort: it would provide an unwelcome new incentive to unscrupulous banks and bankers to take crazy risks in pursuit of short-term profits and bonuses; if the bankers’ bets went wrong, the insurance scheme would pick up the tab.
In other words, bank insurance schemes re-import to the banking system more-or-less the same moral hazard problems as the free insurance that has been provided by taxpayers (without our assent or knowledge) to too-big-to-fail institutions such as Royal Bank and HBOS.
And, by the way, the Bank of England has demonstrated the financial benefit of that free insurance to big banks: over an extended period, they were able to borrow more cheaply than smaller banks perceived by creditors not as inherently more likely to fail, but as less likely to be bailed out by taxpayers were they to get into trouble.
As for what the former fund manager Myners has to say about how shareholders can become more diligent and wise stewards of companies, here he makes a point that was largely ignored in the recent furore over Kraft’s takeover of Cadbury – which is that it is the acquirer of a company and that bidding company’s owners that are more often damaged by a takeover than the target company.
Think RBS and the rump of ABN, which RBS bought in the autumn of 2007. RBS and its shareholders were seriously poisoned by the deal. ABN and its owners should forever be profoundly grateful that RBS’s board put aspiration for global domination ahead of commercial common sense.
Here’s the relevant nannyng point: Britain’s code on takeovers and mergers was created primarily to give protection to shareholders in the biddee not the bidder.
It is designed to ensure that a biddee’s shareholders are not prevented from entertaining a full and proper takeover offer by the selfishness of blocs of minority shareholders or the fear of the biddee’s management that they’d be out of a job were the deal to go through.
But if in the end it is the bidder which suffers more often than not – through having paid too much in an acquisition or through having bitten of way more than can be chewed and digested – perhaps it is shareholders in the bidding company which deserve a bit more protection.
This of course will be at the forefront of the minds of the Prudential shareholders today, as they agonise over whether to support the Pru management’s record-breaking $35.5bn offer to buy AIA.
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