How quickly we forget the flaws of state ownership By John Plender
Financial Times Published: September 28 2008 20:21
The wisdom of hindsight will be brought to bear with a vengeance this week on the pros and cons of demutualisation. The plight of Bradford & Bingley; the rescue bid by Lloyds TSB for HBOS, owner of Halifax; Alliance & Leicester?s disappearance into the maw of Banco Santander, which earlier absorbed the troubled former building society, Abbey ? all this adds up to a sorry verdict on the wave of demutualisations that began under Margaret Thatcher in the 1980s.
Yet before passing a devastating black and white verdict, it is worth recalling that the building societies of the pre-Thatcher era were not God?s gift to the customer. All forms of organisational ownership involve conflicts of interest. In the case of mutually-owned building societies, there was little accountability to owner-customers.
Ambitious building society managers were prone to dash for growth, since growth provided both personal satisfaction and a justification for higher pay. Yet market share was often expanded at the expense of the owners of the business. Even after the demutualisations started, the best deals were often offered to new customers rather than existing ones.
The business model was also inherently unstable because of the maturity mismatch between deposits and mortgage loans. From time to time, building societies ran into trouble. I know, because I once inadvertently started a run on a Midlands building society by pointing out that double-digit growth in lending had brought its capital to the regulatory minimum, yet management had no plans to address the capital strain.
With demutualisation came transitional hazards. First, carpetbaggers who acquired small deposits could tip the balance in favour of demutualisation against the will of larger and longer-standing depositors, because votes were allocated according to the number of depositors rather than size of deposits.
Then, if the process involved raising capital, money tended to burn a hole in the enlarged bank?s pockets. This was the fate of the British trustee savings banks, which acquired £1.3bn of new equity on flotation and quickly blew it on the catastrophic acquisitions of Hill Samuel and the Target fund management group.
In the newly demutualised world, conflicts of interest changed subtly. Dispersed shareholder ownership was not very different in principle from dispersed customer ownership, although the movement of share prices and the attention of analysts provided a running commentary on performance. Yet growth, the capital markets? perpetual mantra, inevitably became a higher priority. And growth was further cranked up by performance-related bonuses and incentives where the yardsticks were earnings per share and total shareholder return.
Bradford & Bingley?s last directors? remuneration report is instructive on this score. The discussion of performance rewards sees the objective as attracting, retaining and motivating people. The chief benchmark was earnings per share and a move was afoot to add total shareholder return in 2009. These yardsticks are open to criticism in any industry, since earnings are too readily manipulable, while the share price is a poor reflection of individual company performance except, perhaps, in the very long term.
Yet in banking, performance yardsticks need to be adjusted for risk. Incentive structures cannot simply be about attracting, retaining and motivating. For one of the biggest lessons of the present financial debacle is that flawed incentive structures can jeopardise not only a bank, but the whole banking system. The absence of a discussion of risk in the Bradford & Bingley directors? remuneration report is thus significant.
That is not to say that mutually-owned lenders do not have performance- related pay. Nor do they eschew benchmarks such as profits and earnings. But the latest remuneration report from Nationwide, the biggest mutually-owned lender, has a far wider set of benchmarks than Bradford & Bingley, and they are not all financial in focus. Executives are even required to look after the hapless customer.
In a business without access to outside capital, the language of the report is less growth-oriented and more cautionary. It tells the story of a very different culture. No doubt some building society will be in trouble before too long. But I suspect the conflict of interest in the building society movement between managers and customer-owners is less acute than that between managers and shareholders in demutualised banks.
It is impossible to pass a definitive verdict on demutualisation because we cannot know how these banks would have performed without demutualisation. But the outcome looks, at best, unhappy. It is ironic that state ownership, which was regarded in the 1980s as hopelessly flawed, should suddenly be regarded as preferable to private ownership in handling the strains of an industry that lies at the heart of the capitalist system.