Jeremy Warner's Outlook: There's a gallows humour about the City. Few expect to survive for long

Sutcliffe takes the bullet at Old Mutual; First too optimistic, now too pessimistic
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The Independent Online

Is this the end of investment banking as we know it? To Andrew Gowers, the former editor of the Financial Times and latterly head of communications for Lehman Brothers in Europe, it must seem that way. There he was, hitting the phones to the London press to put the best possible gloss on a truly disastrous set of announcements. An hour later, the story went round that he was being axed along with great swaths of others, the latest victim of Lehman's increasingly desperate bid for survival.

To be fair on Mr Gowers, that's not quite what happened. He is indeed planning to leave, but he's not yet been asked to, even following the departure of his chief mentor at Lehman's, Jeremy Isaacs.

Yet the story nonetheless seems to epitomise the febrile atmosphere of destruction that now stalks the City. There's a gallows humour about the place quite unlike anything I've ever witnessed before. As the sense of crisis builds, few expect to survive for long. The purges are becoming relentless. Nobody knows where they will strike next.

Perhaps the best that can be said about the shocker of a statement from Lehman Brothers yesterday is that it could have been even worse. Everyone was expecting a death sentence after news that Lehman's Korean fairy godmother would not be coming forward with the hoped-for dollop of new capital.

Yet in the event, it wasn't quite that bad. The set of initiatives outlined yesterday amount to at least a reprieve, and may even mean that Lehman survives. Yet in whatever form, it will be a pale shadow of its former self. By the time the credit crunch is over, the investment banking landscape will be changed beyond recognition.

But first the detail of Lehman's plans to address the collapse in confidence around its affairs.

Some $30bn of commercial property assets are to be spun off into a separate company. In what has become the model for extreme workouts of troublesome financial businesses, the bad assets that threaten to bring down the whole edifice are to be divorced in the hope that this will allow the core banking franchise to survive.

This also gets Lehman off the debilitating treadmill of mark-to- market accounting for these assets. As a non bank, the new company will be able to apply a different accounting treatment, allowing a reasonable chance of being able to hold the assets to maturity, by which time they ought to be worth a lot more than in today's bombed-out markets. Mark-to-market accounting has significantly increased the scale of the crisis for banks, and has also added to the fall in asset prices by forcing fire sales.

Separately, some $4bn of UK mortgage assets are to be sold to Black Rock, though, laughably, Lehman is having to lend Black Rock 75 per cent of the money needed to take them off its hands. The rest of the mortgage-backed securities portfolio has already been substantially reduced through asset sales. By derisking the bank in this way, Richard Fuld, the chief executive, hopes to remove the key sources of uncertainty that have been undermining confidence in the bank's future. Unfortunately, the separation of the bad assets isn't quite as painless as it might seem. The new company will require lots of debt and perhaps as much as $7.5bn of equity capital. To provide this capital while at the same time leaving enough in the kitty to keep the core bank going, Lehman is having to sell some of the crown jewels, notably the asset management division. The dividend is also being reduced to a token amount to conserve capital.

By the time all this restructuring is over, Lehman will be back to where it was 30 years ago. But it is not just Lehman. Virtually all the bulge-bracket investment banks of Wall Street and the City, with the possible exception of Goldman Sachs and JP Morgan Chase, are being forced into a radical rethink of their business models. The days when investment banks were more like hedge funds than traditional, client-orientated securities houses, and where it was the traders, or self-styled masters of the universe, that ruled the roost, may well be over for good. For the time being, it is the markets which are forcing the pace of change. A huge programme of deleveraging and balance sheet reduction is underway. Yet the regulators won't be far behind.

The US Federal Reserve hasn't opened its discount window to Wall Street for nothing. A very sizeable penalty will be extracted for these taxpayer-funded bailouts which will change the shape of Wall Street for a generation or more.

Sutcliffe takes the bullet at Old Mutual

So farewell then Jim Sutcliffe, chief executive of Old Mutual. He said he'd take responsibility for the problems if US Life got worse, and they did. It's not the first time Britain's tallest life assurer has been bundled out the door without so much as a decent leaving party let alone a well-flagged succession plan.

Back in the 1990s, when he was chief executive of Prudential's UK operations, he was made to take the bullet for the company's botched handling of the pensions mis-selling scandal, when he was similarly given the black binliner treatment.

He wasn't responsible for the mis-selling itself; that was largely before his time. But the issue of compensation was appallingly mishandled, resulting in a big fine from the regulator and extreme damage to reputation. Fortunately for Mr Sutcliffe, the damage wasn't so bad personally that it prevented him getting the top job at Old Mutual shortly after the South African life assurer transferred its listing and domicile to London.

Now he's become the latest victim of the credit crunch after it emerged that, bizarrely, the company is a big holder of preference stock in Fannie Mae and Freddie Mac. Following the Federal government bailout, the holdings have become virtually worthless. This was only the icing on the cake for it comes on top of a string of other disappointments, including the failure to sell Mutual & Federal in South Africa, and a series of provisions against guaranteed annuity products in the group's US life business.

These were first flagged in June, doubled in August when it turned out that the hedging of these products was even more botched than thought, and have now been raised again, prompting a forced $250m capital injection. In any case, it all became just too much for the City to take, and Mr Sutcliffe had to go.

Old Mutual was one of a plethora of South African companies that listed in the UK in the late 1990s. It was a great little wheeze at the time, for the change in domicile gave these pillars of the South African economy the access to international capital they had so long been starved of under apartheid.

Assured places in the FTSE 100 forced tracking funds to buy into companies they would otherwise never have considered for investment. Share prices rose and previously locked-in local South African investors, still constrained by capital controls, were able to get out at a healthy profit.

Regrettably, Old Mutual has been the least successful of these asset transfers. For the South African brewer SABMiller the switch enabled an aggressive international expansion which has transformed the company into one of the most powerful drinks groups in the world.

Old Mutual's attempt to mirror this diversification away from its South African roots has been far less rewarding and it has ended up just a disjointed collection of far-flung life companies. US Life in particular has been a disaster. Mr Sutcliffe deliberately encouraged a decentralised approach to the management of his assets. This was plainly a mistake, which the new man in the hotseat, Julian Roberts, will be trying to reverse. He also needs to answer the question of just what is the point of Old Mutual. Despite his stature, Mr Sutcliffe never could.

First too optimistic, now too pessimistic

Official forecasters have been far too optimistic about prospects for the British and world economies. In attempting to get back ahead of the curve, they are now in danger of becoming too pessimistic. The European Union yesterday forecast that Britain would have three quarters of negative growth and that growth for next year as a whole would be negligible. Maybe, but if the price of oil and sterling keep bombing as they have, the UK economy may end up faring better than the growing band of doomsters think.

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