We let down diligent folk at the Halifax


John returns to his experience as a Halifax director to retrace the rocky road to last week’s rescue takeover.

I once gave away more money than Andrew Carnegie or Bill Gates. Ten years ago, as a director of the Halifax Building Society I authorised the distribution of almost £20bn to its 8m members on flotation of the business. Last week, the story reached a sad denouement and much of the windfall slipped away. The organisation, now part of HBOS, agreed to a rescue bid from Lloyds TSB.

The business I joined gathered deposits from small savers, mostly through its branches. It lent the proceeds to house buyers. Founded as a self-help organisation by provident Yorkshire folk 150 years ago, the Halifax became the world’s largest mortgage lender. Its quality of service and competitive interest rates trounced conventional banks in the UK retail savings market. The simple business model was very robust. In the early 1990s, a combination of high interest rates, recession and falling house prices posed much more serious problems for UK homeowners than anything seen, or likely, in the current credit crunch. But the Halifax remained profitable and mortgages readily available.

Accepting deposits and underwriting and administering mortgages requires that millions of records should be maintained and updated every day with almost no errors. This activity does not require flair or imagination but does require conscientious individuals with integrity and loyalty. The Halifax was a precision machine that made the most of the talents of ordinary people. I came to understand the fundamental incompatibility of the cultures of retail and investment banking and why the marriage of the two so often leads to tears.

The road to nemesis began, not at conversion, but earlier – on the day it was decided that treasury should be a profit centre in its own right rather than an ancillary activity. Legal restrictions on UK mortgage lenders were relaxed in 1986. Halifax’s main rival, Abbey, converted to a public company and leveraged its deposit base to build a large balance sheet. Most bankers were incredulous that the Halifax had been so slow to take advantage of this opportunity.

For an economist who taught that profit could be sustained only as a result of competitive advantage, this diversification raised a simple question. Some businessmen on the board, accustomed to a world in which profit is earned only by meeting customer needs, saw the same difficulty. Trading in short-term money market instruments is essentially a zero-sum game – one party’s gain is another’s loss. So what was the source of the trading profits that not just our company, but every company in this business, claimed to make? The experienced bankers would shake their heads at this naivety. If they deigned to answer the question at all, it was to say that our traders were uniquely perceptive and prescient, although it was difficult to remain convinced of that once you had met them. Large banks derived an informational advantage from the volume of business they transacted for their main customers. But it was hard to understand why those customers tolerated it, or how newcomers could muscle in.

Most apparently successful trading strategies involve what I now call Taleb processes, after Nassim Taleb’s book The Black Swan. A series of small profits is punctuated by occasional large losses. Then cognitive dissonance combines with short memories. The profits are attributed to successful trading, the losses are the result of unforeseeable events.

There, in a nutshell, is the story of the credit crunch. And there is the story of how a business that had grown for 150 years forfeited its independence. When the dust settles, many banks and hedge funds will have lost more money on their trading activities in the past year or so than they had made in their entire history. Those conscientious people who process deposits and issue mortgages are still there, though many have had the worst weekend of their lives. The business they do continues to make money. Customers mostly remain loyal. The pursuit of shareholder value damaged both shareholder value and the business. We let them all down.

John Kay stepped down from the Halifax board in 2000.

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