Red Pepper » Christopher Hird

A bank worth backing

admin — Fri, 18 May 2012 19:39:56 +0000

Illustration: Cressida Knapp
At first glance, the 2010 annual report and accounts of the Co-op Bank is much like that of any other big business – the bank has assets of nearly £70 billion and eight million customers. There are pictures of the board members and senior executives (all white men, except for one woman), fulsome references to the community projects the bank supports and testimony from satisfied employees and customers. And the report has a justifiably triumphant tone to it – after all, in 2010 the bank (which includes the Co-op Insurance company) increased its profits by over 17 per cent in a year in which most banks made massive losses.
Even in the dark days of 2007, when the financial crisis broke, the bank was making money. This performance enabled it to merge successfully with the Britannia building society in 2009, making it the largest mutually owned financial services company in the world.
But there were two things that probably would not appear in any other bank’s annual report: the news that the company had turned down £1 billion of new business because the potential customers did not measure up to the bank’s ethical standards, and that in its mortgage business the bank’s policy was ‘lending to customers what they could afford to pay’. It is not every business that boasts that it is deliberately forgoing profits.
One response to these remarks is to feel a glow of pride that this is what a co-operatively owned business can do. Mine is rather different. I think it highlights the exceptionally complex position in which the Co-op finds itself, especially at a time when it is trying to take over more than 600 branches of Lloyds bank.
Red Pepper readers will probably be familiar with the origins of the Co-op – formed in the middle of the 19th century by working-class activists to provide decent food and provisions because the established retailers sold them overpriced rubbish. What the Co-op wrestled with for many years – certainly since the second world war – was how to survive as a business when consumers deserted it for a better offer from the capitalist providers. The Co-op Bank was probably the first part of the co-operative movement to spot that the solution was to serve the middle class – and to provide not just a decent banking service but promote the idea of being an ethical business too.
In other words, it embraced the market. There were always rumblings from some members of the co-operative movement that this wasn’t doing anything for the working class. But it got away with it probably because the bank was such a small part of the Co-op and it made no call on the resources of the rest of the movement. Now, with the banking industry in crisis and large chunks of it owned by the state, people from across the political and business spectrum are wondering whether it might be a model for a new form of bank.
Perhaps one of the most important people talking about a new form of ownership for banks is Andrew Haldane, the executive director for financial stability at the Bank of England. In a series of speeches and articles (all on the Bank of England website), Haldane has shown how the institution of the limited liability company – that’s the conventional shareholder-owned business – has become corrupted, so that in banking the executives were able to take massive risks with other people’s money, make excessive profits underwritten by governments and on the back of this pay themselves excessive wages.
It is Haldane who has pointed out that in 2007 the average pay of the chief executives of the largest four UK banks was 230 times the average household income. It is worth reinforcing the point – these men did not take any personal risk and the risks they took with other people’s money were underwritten by the government. In the same speech, Haldane estimated that the public subsidy to the big four British banks between 2007 and 2010 was $340 billion a year. (Yes, billion.) And remember this is all from a senior executive at the Bank of England. No surprise therefore, that he thinks we need to look again at the mutually owned co-operative as a model for banking – in his words, ‘the stakeholder democracy model’ rather than the ‘equity dictatorship model’.
What kind of co-op?
Co-operative Financial Services, the business that owns the Co‑op Bank and the Co-operative Insurance Society, is a mutually owned co-operative. But it is important to understand just what this means. It is not a workers’ co-operative and it is not run like a co-operative. It is mutually owned in the sense that there are no outside shareholders and it is run for the benefit of all of its members – the customers. But these customers exercise very little influence or control over the way the bank is run.
The structure of the Co-operative is one of indirect parliamentary democracy – the six million members of the Co-op elect representatives to their area committees, which send representatives to the regional committees, which send representatives to the main board, which also has on it the chief executive, who heads the executive, which runs the business day to day.
In the past decade the fortunes of the Co-op have been transformed, including in the highly competitive retail sector. It now accounts for 8 per cent of supermarket trade, compared with 4 per cent at its nadir ten years ago. It is making profits of nearly £250 million, after paying customers a dividend of more than £100 million – the amount each member receives being in proportion to their spending.
There is little doubt that the movement’s structure – which gives elected representatives responsibility for setting the overall strategy but no power in the day-to-day running of the business – has been one of the reasons for the Co-op’s revival. It has allowed the retail professionals to devise a strategy that worked, given the stores and brand image they had. In the recently published report of the Ownership Commission (PDF), there is an interesting chart of the life cycle of a co-operative, which shows that Phase 3 of ‘growth and glory’ is followed by a period of introspection. This is the critical time for the co-op because if it cannot reinvent itself, it will probably decline and eventually disappear. It seems clear that the Co-op has successfully reinvented and reinvigorated itself, which may herald a new sustained period of growth and success: increasing market share and profits can create a virtuous circle of growth.
But this brings with it a whole new set of challenges, which goes to the heart of the debate about capitalism that the Occupy movement has been so successful in provoking. And if we are to create new and better structures, we need to find a way of disentangling concepts such as markets and profits from an abstraction called ‘capitalism’. The Co-op’s success is a good starting point.
Competition, profit and ownership
The Co-op has succeeded in a highly competitive market. Even allowing for the fact that many of our demands as consumers are shaped by social factors (of which advertising is clearly a major one), markets have proved to be an effective way of meeting consumer needs. And in one sense the Co‑op is a capitalist institution – it owns large amounts of capital (in the form of shops) and its whole survival depends on it making a profit.
What makes it different is its ownership structure. Because there are no shareholders, the size and use of profits can be contested. In a large shareholder-owned business there is a simple clarity of purpose – to maximise the profits for shareholders. Customers need to be satisfied, laws need to be observed, corporate reputations need to be protected – it is a complex interplaying of forces, but it is, in the end, to the purpose of satisfying the shareholders.
For a co-op it is both simpler and more complex. Simpler because there are no shareholders; more complex, because there are not simple measures of performance. The competing claims of workers, the financial strength of the business, consumers, the values of the business and the wider world have all to be balanced – and in a structure in which some of these claims on the business’s profits have no formal voice.
Clearly the Co-op has had some success in recent years in managing these competing claims and using the money that in a conventional shareholder business would go to shareholders to support a wide range of other interests. But if the new enthusiasm for reviving mutuals (after they were almost killed off by the Thatcher government) does extend to the banking sector, there are several issues that need to be addressed.
The Co-op Bank is rightly proud of how it has weathered the banking crisis. One of the reasons why it has been so successful is because it has been conservatively managed – as its commitment to not encouraging people to borrow money they cannot afford shows. This means that the bank grew slowly in the boom years, in what turned out to be a good long-term strategy. Partly this was policy but partly it was necessity: as a co-op the bank was not able to get access to outside capital to expand its business.
This may be okay when you are small – and the Co-op is still a relatively small bank – but it is a substantial impediment if you want to grow. And growth may be necessary to compete with the shareholder-owned businesses. The Ownership Commission report highlighted this disadvantage, saying it had ‘serious consequences for financial service mutuals and co-operatives’, and recommended that the government should change the law to make it easier for mutuals to raise outside capital without threatening their mutual status.
This is not an arcane discussion about bank ratios. To be an effective competitor to the big banks, it is estimated that the Co-op would need to have about 6 per cent of the UK retail banking market. The Lloyds takeover would achieve that, but one reason the takeover is stalled is that the regulators are concerned about the capital base of the new bank. A private company could go off and get the capital; at the moment it is virtually impossible for a mutual to do this.
But it could be made possible. Last year the employee-mutual retailer the John Lewis Partnership raised £50 million from its customers through a bond offering. Because it is a bond, it gets a fixed return – it doesn’t share in the profits of the business and it doesn’t undermine the company’s mutual status.
Such a ‘crowd funding’ financing model could be adapted to fit the Co-op Bank if the government changed the rules. And it could be reinforced if mutuals – with their conservative banking policies – were required to have less capital than the riskier banks. You can be sure that the established banks will oppose such ideas, lobbying to keep things as they are. So it is important that all those who believe in the idea of a co-operatively owned bank fight back.
Christopher Hird is managing director of documentary film makers Dartmouth Films and executive producer of The Flaw, which tells the story of the root causes of the financial crash. His latest projects include the film of the book The Spirit Level, for which he is currently raising funds. You can back it by going to www.thespiritleveldocumentary.com

The Cost of Inequality: A chronicle of capitalist catastrophe

admin — Tue, 10 Apr 2012 14:00:23 +0000

This book chronicles the catastrophe of the capitalism of the last 30 years. It is the story of what happened when what Stewart Lansley terms the ‘managed capitalism’ of the post-war period was replaced by the ideology of free-market capitalism espoused by Margaret Thatcher and Ronald Reagan and continued by New Labour. The theory was that self‑regulating free markets and the pursuit of profit would deliver economic prosperity for all. This book shows what a disaster this has been.
I use the word ‘story’ because the book is not an argument, not a point of view – it records what actually happened.
Milton Friedman really did say that the basis of a free society is companies making as much money for their shareholders as possible. Thatcher adviser Brian Griffiths really did say inequality would ‘achieve greater prosperity for all’.
And it was nonsense. Economic growth has slowed – just over 2 per cent per annum between 1980 and 2009 in the UK, compared with 3 per cent between 1950 and 1973. Productivity growth is lower and real wages have fallen for the vast majority of the population. Wages now account for 45 per cent of GDP compared with 60 per cent in 1979.
While the majority have got poorer, the rich have got richer. In the US, for example, in 1976 the top 1 per cent of the population accounted for 8.6 per cent of income; today it is over 23 per cent. The trend has been the same in the UK and even though it has not been as marked, it has ensured that the UK has moved from one of the most equal societies to one of the most unequal.
In other words, free-market capitalism does not work – it has not delivered on its promise. Whole industries have been sacrificed in the pursuit of ‘shareholder value’ – free‑market capitalism’s corporate creed. Lansley reminds us of the destruction of two of Britain’s successful businesses – Marconi and ICI – in a period in which finance capital was allowed to rule.
But it is even worse than that. As Lansley shows, free‑market capitalism creates instability and economic crises. Indeed, it is the root cause of the 2007/08 crisis.
As the rich got richer, their bank accounts bulged and there were ready customers to borrow this money – the majority of the population, whose living standards were falling. In the words of the American economist Louis Hyman in The Flaw, a Dartmouth Films documentary about the financial crash: ‘Whilst the rich weren’t willing to pay more wages, they were willing to lend them the money.’ Of course the mechanism by which this takes place is complex, making money for the many financial intermediaries – but the key dynamic is inescapable: money in the hands of wage earners, who need it, will be more productively spent than money in the hands of the rich, who don’t need it.
What is striking about this insight is that it is now widely accepted. The IMF thinks that wages’ share of GDP should rise, stating that the increase in inequality ‘is the most serious challenge facing the world’; the Bank of England thinks the banking sector is too large. And hardly an economist disagrees.
Despite this, nothing much has changed since the crisis, and Lansley’s got the facts – productivity up, profits up, wages down, inequality on the rise. Governments might have saved us from a second depression but they have done nothing to solve the underlying problems of current-day capitalism.
Lansley’s solution is to increase taxes (including an international crackdown on tax avoidance), weaken shareholder power through a ‘new contract’ with labour that introduces ‘flexicurity’ to the labour market, and rebalance the economy from finance to productive industries through taxation, regulation and the establishment of a national investment bank committed to social entrepreneurship and building a green infrastructure.
There is not much to disagree with in this programme. Indeed, Lansley typically manages to find support from unlikely quarters. The question is one of implementation: how is this to be made a part of the political debate and then adopted by a government committed to a decidedly ‘unmanaged’ capitalism?
The period of managed capitalism described in the book is one in which there was also progressive taxation and an inclusive welfare state. Both these and the idea of ‘capitalism controlled’ were the products of a powerful social movement: organised labour.
Yet, as Lansley recounts, this has also been virtually demolished in the past 30 years – a quarter of the labour force is unionised in the UK today, compared with half in 1979. For a number of reasons it is not possible (nor desirable) to re-create the union movement of the 1950s and 1960s but, as this book shows, there is a pressing need to create the 21st-century equivalent.
Crammed with data and evidence, with this book in your hand you never need go into an argument unarmed.

Rocking the market

admin — Wed, 30 Jan 2008 14:30:53 +0000

Just after the government’s rescue of Northern Rock, I was at a dinner at the Institute of Economic Affairs. The IEA is generally described, especially on the left, as a ‘right-wing’ think tank – a soubriquet it resists, preferring something like ‘free market’.

During the 1970s, in particular, its stream of pamphlets attacking state intervention and espousing market solutions for almost all areas of public policy made it a powerhouse of ideas for the Thatcher-led Conservative party and government. Today, with no substantial ideological divide between the main parties on the role of the market, the IEA does not have the political potency it once had. But one might still have expected there to be criticism of the government’s meddling in the market by stepping into to save Northern Rock.

Around the table at the IEA were leading economists, former bankers, businesspeople, academics, newspaper columnists and so on. But none of them (with the exception of a young IEA staffer) thought that the government had made a mistake in rescuing Northern Rock. There may have been some argument about how it had been done, what the long-term consequences would be, but everyone realised that in our society, no government could allow hundreds of thousands of ordinary savers to be impoverished.

This pragmatism was in sharp contrast to the approach of the government, whose handling of the Northern Rock affair showed that it has still not got a handle on how to deal with the power of the financial markets. But it also raises important questions for anyone on the left who wants to have practical policies that tackle the role of financial institutions in our society, on which most of us to some extent rely.

Profit makers to profit takers

Once upon a time, Northern Rock was a modest but successful building society, which operated mainly in the north of England. Building societies were mutual organisations, dedicated to providing mortgages and owned by the people who saved with and borrowed from them. They needed to make profits to stay in business, but, in words they often used, they were ‘profit makers, not profit takers’.

One should not be too dewy eyed about building societies. Over the years they had become large managerial organisations in which much of the original democratic impulse of their founders and constitutions had been lost. Their lending policies were excessively conservative, discriminating against the unmarried and the working class. Indeed, these were among the reasons why there was no great outcry to save the building societies when, in the 1980s, the managers of many of them decided to turn them into banks.
The arguments in favour of this process of ‘demutualisation’ were various but in reality the process was driven by the ambition of the managers, who saw the prospect of running big banks, not boring building societies. It was eagerly lapped up by building society members, who received windfall profits as their mutual organisations became shareholder-owned companies. One of the building society chiefs attracted by this was Adam Appleyard of Northern Rock, who successfully demutualised the society in 1997.

Although mutual organisations are far from perfect, they do offer the opportunity of a different form of business model – one for which profit is not the driving force and that could develop different types of accountability and participation. However, partly because far too many people on the left were stuck in traditions of socialism that focused only on the role of the state and of labour, there was no substantial attempt to save them. We are paying the price of that narrow vision today.

Freed from the constraints of being a building society, Appleyard set about trying to achieve his ambition of turning Northern Rock into one of the largest mortgage lenders in the UK. To do this he needed literally billions of pounds of people’s savings and without a large network of branches across the country this was quite a task. He achieved it by a big campaign to attract online savings deposits – often at relatively high rates of interest – and also by relying on borrowing money from the money markets. The latter strategy was to be his and Northern Rock’s undoing.

Money market deposits come from the vast sums of cash sloshing around in banks, international companies and other financial institutions. With the growth of globalisation, these funds are international and their key feature is their volatility – the money moves where there is the highest return and it can quickly move on if professional investors get nervous.

That is exactly what happened last year when, bothered by losses in the US mortgage market, the supply of short-term credit, which was so important to Northern Rock, started to dry up. Northern Rock had made the fatal error of lending its money long term – on mortgages – but had funded these disproportionately with short-term funds. So, when it found it hard to lay its hands on more short term funds, it had to go to the Bank of England to see if it could help out.

Foresight failure

Could all of this have been foreseen? The answer is, unequivocally: yes. Indeed, many people in the banking industry had been commenting on Northern Rock’s vulnerability, but while the plan seemed to work, with Northern Rock’s profits and share price rising, not many people listened to these warning sounds.

The people who should have been saying something were Northern Rock’s shareholders, particularly the big institutional investors, who manage the savings and pensions of us all. Why did they do nothing? Largely because in the UK we still have a very strong tradition of the non-active institutional investor.

This failing of the UK financial sector was exposed and discussed last year in the rather unpromisingly titled book, The New Capitalists, one of whose authors is David Pitt-Watson, once finance director of the Labour Party and now a fund manager in the City. The book argues that the big investment funds should recognise that they are interested in the capacity of the companies in which they invest to generate sustainable profits in the long term – often the very long term. Therefore, investors should actively pressurise the boards of companies to change their policies if they do not make long-term sense. If the investors in Northern Rock had had their wits about them, they would have gone to Appleyard and pointed out the long-term danger of him building profits growth in the way he was. If they had done that, the crisis may never have happened.

But the obsession with profits growth often militates against taking the more sophisticated long-term view. The crisis in the US that provoked the problems at Northern Rock was the result of a combination of the professional ambition of people running banks over there and the demands from their shareholders for profits growth year after year. These pressures encouraged the banks to take greater and greater risks as they increased their lending – the best known example of which has been the much reported ‘sub-prime’ mortgage business in which money was lent to people with no incomes, often already heavily in debt and often on houses that were not even inspected.

Personal responsibility

Of course, we should always remember that no-one forced those Americans to borrow money they could ill afford – just as no one forces us to have credit cards and (unlike the pre-war and immediate post-war generations) we freely choose to buy things on credit, rather than save for them. So, although Northern Rock does make us ask questions about the forces that drive businesses, it should also make us ask some questions about our own behaviour as consumers and citizens. And whereas once many of the left would think that the regulation of financial markets and the interests of consumers was not an appropriate area of interest, that is certainly not now the case.

One of the many consequences of the economic and political changes of the past 20 years has been a withdrawal of the state and employers from providing things such as pensions and the increase in the individual having to take responsibility for them. The blunt fact is that many people are disturbingly ill-informed about the risks they face. Recent work by the Financial Services Authority showed a widespread ignorance among the holders of ISAs (which are widely held by people of modest means) about the risks they faced. People queued up to withdraw their money from Northern Rock because they thought they would lose it, even though Alistair Darling’s initial statement made this extremely unlikely.

Of course, Darling did botch the whole job. He should have given an unequivocal guarantee that all deposits would be safe – which in the end he was forced to do. He hung back from doing this in the first instance because he was advised that this would amount to a carte blanche to the whole of the financial sector that the government stood behind all its deposits. This would create what bankers refer to as ‘moral hazard’ – encouraging banks to take risks without regard to the consequences. But the reality is that whatever the textbooks may say, there are a complex series of forces that would stop banks going mad just because one rather rogue company had been saved. The people at the IEA dinner understood this, even if Darling didn’t.

What next?

So what happens now? In the short term, the chances of Northern Rock being taken over by the government, or by a government-backed rescue, are very high. Already the bank is largely financed by the special loans from the Bank of England. If this happens, then the government just has to make sure that this takes place on good terms for the taxpayer and that it acts imaginatively with regard to Northern Rock’s future. This would be a chance for the government to increase the diversity of financial institutions by doing something other than re-selling it to the highest bidder. It would be a chance to create a major institution, which, while profitable, is not driven simply by the need to maximise profits. An example of social entrepreneurship.

In the medium term, the government will almost certainly increase the formal protection for savers, but the Northern Rock affair has highlighted something more important: there is a need to make us as financially literate as we are politically literate. We know that large companies are increasing centres of power, but we also know that they respond to public and political pressure.

This is a good thing – the more that large economic organisations can be forced into a social relationship with the society around them, the greater the chance of turning these organisations to a social purpose. But we cannot embark on such a political strategy if we don’t know what we are talking about.

Improved regulation is important but, as with many things, it would be better still if the government helped us do it ourselves. So, for the left, one response to Northern Rock would be to demand the government promotes the socially active financial citizen as much as it promotes, for example, faith schools or academies.