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Keep it simple, stupid

This month’s dispatch comes from the Labour Party conference in Manchester. One of the unalloyed joys of party conferences is the fringe – meetings that go on around the main conference on this or that issue in overheated and undersized hotel function rooms.

Most fringe meetings at Manchester focused on financial services and related issues, so for us at Cicero it was important to do the rounds.

One thing that we all hope for is that someone – especially a minister – will say something interesting. I don’t mean interesting in the worthy sense of giving us a valid exposition or defence of a policy but in the more compelling sense of saying more than they meant to or being more frank than they usually are when the cameras are rolling.

These moments are rare but thankfully a Labour MP did say something interesting in a meeting attended by one of my colleagues. He said: “I’ve yet to meet a wise person in financial services. I wish they’d bloody well keep things simple.”

That MP was John McFall, chairman of the Treasury Select Committee, expressing what is becoming an increasingly widely held view.

A few months ago I would have re-garded his as the view of a Luddite who simply did not grasp that the business of building financial products is necessarily a complex one, just as the business of building an Airbus airliner or a Large Hadron Collider is. Nobody ever exhorted the engineers on those projects to keep things simple, so what is so different about finance?

But now I’m not so sure. It was after trying to explain to my grandmother why an apparently profitable, reasonably well capitalised bank that was the mainstay of the UK mortgage market had gone down the toilet in such short order that I realised McFall is right – the cleverer you try to be in explaining this mess, the more stupid you end up sounding.

Bankers and commentators have been bandying about all sorts of jargon – derivatives, collaterised debt, short-selling, a correction in the pricing of risk and deleveraging. But the public are increasingly treating all this with the contempt and incredulity it de-serves – they are beginning to recognise that much of it is simply people trying to cover up their own mistakes with sophistry.

Indeed, in the tens of thousands of words of garbage I have read about the market turmoil in the daily and Sunday newspapers in the past few weeks by people that should know better (one columnist saying that even though she didn’t understand short selling, she felt herself sufficiently well informed to condemn it as a hateful and cynical practice in a national newspaper), only Bill Emmott, former editor of the The Economist, writing in the Sunday Times told it how it really was.

Emmott said that the banking business was largely an elaborate confidence trick which is fine when times are calm, but when confidence fades even HBOS tumbles like a high-class pyramid selling scheme.

And why did confidence desert the bank? Well, I think even my grandmother would recognise that it is nothing to do with the estimated 2.5% of HBOS shares that were held in short positions, but rather the result of a good old-fashioned asset bubble. The financial instruments are new and the jargon terribly complicated but just as investors in tulips once got stung when the upward trajectory of an asset price reversed, fear of HBOS’ exposure to a sharp reversal in the housing market is what underlies its predicament.

What also strikes me is how this crisis has been reported as an aberration – an epoch-changing event. But the truth is that while the scale of the problem is different, it is a deja vu all over again. People are losing their shirts just like they did when hedge fund Long-Term Capital Management went down and the dot com bubble burst.

Risk models probably say the current financial crisis is a one-in-a-1,000-year event but I have always been sceptical about the ability of spreadsheets to provide profound insights into anything that is subject to the whims of human behaviour.

So, when I get out of this conference I’ll be looking on Betfair. One thing I can say with confidence is that within my lifetime we will probably see another major banking crisis – and it will be the result of an asset bubble. I think that’s worth a punt.


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