Learning lessons from the crisis


Learning lessons from the crisis


As a convergence with the capital markets continues apace, Geraint Anderson, one-time bad boy of the investment banking world turned author, offers a stark warning of the culture of greed and excess that the reinsurance industry must avoid.

As the reinsurance industry becomes ever more complex and influenced by the capital markets both as a source of capacity and in the way risk is increasingly ‘packaged’ and sold to investors it also inches closer to being more like the investment banking sector.

As the chain between the original risk and the underwriters assessing and pricing it and those selling and those holding the risk is becoming ever more complex and convoluted, so the risks of mispricing, misselling and misunderstandings increase.

Given the boom and bust culture that inspired some spectacular failures in the investment banking sector, and the culture of excess that went hand in hand with that, we asked Geraint Anderson, one of the world’s most famous former investment bankers, for his insights into the risks the reinsurance industry must be at pains to avoid.

The wind of change is blowing through the reinsurance sector. What has often been viewed as a staid industry with an idiosyncratic structure, arcane rules and odd traditions is beginning to talk about ‘modernisation’, ‘incentivisation’ and, dare I say it, even ‘innovation’.

Most worrying of all is that insiders now tell me that its culture may well become more like that found at investment banks.

As someone who has spent 12 long years as a stockbroker let me assure you that this ain’t necessarily a good thing.

I worked at four investment banks between 1996 and 2008—a career that just happened to coincide exactly with what ex-prime minister Gordon Brown would later refer to as ‘the age of irresponsibility’… although I like to believe that my presence had little to do with that scathing conclusion.

I didn’t know it at the time but my City career took place during a truly extraordinary era, which was a product of the regulatory changes that had taken place over the previous 20 years and a precursor to the worst financial crisis in generations.

The problem with investment bankers is that they’re generally pretty smart. That wouldn’t necessarily be an issue but for the fact that, as a rule, you don’t enter banking to fulfil your artistic ambitions or make the world a better place.

No, you enter the heart of the beast to make a fast buck and when you’re a young, (probably) male hyper-competitive banker plying your trade in a hire-and-fire world you might just prioritise lining your pockets over worrying about the implications your actions may have on society.

Indeed, you’re generally only ever going to think about next year’s bonus and subsequently not get too concerned about tedious things like regulation, compliance or ‘long term shareholder value’.

What’s worse, the system in place actually encouraged such behaviour. About 12 minutes into my City career I came to realise that the bonus system was there to be aggressively milked and that the downside from screwing up was minimal; there was, to use the technical term, an ‘asymmetrical risk’.


Risky business
If I, or my trader or the hedge fund I was broking to, took a few massive gambles and they came good then within a year you might receive a bonus big enough to buy a couple of Maseratis.

If, however, those punts didn’t work out no money was actually removed from your wallet. Sure, you might possibly lose your job if you hoofed it badly but back then, when the City was booming, you’d easily be able to obfuscate the causes of your ‘resignation’ and find another job with some other dumb schmucks.

Of course, this wasn’t always the case. When broking firms were partnerships senior employees would potentially lose the shirt from their back if their firms made major losses. Partners would share in the pain as well as the gain, and that would give them pause before betting the house on some dubious derivatives they didn’t understood.

"When the rewards become ever bigger and the end of the party is looming your colleagues cease to be workmates, they are merely competitors for the bonus pool."

Unfortunately, after the ‘Big Bang’ and the acquisition of nearly all the British investment banks by massive (generally foreign) firms, board members were no longer partners and taking risks became a one-way bet. Sure, most front-office staff received some of their bonuses in the form of equity but this attempt to ‘align interests’ singularly failed ever to rein in the egregious excesses of the nineties and noughties.

So, although Bear Stearns and Lehman Brothers had the highest level of employee share ownership, they still ended up as the biggest risk-takers.

The one thing that all bankers need to comprehend more than any other is the relationship between risk and reward. This relationship explains why two companies with a similar growth profile trade on vastly different price:earnings (PE) ratios or why one corporate bond yields twice as much as another.

In addition, bankers’ skill at assessing the risk:reward ratio plays a vital role in explaining why they get up to so many dodgy things. John Tiner (when head of the Financial Services Authority [FSA] in 2006) complained that insider trading was ‘rife’ and the FSA’s own statistics showed that 30 percent of acquisitions were preceded by ‘suspicious share price movements’. Yet in the first 10 years of the FSA’s existence (from 1997) there were virtually no convictions.

You don’t have to be Albert Einstein to work out that supplementing your income with a few dubious insider trades was immensely rewarding and virtually risk-free.

The perceived lack of scrutiny and punishment in our very own Wild West Casino back then meant that market manipulation (eg, LIBOR), money-laundering and insider trading became the order of the day.

Towards the end of my career, fast-and-loose hedge funds would regularly call me up (on my mobile—all our office telephone conversations were recorded) demanding inside info and I soon had to become very adept at changing the subject to Manchester United’s recent misfortunes.

This greedy, risk-laden, short-term corporate culture did not just result in criminal behaviour; it also resulted in clever bankers inventing legal innovative financial instruments (or ‘socially useless’ products as former FSA chair Adair Turner called them) the principal purpose of which was to line their own pockets rather than serve the clients they claimed to be designed for.


The crash was coming

The trillion dollars’ worth of toxic sub-prime mortgage-backed products that almost brought our financial system crashing down appeared superficially to be perfectly solid—provided property prices kept rising and interest rates stayed low for ever.

If we assume bankers aren’t quite dumb enough to believe such preposterous assumptions, then it follows that they at least suspected that these collateralised debt obligations (CDOs) would explode after a few years.

However, they weren’t overly bothered about such tittle-tattle because they knew that by the time the house of cards came crashing down they’d be lying on a beach in Muscat with a Cohiba in one hand and a magnum of Cristal in the other.

As the lunatics took over the asylum and the talk of the inevitable upcoming crash grew louder the other interesting development I witnessed was a huge upsurge in the more unpleasant forms of office politics.

When the rewards become ever bigger and the end of the party is looming your colleagues cease to be workmates, they are merely competitors for the bonus pool. You suspect they are stabbing your back, stealing your thunder and brown-nosing the boss and hence you feel obliged to participate in the same dreadful games—precipitating an appalling vicious circle.

Towards the end of my tenure, office politics become so vicious that even Machiavelli would have been horrified by the machinations of the pin-striped psychopaths around me who would pull out all the stops in order to finance their expensive wives, gargantuan mortgages and their kids’ costly boarding schools. Not a pound of commission would end up being claimed by any less than seven different people.

Hand in hand with all these delightful developments was a working culture of excess. I used to get rip-roaringly drunk with colleagues and/or clients at least four times a week and substance-abuse and serial infidelity seemed to become ever more popular pastimes for my fellow City workers.

The Square Mile has always been a hard-drinking place (it has definitely become more professional now) but the strip-joint, cocaine and champagne lifestyle seemed to be both a cause and a symptom of the madness that gripped us all—the equivalent of Nero fiddling while Rome burned.

What’s worse is that this get-rich-quick culture of excess ‘leaked out’ from the investment banking arms of the integrated banks into the retail side. How else can we explain the multi-billion pound PPI mis-selling scandal?

I eventually become so horrified with the dubious goings-on I witnessed that, while still a banker, I began writing Cityboy, an anonymous weekly newspaper column exposing it and, after leaving my last bank, I published a whistleblower book of the same name.

Deregulation, bonus-based incentivisation and unfettered innovation are all potentially positive developments unless the employees tend to be greedy, ruthless and clever—which unfortunately they inevitably are. Such characters will soon learn how to game the system to their advantage and, in so doing, create a short-term, semi-criminal gambling culture the sole purpose of which is to make them richer.

I really hope that the reinsurance sector successfully modernises itself without adopting a culture akin to the one I witnessed during ‘the age of irresponsibility’. But for that to happen you’re going to have to learn from the dreadful mistakes made by your banking colleagues and put systems in place to prevent them being repeated.

Unfortunately, my banking experience suggests that memories are short, greed is a constant and that humans rarely learn from other people’s mistakes. Who knows, it might end up being you lot who trigger the next financial crisis.

Geraint Anderson is the author of Cityboy: Beer and Loathing in the Square Mile. He can be contacted on Twitter at: @cityboylondon; website: www.cityboy.biz


Insurance, Reinsurance, Geraint Anderson, London, UK

Intelligent Insurer