Financial engineering sufficiently changes the nature of a product – be it a loan, an investment, a derivative or a corporate structure – to allow it not to be caught by rules that an earlier generation had designed to prevent the institution’s involvement in the designated financial activity. This is normally because previous disasters had demonstrated that the buyers were not bright enough to understand the risks and too arrogant to admit it to the silver-tongued salesmen in the investment banks.
It is a good reason not to have sympathy for the banks as they set aside billions to take the assets of Special Investment Vehicles (SIVs) back in-house in the latest crisis. SIVs were only created to allow banks to finance pools of investments off their balance sheets and therefore away from rules designed to maintain prudence in lending. Now the idea has gone sour, banks find they are the only people around with pockets deep enough to pick up the pieces.
The interesting point is that they are under no obligation to do so because the whole point was that these vehicles were legally separate from the sponsoring bank. What the banks are now finding out though – and what a good PR executive could have told them from the beginning if they had cared to listen – is that you cannot separate credit from reputation.
A bank with no reputation has no credit and a bank with no credit has no business. If the banks want to continue to be active in borrowing and lending money, they have to be seen to be organisations with integrity. Leaving these SIVs in the lurch, with someone else standing to lose the billions, might save the banks short-term, but would hugely damage their reputations. No one would want to deal with them in future. So it is not altruism that has made HSBC and others take on more than £30bn of this stuff. It is self-interest.
But how much cheaper it would have been to have hired and then listened to good public relations counsel so they did not put their reputations at risk in the first place?
Anthony Hilton is City commentator on London’s Evening Standard