Nicholas Hoare’s Ancestors and Lloyd Blankfein’s Contemporaries.
Many Montrealers have been saddened to hear that Nicholas Hoare, owner of the excellent small chain of bookstores bearing his name, is being forced by changing conditions to close his Montreal branch. While they know his surname for his stores, in England, and long throughout the whole financial world, the name is more commonly associated with the family’s centuries of history in merchant banking, once a vital part of world finance. What gradually happened to Hoare & Co. over the last half century provides a capsule illustration of what happened to almost all banking, with effects that eventually reached every part of modern society.
In the 19th century, on both sides of the Atlantic, the ‘commercial’ banks, those mainly taking deposits and making loans, and ‘merchant’ or ‘investment’ banks, specializing in the making of riskier and more exciting direct business investments, were once not that different in legal status. Both used to be run by small numbers of partners, affluent, financially skilled, and mostly prudent, since they were entirely liable for loans or investments that went wrong, even to being made personally destitute, which sometimes happened.. By the middle of the century, however, the commercial banks, growing huge through Victorian industrialization, began to draw away from the investment specialists. Governments first cautiously allowed them to move to ‘extended liability’, allowing larger numbers of shareholders, who were still required to take a partial hit from financial failures. But by the end of the 1930s. the big banks everywhere were being allowed to become full ‘limited liability’ corporations.
Meanwhile, the investment specialists, like Hoare & Co. in London and Goldman Sachs in New York, remained partnerships with unlimited liability, serving the vital function of launching and expanding entirely new kinds of enterprise. In the 1920s, some big American banks ventured into creating investment banking subsidiaries. But this came to be regarded (although not entirely accurately) as one of the causes of the 1929 Crash, and the Roosevelt administration’s 1934 Glass-Steagall Act strictly divided the two kinds of banking. In any case, the two decades after 1929 did not see much life on the stock market of any kind. An ordinary 1929 portfolio hit by the crash could not be sold at a profit until the 1950s, although its holder might have done well from GM and GE dividends. From 1930 to 1960, most of even the most famous investment banks looked only a little more lively than museums or libraries, often with the same men sitting in the same dignified old buildings into which they had first walked in the 1920s.
From the late 1960s on, however, banking and finance have been subjected to a continuing triple revolution. First of all, a huge new save of demand for equity investment capital re-appeared, almost more than the investment banking partnerships could handle. Secondly, a cascade of failures and frustrations in the highly regulated postwar ‘mixed economies’ of the West led, from the 1970s on, to a very powerful new current of free-market economic ideas, finding an academic base at the U. of Chicago, popularized effectively to the general public by Milton Friedman, and spreading to both political and business leaders.
As well, academic research in statistics, and ‘finance’ as a new university discipline, began to be more and more integrated into the daily practice of banking. That change dovetailed with a third large one: rapidly improving telecommunications and computerization steadily transformed all of financial intermediation, rendering many traditional banking sources of profit obsolete, while opening up all kinds of new ones, promising but not all that well understood, whether by old bankers or young computer sophisticates. For example, academic economists like Robert Merton showed that big commercial banks could boost their profit margins substantially by deliberately embracing more volatility, while their total risk would still be ‘limited’ by their limited liability, but there was little attention given to the terrific ‘moral hazard’ this would offer a few years later.
Commercial banks, their assets growing more gigantic every year, began pressing again to be allowed into the investment banking business. Eventually deregulation made this possible, often simply by buying out existing investment banks. While only Merrill Lynch had long taken the course of functioning as a public company, in time all the other investment banks gave in to internal and external pressure to do the same, although Goldman Sachs held out to the end of the 1990s, and put most of their stock issue in the hands of existing or former partners. The investment bankers in the exact sense also found themselves in frequent bitter internal quarrels with the firm’s traders, firmly fixed on maximizing volume and size of transactions, often regarding mere clients with something of a blank stare.
Hove & Co. showed all the effects of these multiple revolutionary forces. Until it merged in 1970 with another merchant bank to become Hoare Govett, it was led by ‘Kit’ Hoare, who was said to do business on a nod or handshake, never wrote anything down, but knew how to get in on all the best deals. Hoare Govett remained an elite merchant bank for a while, but when deregulation made a new game possible, it was sold for a high price in 1982 to a Los Angeles bank, Security Pacific. Its purchaser went down in flames in the 1992 California real estate crash, and was swallowed by the Bank of America, which then sold Hoare Govett to the Dutch giant, ABN Amro.
In 2007, by which time banking risks had been buried under layers of complex derivatives full of bad American real estate loans, the Royal Bank of Scotland then moved in on ABN Amro, both managing to make a catastrophic deal. That led to Hoare Govett being sold again, for very little this time, ironically enough to a relatively small ’boutique’ American investment bank called Jeffries. The mountains laboured, and what was once a sleek and handsome British mouse was driven hither and yon, at first fattened, then starved, then delivered into a nest of voracious American rodents. The fate of Hoare Govett was one largely shared by the other old British merchant banks from the late 1970s on, described bitterly in Phillip Auger’s The Death of Gentlemanly Capitalism.
In the grim reckoning of 2007-2008, famous American investment banks either went broke outright or were hastily made a compulsory meal of almost equally tottering commercial banks/ Their ‘limited’ liability left a horrendous bloodbath for their main shareholders, institutional investors, mostly acting for pension funds. Their chief executives had been large shareholders in their own firms as well, so they took large losses of their own, but the wider public naturally sheds few tears for them, seeing them depart with years of spectacular salaries and bonuses, leaving pensioners at the bottom of the food chain holding the bag.
There is a lesson in this for conservatives, many of whom were seduced over the last three decades by the ideas of doctrinaire economic libertarians. The 2008 Crash was not just another boom-after-bust that is an ordinary consequence of capitalism. From about 1998, even apparently successful new kinds of financial intermediation simply began accounting for more and more of a proportion of entire Western economies with disguised debt,, frequently masking rather anaemic development in ordinary enterprise, save in China. Letting ‘animal spirits’ rip in ordinary business has been, on the whole, a success story. But not in banking.
The gentleman merchant bankers of the first two-thirds of the 20th century were not infallible, and sometimes could be’piratical’ in their own ways. But by and large, they knew what they were doing, they had to take real personal responsibility for their mistakes, and that knowledge disciplined what they did. A legislative mess like the Dodd-Frank Bill does not come remotely near returning anything like that discipline, and the international increased capital requirements of ‘Basel III’ are only a little better. Banking needs another revolution, one that will take years, For future bankers and political leaders alike, it should begin in a spirit of humility, with great suspicion of systematic economic theories and abstract mathematical formulas, and with intelligent responses to public pressure. The latter may prove especially necessary, including in Canada, to moderate the activities of those politicians who use the term ‘conservative’ only to describe an obedient attention to the lobbying demands of monsters too big to fail.