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When I started my career as a financial journalist in the new year of 1987, a few City gents still wore bowler hats. As I prepare to retire at the end of the year, neck ties are the endangered male sartorial flourish.
Financial services back then consisted of intermediaries connecting the bosses of companies with investors to form capital via public markets. That territory has shrunk as indexation, automation and private capital have expanded. But a few universal constants will always apply. I was blithely ignorant of these as a cub reporter. They have come into sharp focus since.
Individual incentives favour collective instability. I have seen six serious market corrections, starting with Black Monday in the 1987 crash and ending with last year’s US rout. At such times, pundits ask: “Has no one learnt the lessons of the past?”
Why would they? Personal incentives discourage behavioural change. A crash is tolerable if you have transmuted several years of asset price inflation into cash bonuses. The fact that crashes are bad for society only weakly offsets such incentives via regulation. This tends to reduce returns to owners rather than agents. Economic sages Hyman Minsky and JK Galbraith saw markets as innately unstable. They were right.
You do not hear the whistle of the bullet that hits you. Queen Elizabeth II supposedly shamed economists during the financial crisis of 2007-08 by asking “Why didn’t anyone see this coming?”
Commentators had imagined many crises coming. But not the US subprime crisis in any detail. Instead, there were nagging fears of a meltdown in the Asian carry trade, an arbitrage between rates in different economies. It did not happen. Nor is the basis trade likely to crash the financial system. This vast arbitrage between Treasuries and their futures worries too many people for that. Unanticipated snarl-ups — such as US regional banking turmoil — are riskier because scope for panic is greater.
Big banks are not conventional businesses. The classic business sells products or services to customers on a commercial basis. If it does well, it wins applause. If it goes bust, it does not matter greatly.
Most big banks are not like this. They are massively regulated, state-guaranteed, quasi-public franchises financed with private capital. Their job is to create and distribute money for their franchisers, governments and central banks. Returns are unpredictably skewed by politics. In concept, banks resemble supermarkets to the extent that blue whales resemble amoebas.
Chief executives sometimes matter. This is distressing for chief executives, who would prefer to matter all the time. But large, mature businesses carry on imperturbably during interregnums.
The main utility of CEOs is in protecting or creating value during corporate turmoil. Recent examples include Larry Culp at engineer General Electric, Amanda Blanc at insurer Aviva and Andrea Orcel at lender UniCredit. In calmer times, bad CEOs destroy value with grandiose takeovers. Good ones quietly set expectations for middle management, as Richard Cousins did at caterer Compass.
Stock analysts are hedgehogs not foxes. Most analysts are smarter than me. But they also conform to Isaiah Berlin’s definition of creatures with a single conceptual framework (hedgehogs) rather than many (foxes). Their talisman is the financial model they build for each company they follow. They usually interpret resulting numbers positively for reasons of career survival. The result is perceptual narrowing. Analysts repeatedly underestimate the cost of corporate scandals because this derails their models — and careers — least. That made it easy for the Lex column to tell investors to brace for much higher costs during such controversies as Danske Bank’s involvement in money laundering and Philips’ problems with sleep apnoea devices.
Debt matters more than equity, unfortunately. Franco Modigliani and Merton Miller established that the value of an enterprise depends on its future earnings. The exact mix of debt and equity is irrelevant.
It is crucial to investor returns, however. Private equity and many hedge fund strategies depend on leveraging stubs of equity. In important jurisdictions, the UK included, interest payments are tax deductible but dividends are not. Even with US equity markets flying, the world’s debts exceed the value of its quoted equity by a ratio of three to one.
The UK stock market was vibrant when I started my career. It is now going through one of its sporadic sulks. It is dominated by mature businesses whose high-yielding shares might as well be bonds. Bowler hats are bygones. An appetite for innovative equity risk is a habit the UK stock market must rediscover, or it will go the same way.
jonathan.guthrie@ft.com