shock therapy in the city

GEOFFREY INGHAM SHOCK THERAPY IN THE CITY In 1971 Richard Nixon set in train the sequence of events that has given the contemporary capitalist world its distinctive structure. What we now know loosely as ‘globalization’ began in earnest with the removal of the lynch pins of the Bretton Woods international monetary system—the breaking of the gold–dollar link in 1971 and, in 1974, the abolition of all exchange controls on capital movements to and from the US. The money market, as Schumpeter accurately observed, is the headquarters of capitalism, and Nixon’s actions were in part intended to ensure that it remained, if not geographically within US jurisdiction, then at least firmly under the control of its financiers. By the late 1960s, a view had formed in the US that the post-war international financial system was no longer in its interests. On the one hand, a revitalized Wall Street, riding on the backs of US multinational corporations, pressed for the global reach it had desired since the 1920s; it was now in a fit condition to throw off the Bretton Woods fetters. On the other hand, this ambition coincided with a re-definition of the American state’s own interests. An unimpeded inflow of capital, it was now argued, could finance the hegemon’s spiralling expenses. Doubts were also raised about the costs that global monetary responsibility might bring. Robert Gilpin’s influential view, later expressed in his US Power and the Multinational Corporation: The Political Economy of Direct Foreign Investment (1975), was that Britain had been weakened by its management of the international monetary order, and that this had played a part in its loss of dominance in the twentieth century. In 1944, the US had had little choice but to accept the hegemon’s burden; but by the early 1970s, things were beginning to take on a different complexion. The severance of the link between the dollar and gold created a regime of floating exchange-rates and made the successive abandonment of the exchange controls on international capital-flows by the other major capitalist states almost inevitable. It should also be pointed out, however, that with the revival of the world economy after 1945, Bretton Woods had become increasingly difficult and costly to implement. By the 1970s, over a quarter of the Bank of England’s staff was employed in monitoring and enforcing the controls; a similar number in the banks and markets were doubtless busy devising schemes by which to evade them. The existence of formal exchange controls had also provided a basis for the growth of unofficial currency markets. The most important of these was the informal, parallel capital-market in Eurodollars—the result of the City of London’s ingenuity in creating and exploiting a loophole in the Bretton Woods system, by which resident non-nationals could trade in the huge stock of dollars that US deficits had placed in the hands of its foreign creditors. In the 1960s, hampered by their own domestic controls and, at this juncture, by continued US support for the Bretton Woods regime, American banks followed the dollars and established bases in London. The colonization that would lead to the eventual extermination of the City’s native ‘gentlemen’ had begun. Nixon’s abandonment of the dollar–gold standard and the opening of the weakened financial sluice-gates wrought further rapid transformations in all sectors of the money market. Restrictive practices within the closed, locally embedded stock markets had been sustained by the Bretton Woods system. Their ‘deregulation’ was the corollary of a regime of floating exchange-rates. A global market in equities/securities had now become possible but first, these old social and legal structures had to be swept away. ‘May Day’—May 1, 1975—saw the abolition of barriers to entry and fixed commissions on the New York Stock Exchange. With no controls on capital movements to the US, foreign investment—British included—flowed into Wall Street. Overnight, the London Stock Exchange, along with all the rest, became globally uncompetitive and increasingly restricted to poor-grade domestic securities. The US action set off a tidal wave of responses: ‘competitive deregulation’ swept around the world during the 1980s; by 1992, even the Japanese were pushed into a grudging and very gradual relaxation of their ‘closed shop’ stock-exchange rules. As in all previous hegemonic extensions of the market, the odds were that the strongest players would, as intended, dominate the ‘levelled’ playing field—although before the implosion of the Japanese economy, the outcome was by no means certain. Since the mid-1990s, however, US firms have inexorably come to dominate the global money and capital markets. The early threat that London’s stock market might be reduced to a local and declining backwater had moved even the beleaguered Labour government of the late 1970s to issue a lawsuit against the London Stock Exchange, alleging that its modus operandi was in ‘restraint of trade’. The ‘winter of discontent’ and subsequent electoral defeat in 1979 saved Labour the trouble of assuming the then uncharacteristic role of market deregulator. Thatcher’s first act was to follow the US lead and to abolish all remaining exchange controls, before zealously setting about the outstanding matter of Stock Exchange rules. It is at this juncture that Philip Augar takes up the story. Armed with a Cambridge doctorate in history, Augar—presumably wearing the ‘shoes with laces, trousers with braces’ described in chapter 4—had entered the world of stockbroking at Fielding Newson Smith in 1978, and subsequently worked at Natwest and then Schroders investment bank, quitting in 2000 after its sale to Citigroup. The Death of Gentlemanly Capitalism is a thoughtful, intelligent work, rich in personal insight and anthropological detail, laying out a distinctive narrative of the City’s decline. The book’s opening section portrays the ambience in the City on the eve of Thatcher’s reforms as reminiscent of a ‘boarding school, officers’ mess or the junior combination room of an Oxbridge college of the 1950s’, with brokers distinguished from merchant bankers by style of cufflinks, shoes and ties; by sporting interests and weekend haunts. Augar documents the regional and class antagonisms—the public-school ethos and predominantly Home Counties origins of the merchant bankers and brokers; the grammar-school training and provincial backgrounds of the clearing (retail) bankers. He captures well the shocks administered to the ‘twilight world of gentlemanly capitalism’ by the arrival of computerized trading floors and extended working days, and by the disruption of such deeply entrenched class hierarchies. Augar’s account charts the striking disappearance of almost all the elite family firms and partnerships of merchant bankers and stockbrokers that had, for centuries, been at the heart of the world’s dominant financial and commercial centre. Only Cazenove, Lazards and Rothschild now remain, as small and peripheral ‘niche’ players. The cream of Britain’s clearing banks—Barclays, NatWest and Lloyds—showed both an unwillingness and, more importantly, an abject inability to operate in the harsher environment after 1986. Augar deplores what he sees as an ‘unnecessary’ loss of control over national economic destiny, writing presciently (in late 1999) that the first serious bear market of the twenty-first century would see the ‘downsizing’ of activity in London, as Citigroup, Morgan Stanley et al withdrew to their native core. While conceding that US power and the loss of autonomy brought about by deregulation would inevitably have diminished domestic involvement and control, Augar stresses that it is only British firms that have disappeared, or strategically withdrawn, from global investment banking. Continental competitors such as Deutsche Bank, SBC and ING maintain a strong and growing London presence. How did what Augar terms ‘one of the most abject surrenders in business history’ come about? The Big Bang of 1986 abolished the Stock Exchange’s closed-shop membership restrictions, the requirement that its members act in a ‘single capacity’ (that is, as either brokers or jobbers, but not both) and its fixed commissions. Before deregulation, the trading of securities/equities on the London Stock Exchange bore scant resemblance to microeconomic-textbook models of a perfectly competitive ‘market’. The ‘sell-side’ comprised a vertically segregated hierarchy of merchant banks, brokers and jobbers, embedded within structures of social solidarity, informal custom and practice (based on the Exchange’s own rules), under the watchful but genial eye of the Bank of England. In other words, the stock market was governed by a local ‘self-regulation’, held together by the face-to-face contact of status equals whose common social origins eased the informality of its operation. With deregulation and, in particular, the abolition of single capacity, banks were permitted to enter the market as brokers. The expertise and stock-market contacts of the established firms were needed, however, in order to participate in the increasing numbers of international mergers and acquisitions. In the three years after planned deregulation was announced in 1983, British merchant and clearing banks and US and continental investment banks all scrambled to buy a suitable broker. From their point of view, meanwhile, the brokers themselves had to calculate the risks of remaining independent, and thus too small to be players in the new globalmarket. Within three years the City’s structure had changed dramatically. The City merchant bank, Warburg, had bought the brokers Rowe & Pitman, Akroyd & Smithers and Mullens & Co; Citigroup had snapped up Scrimgeour Kemp Gee and Vickers da Costa; and the Swiss UBS had purchased Phillips & Drew. Most ominously, small, efficient American investment banks such as Goldman Sachs and Morgan Stanley entered the fray. Their skills had been honed by over half a century’s experience in exactly the kind of aggressive securities market that the Big Bang had created, and they already knew the City from their experience of Eurodollar trading. This group did not have to undergo any destabilizing organizational, functional or operational change. Rather, in peak condition they slipped into a business they already knew well—integrated securities and corporate finance at the international level. In great—and sometimes repeated—detail, Augar chronicles the carnage that ensued. By 1986, a new competitive dealing-system had been established, and firms forged out of businesses that previously had been rigidly segregated. As a consequence, internal relationships, as well as those with clients, had to be redefined and restructured. Most of the old firms had been partnerships or wholly owned family businesses; employment contracts now had to replace ownership stakes. Few social arrangements would prove capable of handling such a simultaneous perturbation of both internal structure and external environment. Furthermore, the difficulties of fundamental reorganization were compounded by the impossibly short time-scale in which to implement the change—a scant three years from the Parkinson–Goodison agreement in 1983 to Big Bang. At this juncture, the ‘cultural tensions’ central to Augar’s account undoubtedly exacerbated the organizational and managerial problems involved. The public-school partners and owners of the old City firms, as the author observed in person, did not take kindly to their integration as employees in the managerial hierarchy of, say, the NatWest retail bank, run by people with rather different accents and social codes from their own—‘more regional than Home Counties, more polyester than silk’. Along similar lines to the shock-therapy theorists of the transition from socialism to capitalism in Eastern Europe, the Thatcher government had been persuaded that the competitive ‘market’ was both self-generating and self-regulating—just as the micro-economic textbook implied. It was wrong, as events during the 1990s were frequently to prove. Significantly, Augar argues, British implementation omitted one of the vital elements of the US model—strong external regulation of the kind delivered by the Securities and Exchange Commission. The values, norms, practices and social relations that had developed over the years, and which had constituted the ‘old’ City as a functionally viable marketplace, had been blown away by the Big Bang. It took the Barings debacle in 1995 to concentrate attention on the fact that, as Augar correctly implies, self-interest and open competition alone cannot generate and regulate an orderly market. But it is hard to see how, with the best will (and prescience) in the world, a Financial Services Authority could have been put in place in the three years before 1986—or that it would have made any difference. Augar is on stronger ground in posing a sharp contrast between the relative success of the European universal banks, in the post-1986 regime, and the failure of will and competence among their nearest British competitors. By the end of the 1990s, as noted, all Britain’s large, bureaucratically managed retail clearing banks had withdrawn from global investment banking, due to internal failure or predation by stronger competitors. The Death of Gentlemanly Capitalism is very much a view from the inside, and its explanatory reach is perhaps marred by the limits of this perspective. Augar gives too much weight to Thatcherite ideology, as opposed to straightforward strategic self-interest in joining the global competition, and scarcely touches on the international political and economic determinants of deregulation. As a result, he exaggerates the extent to which domestic ownership of the City might have survived. His restriction of explanatory focus to the organizational and cultural problems that disabled the City’s ‘gentlemen’, in an uneven contest with powerful, keen-witted transatlantic invaders, is too parochial. In this regard, his work implies a cruel irony. In the annals of British ‘decline’ literature, with which this journal has been so closely associated over the years, the gentlemanly dominance of the world’s clearing-house has been seen as the source of a debilitating disregard for the British manufacturing sector—the same cosy, insular regime which Augar here argues to be the underlying cause of the City elite’s own demise. But the analysis is overdrawn; there is more to the issue of the City’s fate than gentlemanly culture. Most obviously, British manufacturers themselves have also proved to be feeble global competitors for clearly different reasons (although an indirect influence of the City cannot be ruled out). Nuffield, Rootes and others in the car industry, for example, may have been ennobled, but they were hardly the kind of gentlemen that Augar has in mind. Moreover, the automobile pioneers single-handedly created large corporations based on mass production, not the partnerships and family firms of the old City. Nonetheless, they suffered the same fate—which, similarly, has not been shared by continental Europeans. Ford has been well established in Britain since the 1920s and continues to devour the juicier remnants, such as Jaguar. But Volkswagen and BMW now control significant parts of the British car industry, and the Agnelli family in Italy, for example, is forging global alliances for the marketing of Fiat and Alfa Romeo. The Nissan plants in the northeast of England are as efficient as the ones in Japan. But for Cazenove read Morgan Cars: both exquisite and beautifully crafted, but forever destined to be limited to the comfort of their niche. The imputation of primary explanatory force to ‘culture’ in accounting for the demise of the City firms, or any others, is fraught with methodological and analytical problems. One of Augar’s central arguments is that the near absolute annihilation of British investment banking could have been avoided. Somewhat unconvincingly, he suggests that the US banks were inept at the new business up to the mid 1990s. But even in terms of his own analysis, it is hard to see how domestically controlled investment banking could have prospered. The century or more of the genteel ‘twilight world’ that had ticked over, comfortably and profitably, in the low-risk system of relational exchange and fixed commissions, had disabled the London brokers. It was not so much their ‘gentlemanly’ culture but this mode of operation that was redundant in a world of competitive market transactions. The old City’s strengths had lain in the assessment of credit risk, but the new system was increasingly governed by the analysis of market risk—that is, the price movements that the previous structure had sought to control, if not entirely eliminate. The larger British retail bankers were unable to pick up the mantle. Augar’s passionate belief that the disappearance of British-controlled investment banking represents the loss of a valuable resource is, perhaps, too coloured by nostalgia. The loss both of power and of a ‘culture’, charted so passionately, was also a personal one. However, his indictment implies a deep intuitive scepticism of the current, supposedly apoliticalconception of economic globalization to be found in New Labour’s Third Way. Augar begins his narrative with an account of a conversation over dinner with Eddie George, before he became Governor of the Bank of England. George was utterly indifferent to any problems that might result from the growing dominance of the City by American investment banks, invoking the analogy of the Wimbledon Tennis Championships: it was held in Britain, staffed by locals, dominated by foreigners; but it generated money and prestige for the UK. More recently, he has similarly averred that ‘nationality’ has no significance in the global market place. Augar disagrees, and evokes for comparison the loss of strategic control, particularly over employment, that foreign ownership of manufacturing has brought. In the heady days of the 1980s, he notes, the ‘globalization’ of financial markets was seen as a continuous, three-legged circuit between the equal stages of New York, Tokyo and London. Now, Augar suggests, a wheel-like structure with New York as the controlling hub is a more appropriate image. As it has done for centuries, the City continues to exercise an almost unchecked dominance and influence over the rest of the British economy; this is, of course, in the nature of any ‘headquarters’ of capitalism. But until recently it was, at least, under domestic control. In the 1920s, London lost its financial ‘weight’ to New York but retained an intermediary degree of controlover a large part of the market structure and the flows of finance. With the power of Wall Street temporarily reined in by Bretton Woods, London—with its networks, expertise, guile and more than a slice of luck—hung on famously to ‘live by its wits’. Now even these have been bought—but, of course, at a price acceptable to the sellers.