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25th Anniversary series: 2008 – The Financial Crash

May 6, 2015

Her Majesty was not amused. During a briefing by academics at the London School of Economics on the turmoil in the international markets, The Queen asked, “Why did nobody notice it?”

Professor Luis Garciano, director of research at the LSE’s management department tried to explain. “At every stage”, he said, “someone was relying on somebody else and everyone thought they were doing the right thing.”

Four years later, during her Diamond Jubilee, The Queen visited the Bank of England. Sujit Kapadia, a senior economist at the Bank tried to answer the same question. He said that the City had got “complacent”, and many in it thought that regulation wasn’t necessary. He added that financial crises were a bit like earthquakes and flu pandemics in being rare and hard to predict, ad reassured Her Majesty that the Bank was there to help prevent another crash, prompting Prince Philip to ask, “Is there another one coming?”, and to add the warning, “Don’t do it again.”

Both the given explanations are partly satisfactory. But the most compelling evidence is that the warning signs of a bursting bubble were there for all to see, but the people who needed to understand the signs, and respond to them, did not do so.

In “Beyond Crisis”, Gill Ringland, Oliver Sparrow and Patricia Lustig analysed the debt crisis. They observed that “the banking sector boomed, paid out very high salaries and bonuses, and lost control of its fundamentals”. So great was the impact of the trade in debt and derivatives that Brokers’ fees in 2007 were assessed as being around $500bn – 1.5% of the entire world’s gross product. Financial services represented 35% of world profit in 2005, up from about 10% in 1965.

Those figures tell their own story. People had become very rich indeed, and would continue to become richer, as long as the “bubble” continued to expand. The turnover and profits became their own benchmark. Even those fund managers who could see the warning lights flashing felt that they had to play along, knowing that not to do so, would make their institutions – at least in the immediate term – look like laggards and cost them – at best – their bonuses, and at worst, their jobs.

At the same time, the regulators, who were supposed to provide a bulwark against excessive enthusiasm and short-termism in the financial sector, seemed to offer no real challenge to the unfolding narrative. Mainstream politicians – on both sides of the UK Parliament – rushed to praise the financial sector for the wealth it seemed to be generating.

At the time of the Northern Rock crisis, one year before the fall of Lehman Brothers, a former Director of a large global investment bank cheerfully told me that the Directors of the Banks didn’t really understand what their subordinates were doing – a remark corroborated by the evidence gathered by the authors of “Beyond Crisis” – and that Northern Rock was likely to be a template for a more general and much bigger banking crisis in the near future. His words were prophetic.

So how to make good on the assurances given to the Queen in 2012?

Beyond Crisis identified three “dimensions” that characterised a Purposeful Self-Renewing organisation:

  • Clarity of task – clear roles for employees, with opportunities for leadership and a clear set of values and “narrative”
  • Clarity of purpose – a compelling insight into the possible direction of change, including an understanding of the options for the future
  • And environment that encourages openness, trust and challenge, both from within, and using external sources of insight and intelligence.

We must all hope that the financial institutions have taken these lessons on board. But we should also plan to mitigate the risk that they haven’t.

Written by David Lye.

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