Martin Vander Weyer: Five simple rules to avoid the next crash

The show trials of bankers have been entertaining enough, but what have we learnt that can stop history repeating itself?
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The Independent Online

Enough with the show trials already. Enough with the Treasury Select Committee and its peacock chairman, John McFall, with his gritty questions that never quite elicit anything we didn't know already. And more than enough of those lawyer-scripted, without-prejudice public apologies: the guilty men are never actually going to prostrate themselves and say: "Yes, as a matter of fact you're right, chairman. I was unqualified to run a bank, and my judgement became utterly warped by the size of my bonuses, so now I'm personally responsible for billions of losses. Sorry."

We have been distracted from the fact that the Government is exhausted of new ideas as to how to get us out of this mess. But before examining that, let us consider a simple list of warnings to watch for next time round.

The first signal is, of course, a boom in bankers' pay. Research from New York University has shown how it soared in relation to other professions in the 1920s, the mid-1980s and in spades in the present decade, each time offering a perfect indicator of the crash to come. We need banks themselves to accept that if they pay grossly more than comparable professional work – making millionaires of middle managers and deluding directors into thinking themselves on a par with great entrepreneurs – then things will inevitably go to the bad. Unsound trading decisions will be taken, huge strategic risks will be ignored, shareholders' and clients' interests will be endangered, and off we go to perdition once more.

Second, beware of banks not run by bankers. In the line-up of former HBOS and Royal Bank of Scotland chiefs in front of chairman McFall this week – Lord Stevenson and Andy Hornby, alongside Sir Tom McKillop and Sir Fred Goodwin – not one had significant hands-on experience of the small-scale lending decisions and day-to-day customer interface that are the bedrock of the seasoned banker's professional formation. At Northern Rock, we should remember, Adam Applegarth was a marketing man with no banking qualifications, and his chairman, Dr Matt Ridley, was an expert on Charles Darwin. Lifelong, branch-trained managers are not immune to errors – they made plenty in the 1980s – but they are an innately cautious breed who are unlikely to go haywire on the spectacular scale of the current bust.

Third, beware of excessive sophistication. Securitisation of mortgages was, when first invented, a useful way of increasing liquidity in the US home loan market. But it became so over-elaborated that it almost wrecked the global financial system. Likewise, derivative instruments were devised to help farmers and manufacturers protect themselves against future risks, but the complexity of modern derivative trading turned them into what Warren Buffett called "weapons of financial mass destruction".

Next, watch for over-priced mergers, a sure sign that the top of the cycle has been reached – or just passed. RBS's £50bn consortium takeover of ABN Amro, desperately outbidding Barclays, will go down as one of the worst misjudgements in financial history. And if it's true that Lloyds TSB had an opportunity to back out of the HBOS merger, but chose to stay in because it offered a "once in a lifetime" opportunity to grab more market share, then the £10bn loss revealed last Friday puts that deal in a similar category of folly.

Finally, watch out for obfuscation and self-delusion. The annual reports of RBS, HBOS, Northern Rock and Bradford & Bingley before they collapsed were models of corporate correctness which gave no hint of the horrors hidden on and off their balance sheets. Bradford & Bingley's should become a set text for business-school students: up to their eyeballs in toxic buy-to-let lending, the directors confirmed "they are satisfied that the company has sufficient resources to continue in operation for the foreseeable future" and gave far more space to diversity analysis and green toilet-flushing systems.

Five simple warning signals for the next financial crisis. But to get to the next one, we have to extract ourselves from this one. How on earth do we get there?

In the short term, the Government and the Bank of England have the biggest role to play through liquidity and insurance schemes for bank lending, the implied promise of further capital support from taxpayers, and the prospect of near-zero interest rates and new-minted cash pumped into the system. As the Bank's Governor said last week, these measures will work positively – but we have to be patient. If President Obama's fiscal stimulus package begins to stabilise the US economy and housing market, that will help. If, later this year, UK homebuyers begin to feel that house prices are affordable and unlikely to fall much further, that will help too.

Only when banks can draw a line under the property crash and put a final figure on what it has cost them will they begin to move forward again. When they do so, our five key points should be framed in their boardrooms. Don't let pay scales run out of control. Promote your shrewdest lifelong bankers to the highest levels, and don't override their opinions. If your young thrusters invent new lines of business you don't understand, just tell them to stop. If anyone offers you a global mega-merger, show them the door. Finally, make sure the risks you take are crystal clear to shareholders, customers, regulators – and most important, yourselves. That way, we might not have to go through all this again – at least, not in this lifetime.

Martin Vander Weyer is editor of 'Spectator Business'