Today’s parliamentary report on HBOS is a fascinating correction to the assumptions I made and prejudices I came across working there. It’s also full of some wonderful turns of phrase; I found it a pleasure to read.
It provides a salutary lesson in cognitive biases (where people see what they want to see) and the Dunning-Krueger effect (where people think they are cleverer than in fact they are). Both can be seen in the Financial Services Authority, the HBOS Board, and HBOS Executives throughout the organisation.
In a nutshell, the Halifax – a retail mortgage giant – bit off more than it had the knowledge or skill to chew when it took over Bank of Scotland in 2001. It seems that HBOS would have failed anyway (I believe that CEO sir James Crosby knew this when he left in 2006) and the downturn of 2008 just made the inevitable disaster happen sooner.
I still blame HBOS’s Retail products for much of the housing crisis we face in the UK today because they broke the link between earnings and house prices. They also primed the negative equity situation with 125% mortgages. Wicked though this is, it seems the Retail Division did not break the bank.
The Corporate, Treasury and International Divisions (formerly Bank of Scotland) thought they were too cool for school and bought market share by lending to customers other bankers would not touch. Meanwhile, the leadership came from Retail (formerly the Halifax) and did not have the skills to challenge or control the other Divisions.
None of them saw any problem with this and it seems that some of them still don’t.
I have read the report, so you don’t have to. The numbers are the paragraph numbers of the report.
Denial is not just a river in Egypt
137 – In many ways, the history of HBOS provides a manual of bad banking…
18 – Despite pursuing a strategy of high growth with commensurate risk, HBOS preserved the self-image of a conservative institution.
The writer of the report is exasperated by the way those involved STILL think HBOS was conservative, and mentions this several times.
19 – [The] culture … in the higher echelons of the bank… was brash, underpinned by a belief that the growing market share was due to a special set of skills which HBOS possessed and which its competitors lacked.
29 – “We always believed and my colleagues in the corporate bank always believed that they had a good understanding of the risks they were taking.” – Sir James Crosby (CEO 2001 – 2006)
… but in fact they were just bad bankers
30 – [HBOS’s] losses were on a larger proportionate scale than those incurred by any other major UK bank. This was caused … by its distinctive loan book.. [which was] significantly more exposed to the domestic downturn than that of any other large UK corporate banking businesses.
31 – The roots of all these mistakes can be traced to a culture of perilously high risk lending. The picture that emerges is of a corporate bank that found it hard to say ‘no’.
32 – … the losses were the result of incompetent lending and not caused solely by the events of 2008.
… who blamed external circumstances
32 – we are extremely disappointed by the attempts of the most senior leaders of HBOS at the time to attribute the scale of the consequent losses … to the temporary closure of wholesale markets. The lending approach of the Corporate Division would have been bad lending in any market.
39 – The losses incurred by HBOS in Ireland and Australia are striking, not only in absolute terms, but also in comparison with other banks. … The repeated reference in evidence to us by former senior executives to the problems of the Irish economy suggests almost wilful blindness to the weaknesses of the portfolio flowing from their own strategy.
The people employed with controlling Risk were amateurs….
41 – some members of the Board may not have … understood that there was greater risk inherent in the move to instruments with higher returns … judging by Jo Dawson’s (Group Risk Director in 2004-05 …) admission that she “would not have known what an Alt-A security was”.
Let me repeat that: the group risk director did not understand different kinds of financial securities and instruments.
42 – All relevant functions at HBOS, from the Board downwards, did not properly understand the nature of the risks embedded in the Treasury Division’s structured investment portfolio
50 – the senior management of HBOS clearly had a lot less understanding of corporate banking than the divisional managers
54 – … the Group Chief Executives did not develop a strong Group-level risk function. …. Paul Moore [head of group risk and later a whistleblower] … detected what he termed a “cultural indisposition to challenge”.
57 – During her brief time in the role of Group Risk Director, Jo Dawson concluded that she had influence rather than authority.
58 – “In HBOS [the group risk role] was viewed more as a rotational set of assignments to round out people. So rather than getting experts, they would bring in people as development experiences.” – Eric Daniels (CEO of Lloyds when it took over HBOS)
61 – Jo Dawson indicated that Corporate was less open to challenge and that it did not believe Group functions had the expertise to advise it.
That was true so far is it goes, but it seems Corporate did not have the skills or appetite to assess Risk either.
64 – … Successive Group Risk Directors were fatally weakened in carrying out their duties by their lack of expertise and experience … by the fact that the centre of gravity lay with the divisions themselves … and by the knowledge that their hopes for career progression lay elsewhere in the bank.
Most shockingly of all:
65 – The weaknesses of group risk in HBOS were a matter of design, not accident. Responsibility for this lies with Sir James Crosby, who as Chief Executive until 2005 was responsible for that design, with Andy Hornby [CEO from 2006 – 2008), who failed to address the matter, and particularly with Lord Stevenson as Chairman throughout the period in question.
Wow. Just… wow.
To my surprise, the Retail business (formerly the Halifax and Leeds Permanent Building Societies) were not to blame….
46 – The impairments incurred by the Retail Division were substantially less than those incurred by the Corporate and International Divisions and were not a material factor in the failure of HBOS.
This surprises me, given the aggressively competitive nature of their mortgage products.
Regulating the regulator
The Financial Services Authority (FSA) comes in for criticism too
It had concerns in 2002-2003 including
69 – … A lack of clarity about the point at which management would cease to feel comfortable about increasing the exposure to commercial property;
70 – [However, independent firm PwC reported in 2004] that the risk management processes within HBOS in general, appeared “to work well”
71 – From this point onwards, the regulatory pressure for improvement appears to have diminished.
Note that in January 2004, Crosby was appointed a non-Executive Director of the FSA whilst still CEO of HBOS. The report does not note this conflict of interest and coincidence of timing, instead it says the FSA’s focus shifted to other regulatory initiatives.
83 – … the FSA’s regulation of HBOS was thoroughly inadequate. … The FSA failed to follow through on [its] concerns and was too easily satisfied that they had been resolved.
85 – Too much supervision was undertaken at too low a level
I am shocked and disappointed that the report does not mention Crosby’s dual role at this time.
All aboard …
Everyone on the Board thought the Board was wonderful
91 – The corporate governance of HBOS at board level serves as a model for the future, but not in the way in which Lord Stevenson and other former Board members appear to see it. It represents a model of self-delusion, of the triumph of process over purpose.
92 – … the expectation was that the Board would approve the executive business plans; challenge would be expected to come from the executives, rather than the non-executives or the full Board.
This is the opposite of how Boards are supposed to work.
The Board weren’t bankers, and neither were the people running the bank:
93 – There was insufficient banking expertise among HBOS’s top management. In consequence, they were incapable of even understanding the risks that some elements of the business were running, let alone managing them.
94 – The non-executives on the Board lacked the experience or expertise to identify many of the core risks that the bank was running. … The board was composed in a manner which appeared suitable for a retail-oriented financial services company, but that board lacked the necessary banking experience among its non-executives…
95 – Judging by the comments of some former Board members, membership of the Board of HBOS [was] a positive experience for many participants. We are shocked and surprised that, even after the ship has run aground, so many of those who were on the bridge still seem so keen to congratulate themselves on their collective navigational skills.
I think I am falling in love with whoever wrote this report.
Smugness, complacency and hubris…
HBOS’s management did know they had problems, so they were not entirely blind:
98 – The 2003-07 Business Plan (drawn up in 2002) cited funding and liquidity as possibly the bank’s “greatest single challenge”. … in November 2002 … Sir James Crosby acknowledged that funding was a “significant risk”.
Smugly, they thought they had done enough:
103. – “without wishing to be complacent or hubristic, management has done a superb job-a job that started five years ago and not in August … – Lord Stephenson to the FSA in 2007
And they whistled in the dark with excessive use of exclamation marks which is always worrying. Here is Lord Stephenson in March 2008:
105 – “I and we are feeling about as robust as it is possible to feel in a worrying environment which we would rather did not exist! … How would we fare if liquidity completely dried up, you asked? Does that keep me awake at night? Well yes of course one worries about everything, but the answer is no!”
The domino effect
It is easy to forget what a disaster this was – HBOS had more small-scale private shareholders than any other company in the UK
108 – Former HBOS shareholders have seen 96 per cent of its peak value disappear. [From almost £12 per share to about 60p]
108 – … the Treasury and Lloyds Banking Group injected a total of £28 billion of equity into HBOS. The market value of the Treasury holding in LBG is still £5 billion below the £20.5 billion invested.
109 – There has also been an adverse effect on the operation of the banking market. HBOS was weakened in its ability to continue its retail lending and its support for SMEs. The banking market has become less diverse and less competitive in consequence of the merger. UK competition law was altered … Consumers and the wider economy, as well as shareholders and taxpayers, have paid a heavy price for the blunders of the HBOS Board.
Not their fault guv…
Once again, the cognitive dissonance and denial comes through.
110 – in evidence to the Treasury Committee in 2009 and in evidence to this Commission, senior figures within HBOS have portrayed themselves as victims of forces beyond their control.
But the Commission has no patience with this
114 – As a home-grown banking failure in traditional banking, HBOS stands alone.
115 – The problems of liquidity were the occasion for the failure of HBOS, not the cause.
116 – The HBOS failure was fundamentally one of solvency.
In other words, they failed because of too much high-risk lending (they were insolvent); the fact they could not borrow money (lack of liquidity) to cover those risks just exposed the underlying problem sooner.
This gets the prize for the best use of the word abyss I have seen in the last 5 years:
125 – The Commission was very disappointed by the attempts of those who led HBOS into the abyss to acknowledge, even now, either the nature of the problems that eventually consumed the bank or the extent to which they flowed from their own decisions rather than unforeseeable events. … the scale of HBOS’s credit losses was markedly worse than that of any of its major peers. In these circumstances, the apologies of those at the top of HBOS for the loss imposed upon the taxpayers and others ring hollow; an apology is due for the incompetent and reckless Board strategy; merely apologising for having failed to plan for an unforeseeable event is not much of an apology.
It’s not just about the bank, though, it’s about the bankers. I have always thought James Crosby knew what he was handing over to Andy Hornby in 2006
128. After leaving the bank in July 2006, Sir James chose to sell two thirds of his holdings [in HBOS]
The Commission seems to think so too.
135 – In the view of this Commission, it is right and proper that the primary responsibility for the downfall of HBOS should rest with Sir James Crosby, architect of the strategy that set the course for disaster, with Andy Hornby, who proved unable or unwilling to change course, and Lord Stevenson, who presided over the bank’s board from its birth to its death. Lord Stevenson, in particular, has shown himself incapable of facing the realities of what placed the bank in jeopardy from that time until now.
Worryingly, not much has changed
136 – The regulatory structures at the time of the last crisis … have shown themselves incapable of producing fitting sanctions … in a manner which might serve as a suitable deterrent for the next crisis.
138 – One lesson relates to structural reforms [of the banking sector]. This was … a case of a bank pursuing traditional banking activities and pursuing them badly. Structural reform of the banking industry does not diminish the need for appropriate management and supervision of traditional banking activities.
139 – Another lesson is that prudential supervisors cannot rely on financial markets to do their work for them. In the case of HBOS, neither shareholders nor ratings agencies exerted the effective pressure.
The invisible hand is not operated by an all-seeing eye.
So in conclusion – HBOS fell because of bad management, it’s board did not have the knowledge to stop it, and the FSA did not regulate it properly. And, yes, it could all happen again.
Disclosure: I worked for HBOS from 2005-2010 well away from the dramas, deep inside the IT function within the Retail division. During that time, I used HBOS as a case study for several assignments in a Masters degree, including a case study of the failure of leadership by Crosby, Hornby and Stephenson which led to the failure of the bank.
This was first published here as a note on Facebook.