Banking Crisis - Treasury Contents


Memorandum from Michael McQuade

1.  CONFIDENTIALITY

  1.1.  I am more than happy that any information or opinions that I give in this submission remain in the public domain however I would ask that my personal contact details should not be published and should remain confidential as I have no wish to be inundated with spam emails or unsolicited telephone calls.

2.  ABOUT MICHAEL DOUGLAS MCQUADE

  2.1  I am a retired bank manager. In 1964 I joined the Leicester Trustee Savings Bank and in 1975 I was appointed manager of the TSB in Lutterworth, Leicestershire. At that time I was the youngest appointed lending manager. (TSB had just begun to lend to its customers). During my career I managed a number of branches then was appointed to an Area role. When I was forced into early retirement in 2001, by Lloyds TSB Bank plc, I was working on various projects including Complaint Handling and Telephony. I was a Director of the Lloyds TSB No 2 Pension Fund. During my time at the bank I achieved a number of notable successes:

  2.1.1  I saved the bank £6 million per year (every year) in cash management;

  2.1.2  I saved the bank from being fined by the FSA for untimely management of investment proposals;

  2.1.3  I lent more money on mortgage from my branch in Leicestershire than the whole of the other branches in the County put together;

  2.1.4  My bad debt record was exemplary;

  2.1.5  I wrote the chapter in the Bank Lending Manual that dealt with Overdraft Reviews;

  2.1.6  I designed an Objective Based Appraisal System used to support Performance Related Pay and introduced it across the TSB national branch network; and

  2.1.7  I was the first branch manager to sell £1 million of life insurance cover.

3.  SUMMARY OF THE MAIN POINTS OF THIS SUBMISSION

  I would like the Committee to consider my views on:

    —  Professionalism in banking.

    —  Historic regulation in the mortgage market.

    —  Effects of de-regulation.

    —  The mortgage borrower.

    —  TSB and Building Societies as Public Limited Companies.

    —  Who Pays the Price.

3.1  Professionalism in banking

  3.1.1  When I started my career in banking it was made clear to me that if I expected to progress toward an appointment then the minimum standard that I would need to achieve was to become an Associate of the Institute of Bankers, now the Chartered Institute of Bankers. I studied General Principles of Law including, sources of law, contract and tort. I studied Principles of Accounting so that I could understand company accounts, total and marginal costing, budgetary control and investment appraisal.

  3.1.2  Today bank staff are encouraged to study for the Financial Planning Certificate to enable them to sell insurance products. Bank staff are encouraged to be licensed to sell home insurance, car insurance, mortgages, life insurance and pensions. Professional banking qualifications are very low on the priority list. Proof? Ask the Chartered Institute of Bankers for the statistics of UK "ACIB" award made over the last 25 years and look at the trend line.

  3.1.3  We cannot expect our front line banking staff to offer professional advice to help customers manage their business and personal finances when they have a sales biased education and the focus of bank "Customer Service" is based upon selling bank products.

3.2  The Page Report

  3.2.1  Around 1976 a government commission looked into the future of the TSB and banking in Great Britain. The findings were published as The Page Report. This report proposed that:

    (1) The joint stock banks, then the Big 5, Barclays, National Provincial, Westminster, Lloyds and Midland should concentrate on serving the commercial customer.

    (2) The TSB should be developed to service the banking needs of the general public.

    (3) The Post Office Savings Bank should be developed to service the personal banking needs of those people who lived in areas where it was uneconomic for banks to operate.

  3.2.2  The report was ignored.

  3.2.3  The bank branch network has been destroyed, profit before service left many without easy access to personal banking services.

3.3  Historic regulation in the mortgage market

  3.3.1  In 1973 I bought my first house, a terraced house in Leicester. To obtain a mortgage I had to have saved regularly with a building society and built up a deposit in my account.

  3.3.2  Saving regularly had two purposes, (1) to build the deposit and (2) to prove to the building society that I could regularly put on one side a sum of money and still maintain a standard of living.

  3.3.3  In 1973 only building societies were allowed to lend money over 25 years for house purchase. Bank lending did not extend beyond 10 years and the rates charged were significantly higher than those charged by building societies.

  3.3.4  Tax relief was available on building society mortgage interest.

  3.3.5  Building society mortgages were only available for the purchase of the borrower's principle place of residence.

  3.3.6  Building society mortgages were not available for the purchase of second homes or houses in the rental sector.

  3.3.7  Building society mortgages were in short supply and prospective borrowers often had to wait their turn.

  3.3.8  The buying of houses to rent was considered a business enterprise and borrowers were directed to the banks for a commercial loan. Bankers in those days considered lending in proportion to the borrowers stake in the enterprise. Buying houses to rent required the borrower to use their own money and the bank lent in multiples of the borrowers stake, double nothing was nothing! The bank held the deeds as security. The loan to value ratio never went above 70% of the value of the property and this valuation was taken not on the open market freehold value but on a 7-10 year return on rent. The repayment period rarely reached 10 years.

  3.3.9  In every case where I lent money to a customer I always looked for two things, an intention to repay and an ability to repay. The first I covered by looking at the borrowers banking history and checking with a credit reference agency and the second I covered by completing an income and expenditure account. If the borrower proposed to take on the commitment to repay a given sum each month and he or she had not been saving that same sum over at least the previous six months, where was the repayment coming from? What was to be given up? Was that reasonable? Following these principles my lending was sound but more importantly my customers never entered into commitments that they could not afford.

3.4  Effects of de-regulation

  3.4.1  During the 1980's the government of the day pursued a policy of a free market economy. De-regulate the market place and allow competition to drive out inefficiencies and allow the market to find its own level.

  3.4.2  Building societies were allowed to borrow money from the wholesale market and make it available for mortgage borrowers. Borrow short and lend long! Not a sound business philosophy, totally dependent upon the continuing supply of short term wholesale funds. The experience of 2007 proves this point.

  3.4.3  Banks were allowed to lend money for house purchase on mortgage loans over 25 years.

  3.4.4  The sudden free availability of mortgage funds across the market place initiated the housing boom. With freely available funds and more buyers in the market competing for a limited supply of houses the market responded like any other market, the price went up. This deregulation of mortgage lending was a major cause of the boom in property prices in the last quarter of the last century.

  3.4.5  With building societies having endless capital to lend and the banks entering the market bringing their massive lending capacity, there were insufficient borrowers able to take up the supply of money to buy principal places of residence. The banks and building societies had to become inventive in lending. Lending on house purchase was seen as low risk, "Safe as Houses"!

  3.4.6  Tax relief on mortgage interest is withdrawn.

  3.4.7  The effect of tax relief being withdrawn and the inexhaustible supply of money meant that the loan purpose was no longer restricted to buying the borrowers principle place of residence. Banks and building societies fell over themselves to refinance each others mortgage lending to provide the borrower with fund to buy anything. One recent TV advert showed an obese couple sitting on a sofa saying that XYZ Finance Company made it very easy for them to refinance their mortgage over 300 easy monthly payments so that they could have a new kitchen and there was enough money left over to go on holiday. This couple had borrowed money for a two week holiday and were paying for it over 25 years!

  3.4.8  Deregulating the finance market gave rise to lenders advertising to encourage the general public to "free the equity in your home". Again, questionable. Equity was not freed from the home, the home remained exactly as before, the borrower was encouraged to become deeper in debt.

  3.4.9  Excess funds to lend, a booming property market and minimal regulation led the mortgage lenders to offer "non-status" mortgages. Instead of the lender confirming the income of the borrower and lending in proportion to it, the prospective borrower simply stated the amount of money he or she earned and in exchange for paying a higher interest rate the stated income was taken on face value and not confirmed. Some borrowers borrowed more than they could sensibly afford to repay which was fine while both parties were fully employed but became impossible when incomes reduced for whatever reason.

  3.4.10  Not satisfied with offering "non-status" mortgages, lenders now moved to 100% mortgage loans and these loans even covered carpets, white goods installed by builders and also included stamp duty and solicitors fees! 100% lending meant borrowers had no commitment of their own and hence nothing to protect when the times became difficult.

  3.4.11  Non-status mortgages and the booming property appealed to greed. Greedy borrowers philosophy was to borrow maximum today, fund repayments from capital and either relax when real earnings caught up or else sell after a couple of years and pocket the property capital appreciation.

  3.4.12  Deregulation opened up buy to rent propositions. Buy a house and rent it out. The rent covers the mortgage payment and the borrower uses the capital appreciation to support further borrowing to buy more houses to rent. The effect of this deregulation in university towns is that low priced housing is snapped up by buy to rent landlords leaving first time buyers priced out of the market.

3.5  The mortgage borrower

  3.5.1  Sadly we live in a consumer led society. The government today is actively promoting initiatives to try to stimulate the retail economy. Consumers are encouraged to consume and not to save. The general public want everything today and are not content to wait and improve their standards of living over time.

  3.5.2  In 1973 I bought my first house, a terraced property. At that time my expectation was to progress in my job to the point that I could afford to move to a semi-detached property and then when my career developed to move to a detached property. We started with hand-me-down furniture. We used the local launderette to wash our clothes. Today instead of waiting until we can afford improvements in our life style, they are bought on credit. There is no recognition of financial management failure when mortgages are refinanced to provide money to purchase cars and holidays.

  3.5.3  The general public want all of the materialistic things that a retail economy has to offer. Lenders have had too much money to lend and any lender who adopts a regulatory or controlling policy like confirming income or completing income and expenditure forms will soon lose lending to a competitor. In any event in a booming economy what losses do occur are more than covered by the profits from new business growth. That is, until there is no new business growth.

  3.5.4  Most members of the general public have never had lessons in financial management. School children are not interested in budgeting to pay the electricity bill or the mortgage. These things are not real in their lives. My children never turned off lights or ate the last slice of bread in the old loaf until they started to pay the bill. The general public will not, of their own volition draw up family budgets, they need stimulation at appropriate times to recognise the importance of forward planning.

  3.5.5  More people respond to greed than to need, indeed many salesmen's sales pitch appeals to greed and ignores need. Lenders and deregulation have done nothing to reverse this trend. Lenders have actively appealed to greed to encourage borrowers to remortgage their homes and buy consumer goods that they do not need. I have need of a television set, my need is satisfied by my existing set, it is a few years old and is digital. However, I am bombarded daily with advertising coaxing me to buy a 42 inch plasma home theatre. Why? I do not need one and I cannot afford to buy one but if I borrowed on my credit card, loan or mortgage I could have it today.

  3.5.6  We are all naturally greedy people, some of us have self discipline, others, however, need help.

  3.5.7  Last year, post nationalisation, Northern Rock Building Society was criticised for over zealous repossession. A borrower was shown on television standing outside his home, that had just been repossessed. He was lamenting that he had lived there for over 30 years and now it was gone. How could that be if he had bought the house on a mortgage over 25 years? Clearly this man had remortgaged his home to yield money to spend on things other than his home. Who was to blame?

4.  TSB AND BUILDING SOCIETIES AS PUBLIC LIMITED COMPANIES

  4.1  In the 80's the free market was everything. The Page Report had been rejected and the government was on a path to privatisation. The Trustee Savings bank was an anomaly, nobody owned it. The government wanted to see it privatised and eventually the courts approved.

  4.2  At floatation the Bank was worth £865 million. Floatation raised £1,000 million and the whole of the share capital came back to the Bank. TSB Bank plc was worth £1,865 million on Day 1 and it had £1,000 million in cash in its bank and no concrete plans to spend it.

  4.3.  Floatation may or may not have been a good idea but the reality of the situation was that TSB management were steeped in TSB culture and background. They were not hard faced commercial businessmen who had built successful business in a challenging market place. Prior to floatation TSB was limited in its activities by acts of parliament and its future was guaranteed by the Treasury/National Debt Office.

  4.4  In British economic history here had never been, nor has been since, a company that had £1,000 million cash to spend/invest. This frightening situation was made worse by the Company not having grown this nest egg from its successful trading activities but by its being given it almost as a windfall on a plate. The frightening situation was made terrifying by the fact that the purse strings were in the hands of inexperienced managers.

  4.5  TSB bought Hill Samuel Bank for a price agreed before Black Monday. Following stock market collapse on Black Monday the valuation of Hill Samuel fell but TSB went ahead and bought Hill Samuel at the pre collapse price. The Bank then expanded its commercial lending book and suffered great losses.

  4.6  Within a few short years TSB had lost £1,000 million.

  4.7  The TSB failure was not unique. Building societies rushed to privatisation as did the nationalised industries. In all cases management of these organisations was swept along by "group think", the euphoria of the 80's of deregulation and open market freedoms. No thought was given to expertise to manage these new privatised companies. Is it any wonder that so many of the companies floated in the 80's have been taken over by other businesses?

  4.8  When Peter Burt was Chief General Manager of Bank of Scotland, he had five criteria to be considered before taking over another business:

  1.  Will it prejudice the continued independence/existence of the Bank?

  2.  Is it "community type" banking? That is, inside existing skill capabilities.

  3.  Does it have a worthwhile share of a worthwhile market?

  4.  What can we bring to the party in terms of competitive advantage?

  5.  Does it make economic sense? We have long pockets but very short arms!

  The second part of point 2 and the whole of point 4 are absolutely essential. In the case of TSB, managing a public limited company worth nearly £2 million was outside the skills of the TSB Board and senior management team. Investing £1,000 million safely was clearly beyond their capability. They would have been better to have invested in a Post Office Savings Account!

  Clearly Bank of Scotland failed on Point 4, they had no capability to manage Halifax Building Society. BOS did not have a highly successful mortgage operation, the management of Halifax Building Society had managed to steer the privatised bank into difficulty that required the BOS intervention and BOS had nothing to bring to the party to shift the culture. Without a shift in culture more of the same will bring about more of the same.

  4.9  Abbey National and Alliance and Leicester have both suffered from enthusiastic building society managers who do not have the experience to run multi million pound companies.

5.  RECOMMENDATIONS THAT YOU WOULD LIKE THE COMMITTEE TO CONSIDER

5.1  Reregulate Mortgage Lending

  5.1.1  As soon as possible introduce legislation to regulate lending. The maximum period of borrowing should be limited to the life of the asset bought, eg house = 25 years, new car = 5 years, holiday = 1 year.

  5.1.2  Limit mortgage lending to provide funds for house purchase only.

  5.1.3  Require borrowers to save deposits.

  5.1.4  Set maximum loan to value limits, say 90%.

  5.1.5  Prohibit "non-status" mortgages. Require all income to be confirmed.

  5.1.6  Encourage responsible lending which includes confirming that the borrower can actually afford the loan.

  5.1.7  Shorten the loan periods for buy to rent properties to 10 years.

  5.1.8  The effect of the above limitations will, (a) limit the number of new mortgages, (b) keep house prices in check and affordable to first time buyers, (c) encourage prospective home owners to save, (d) give homeowners equity to protect when times get tough, (e) prevent the over enthusiastic from living beyond their means.

  5.1.9  Whatever new initiatives are introduced into the market place care must be taken not to allow freely available funds to drive up house prices.

5.2  Reward Saving

  5.2.1  If prospective home owners are to qualify for a mortgage they must save their deposit and their purchase costs. Qualifying schemes should be made available to savers to encourage them to save.

5.3  Shared Ownership Housing

  5.3.1  Encourage home ownership through shared ownership schemes. Government funds, or carefully controlled PFI funds, should be made available to Housing Associations or appropriately authorised/controlled lenders, to allow them to participate in shared ownership of properties on the open market. Provided that the homeowner has a stake in the property he has something to protect. The homeowner should be responsible for the maintenance of the property and sensible arrangements made at outset to clarify how the homeowner buys an increasing share in the property.

5.4  Scrutinise Merger Propositions

  5.4.1  When financial institution propose to merge or take over others, they ought to be required to address Peter Burt's five criteria.

  5.4.2  In answer to the questions at 6.4.1 above the reviewing panel ought to ask my generation of lending banker's two favourite questions, "How do you know that?" and "What if..?"

6.  WHO PAYS THE PRICE?

  6.1  Every decision ever made has a price to pay. The price may simply be the opportunity cost of the decision or it may be as drastic as life or death.

6.2  When lenders lend recklessly?

  6.2.1  The first person to pay is often the borrower. He lands in debt that he cannot afford. Irrespective of who ought to take responsibility, the borrower generally loses.

  6.2.2  The family of the borrower. It is hardly the children's fault when the family home is repossessed.

  6.2.3  The shareholder of the lending company. As a shareholder either directly or via a pension fund, bad debts lead to lower profits which lead to lower dividends and lower share valuations. Mr General Public has absolutely no power through his or her share voting rights to moderate the behaviour of companies. It is a myth to suggest that ordinary shareholders have influence. That is not true, only the big investment funds and city analysts have the ability to persuade.

6.3  When the Board/Senior Management make errors?

  6.3.1  The first people to pay are the employees at the sharp end of the business, jobs disappear, people are made redundant. The senior managers who made the bad decisions are often protected with contacts that have to be bought out, they are often rewarded by huge lump sum payments to vacate their chairs. Junior staff who have performed exactly as required and who did not make mistakes in their jobs have little or no protection.

  6.3.2  The shareholder, bad decisions lead to lower profits which lead to lower dividends and lower share valuations. Again Mr General Public has absolutely no power through his or her share voting rights to moderate the behaviour of companies.

6.4  Shareholders

  6.4.1  There is some mythical view postulated that shareholders are rich people. This cannot be further from the truth. Most shareholders are not rich. Most shareholders do not own shares in their own names. Most people are shareholders through their pension funds or through their life insurance policies.

  6.4.2  By and large, young people do not invest directly in shares, it is the middle aged and elderly who's children have grown up and have an eye to their retirement who invest in shares many through personal pensions or unit trusts.

  6.4.3  All shareholders, whether direct or indirect have paid a very heavy price due to the banking crisis. Many people have seen their wealth and their dividend income disappear through absolutely no fault of their own. It is unreasonable that the government should now expect them to suffer further.

  6.4.4  All reasonable effort should be given to limit any bonus payment given to any group of employees simply for doing their job. That is what salaries and wages are for. Bonuses should only be paid for exceptional achievement and should only be paid from the profits generated by the exceptional achievement. Reward success not failure.

  6.4.5  I believe that it is unreasonable for government to prohibit banks, who have borrowed from government, from paying a dividend. Direct shareholders often live on those dividends and pension companies need dividends to pay pensions. There has to be a better way than penalising the shareholder for the errors of those protected.

11 February 2009





 
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