Friday, 27 February 2009

Borrowing from Fred Goodwin's Bank

Thought I might as well lay in on this one, everyone else is after all.

Imagine for a moment that I, Gordy Braun, am a businessman. Having drawn up a business plan I approach a bank, RBS in fact (clearly you can now see this post is a work of fiction). The bank, having seen my business plan which they really like (I have an MBA from Harvard so my business credentials are automatically of the highest order), agree to lend me the cash to set up my new business - CastlesBuiltOnSand Ltd. But in common with all such lending, the loan is secured. It's initially secured against company assets but backed by a personal guarantee from the Directors (ie myself) which is in turn secured against my house. Anyway, cash comes through and off we go...

Then what happens? Oh no! Calamity! The world market has turned against me, there's a global recession, I did not see that coming! My company can't pay the interest, so the bank calls in the loan. But it's too late the money has been spent, so what happens now? Well the bank invokes the guarantee and I lose my house, but the bank gets its money back so that's OK really.

This scenario is not unusual. Banks just do not lend money without security, and when it goes wrong they will take your house off you. Of course they are very happy to borrow huge amounts of money without offering security, but they won't lend any of that to you. And this is where the ordinary person (or at least the ordinary businessman) starts to get annoyed; there is truly one rule for me, a better rule for you (if you happen to be the director of a bank).

Now we turn to Sir Fred Goodwin. RBS has this week posted the largest loss in UK corporate history, consisting of a £8billion trading loss and £16billion write down on good will, mainly due to the disastrous acquisition of ABN Amro. Sir Fred was the CEO at the time of the ABN acquisition and was the principle architect of the deal, the prime mover. At the time of the deal many said that RBS had paid too much, and we now know this to be true. Subsequently Sir Fred was forced out along with the rest of the Board of Directors (and who can say they didn't deserve it). To top this we also learn that under the terms by which Sir Fred left, he receives a £690,000 pension for life, which amounts to a pension pot of some £16million or more!

The question is, why, if I am responsible for repaying the money RBS has loaned to me, are not the Directors of RBS responsible for the money that was loaned to RBS? In fact why when they have made such a bad job of it do they leave with anything at all, why are they still wearing shirts? There is no good answer to this. The obvious one, that no-one (on the whole) could provide a guarantee to cover the amount that RBS has lost doesn't really cut it.

We also hear that the Government has very nicely asked Sir Fred to hand this pension back. Sir Fred has refused (at time of writing, is refusing), on the overt grounds that this was the deal agreed at the time. The underlying reason is quite different - most people's spending aspirations top out at under £1million; by the time you've bought a big house, a fast car, a holiday in the sun etc, it's actually quite hard to spend even larger amounts of money. What Sir Fred is therefore getting is more money per year for as long as he lives than most people could imagine spending at all. I know I for one would be pretty happy to suffer even quite high levels of opprobrium for £690k per year for life, well who wouldn't? Who is going to give this back if they don't have to?

The better question is, if Sir Fred had known that he risked his pension, would he have quite so happily risked the bank on the ABN deal? Would the Board have done the deal if they knew they stood to lose their shirts? The answer to bank regulation is not to make it tighter, it's to make it self regulating. You do this by imposing on the directors of banks the same requirements as any other business. Do you think we'd be in this mess if we'd done that when we set up the FSA?

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