William K. Black, Quito: May 16, 2015

In my immediately prior article I discussed in detail Prime Minister Tony Blair’s May 26, 2005 speech calling on the UK to “win” the regulatory race to the bottom.  In particular, Blair singled out the Financial Services Authority (FSA) for blistering criticism.

But something is seriously awry when … the Financial Services Authority that was established to provide clear guidelines and rules for the financial services sector and to protect the consumer against the fraudulent, is seen as hugely inhibiting of efficient business by perfectly respectable companies that have never defrauded anyone….”
Blair’s attack on the FSA bewildered and angered its Chairman, Callum McCarthy, who was busily eviscerating UK financial regulation in accordance with Blair’s earlier declarations of war on effective regulation.  By 2005, the FSA was spineless and a cheerleader for the corrupt City of London – which McCarthy, in a pratfall of unintended humor, described as a “clean” center of international finance.  Blair did not warn the FSA leadership in advance that he was going to excoriate them “as hugely inhibiting of efficient business.”  The good thing, for those of us seeking to document the causes of the financial crises is that Blair’s rant provoked a written response from the FSA’s leader on May 31, 2005.  The response proves that the FSA was a Potemkin regulator in the run up to the UK crises, that Blair knew that he and his government had destroyed effective financial regulation – and that his response to that knowledge was to order that any remnants of even modestly effective financial regulation be trampled into the City’s dust.

Here are the key points McCarthy made in his response.  Note that he did not challenge Blair’s insistence on further degrading UK finnancial regulation.  Instead, McCarthy pointed out all the ways he was acting to weaken financial regulation in the UK and the fact that the EU was praising McCarthy’s evisceration of UK regulation.

First, McCarthy emphasized that the FSA’s stacking the deck in its faux cost-benefit analyses was providing the model used by other UK anti-regulators to weaken or reject proposed rules to protect the public.  This spread the damage done to the UK by the FSA’s faux cost-benefit analyses well beyond financial regulation.

Second, he noted that the (just completed) Hampton report had praised the FSA’s “risk-based” approach to regulation.  As I explained in my prior column, the FSA used “risk-based” language to ignore the primary risks, i.e., it declared that the frauds that were already epidemic were low-risk areas that the FSA could cheerfully ignore.  
Philip Hampton is a UK businessman who was appointed by the Blair government to study regulation.  Shockingly, Hamilton claimed that UK businessmen were regulated too much.  He urged that a “risk-based” approach to regulation be used to reduce regulation in the UK.  Having helped to destroy the remaining dregs of regulation, and despite his abject failure as a senior official at Lloyds Banking, Hamilton was rewarded with a knighthood and was made head of the government-owned-but-not-managed RBS.

Third, McCarthy quoted Chancellor Gordon Brown, the UK’s top finance official and Blair’s right-hand man.  Brown said the FSA should be the model for the EU because it was the “world-leading regulator” (true, it led the global pack in the race to the bottom) and was not resting on its laurels.  After eviscerating effective financial regulation, Brown praised the FSA for continuing to bayonet any surviving rules that might be enforced by adopting a “risk-based approach” in order to “further reduce the burden of financial regulation.”

Fourth, McCarthy bragged to Blair that the FSA was acting as a vector and spreading an epidemic of “risk-based regulation” globally to a “steady stream” of foreign anti-regulators who came learn at the feet of the world’s master anti-regulator.

Fifth, McCarthy said that when the significantly dangerous institutions (SDIs) that were in the process of blowing up the global financial system through their massive frauds were asked which financial regulator they preferred – the “UK always comes out favourably.”  McCarthy quoted a pro-bank group that said that the City of London was a “length ahead on New York,” which it was, in the race to the bottom.

Yes, the largest, most fraudulent banks always preferred UK financial anti-regulation.  That was an indictment of the City and the FSA, but McCarthy was so clueless that he treated it as a compliment – and knew that Blair would do the same.

Note to Blair, Brown, and McCarthy: if your teenage daughter’s friends always want to have the big parties at your house it is not a compliment to your parenting skills.  It means that they know you fail to supervise their parties and drugs and alcohol abound.  When the SDIs said, and showed by their actions, that they all preferred the City of London as the locus for their slimiest transactions it was not a compliment to your financial regulation.  It was the sincerest insult.     
Sixth – I’ll come back to McCarthy’s sixth point.

Seventh, McCarthy told Blair that the most analogous bank based in the City to Citi was HSBC.  He compared the regulatory resources used to monitor the two banks by their national regulators.  The U.S. had 30 in-house, full-time regulators dedicated to Citi plus specialists.  The FSA team for HSBC totaled 6 staff, none of them assigned full-time to HSBC, and none of them resident at HSBC.

Eighth, McCarthy then stated proudly that, unlike the U.S. SEC, the FSA was not a regulator that emphasized enforcement.  McCarthy was pleased to report that, in response to the massive and myriad fraud epidemics by the City’s largest banks, FSA enforcement actions had been slashed by two-thirds over the last three years.  There were zero effective enforcement actions by the FSA against the City’s SDIs during the run-up to the crisis.  In the rare circumstance in which the FSA managed to stir itself to take an enforcement action they were overwhelmingly taken against small regulates and did not even mildly inhibit the huge fraud epidemics run by the SDIs.

Ninth, McCarthy expressed his pride that the FSA dealt with virtually all “problems” through “extensive use of advisory letters (‘Dear CEO’ letters) warning companies of problems….”  Here’s one hint on the problem with that approach:  The CEOs were the “problem.”  They knew all about the bank’s “problems” because they created the perverse incentive systems that caused the “problem” (a euphemism for fraud) and caused the frauds to become endemic.  “Companies” cannot be warned – only officers can be warned.  The FSA was “warning” the person responsible for the fraud epidemics that there were “problems.”  (Even today, FSA leaders are barely able to utter the word “fraud” even when the CEO has caused the banks to plead guilty to massive frauds.)  Note that even when the FSA found fraud at the City’s largest banks it typically refused to call it fraud (instead of, for example, “mis-selling” and refused to order a stop to it.  Instead, it sent an “advisory” (not “directive”) letter to the CEO who led the frauds “warning” him about the frauds so that he could act shocked and promise to deal with those “rogue” employees.

The best thing, from the CEO’s perspective, was that the FSA’s “Dear CEO” letters, unlike the classic “Dear John” letter, never announced a breakup in the relationship.  McCarthy stressed that the FSA not only sought to avoid enforcement actions, but even “direct intervention” to stop “problems.”

The bankers could cheat on the FSA with wild abandon and still face nothing worse than an ultra-polite letter to the CEO expressing mild disappointment in classic ornate upper class prose.  The FSA leadership turned the agency into a giant, long-running Monty Python skit.   No parent, or real financial regulator, would ever be so delusional as to think that relying on “Dear CEO” letters would produce anything other than (1) fraud epidemics and (2) the contempt of the industry for the FSA.

Tenth, and most dishonest and disgusting, McCarthy assured Blair that FSA worshipped at the shrine of the “market” and cited as his sole example of the FSA’s regulatory “success” its market-based (as opposed to regulatory) response to massive fraud by UK banks at the moment he wrote his letter to Blair.  McCarthy’s “market-based” response to that fraud epidemic was a total failure, but he touted it as the FSA’s greatest success (and used “mis-selling” as his euphemism for fraud).

The thrust of our work … is to make the markets work effectively, and so to avoid the need for regulatory intervention – hence our emphasis on encouraging providing clear and relevant information for retail customers (‘key facts’) and on acting against the misleading promotions and advice that in the past led to such significant mis-selling.
The FSA did not require that the information banks provided their customers when selling financial products be “clear and relevant.”  The FSA limited itself to “encouraging” (rather than requiring) the banksters whose primary business plan was ripping off the bank’s customers in order to make the banksters wealthy, to issue “clear and relevant information.”  It was the banks’ controlling officers that crafted and maintained when they knew it led to endemic rip offs of the banks’ customers, the perverse compensation systems and other carrots and sticks that were certain to produce endemic rip offs of the customers.  Relying on the bank to provide “information” and bank customers to be able to spot financial frauds never works and it led to massive frauds against bank customers for well over a decade.

In 2005, when McCarthy wrote his letter to Blair these frauds were not things of “the past,” but rather the paramount retail business practice of the UK’s largest banks.  Ripping off their customers through these frauds was the overwhelming source of retail bank profits in the UK.  Hampton, who is a chartered accountant, and who created the Hampton report in 2005 calling for even weaker UK regulation, would have been well aware of these enormous profits obtained by his bank (which was the worst-of-the-worst in the UK) by routinely ripping off its customers.

Lord Turner:  [Bank CEOs and boards] must have been … looking at management accounts showing that a very large percentage of their total profit was coming from PPI, and that PPI was an enormously high-gross-margin product. I fear that almost nobody around those boards said, “Hang on, shouldn’t that be a signal for us to do a drains-up and make sure that this is really of interest to the customer?” I fear that the reaction was probably, “Well done-give a bonus to the person who is driving that.”
The FSA’s response to this orgy of fraud and rip-offs of the banks’ customers was it sorriest chapter in a depressing saga of repeated failures.  But note that for McCarthy the FSA avoided the greatest sin a Blairite could commit – interference with the markets.  Of course, in this case that meant FSA carefully avoided “interference with the markets’ [frauds].”

The person identified in published reports as being one of the two principal writers of Blair’s unholy war on regulation and workers speech was Philip Collins.  Collins is currently thundering at Labour Party leaders for not showing sufficient pro-business (i.e., anti-labourer) zeal and pushing Labour to embrace the most self-destructive and economically illiterate forms of austerity.  Collins, was Blair’s chief speechwriter, and he remains today the chief promulgator of Blair-blather.  The small fact that New Labour’s anti-regulatory Tory policies blew up the UK economy and brought the Tories to power is religiously ignored by the Red Tories.

I end by referring to McCarthy’s sixth point.  That point was redacted from the letter when it was released to the public.  The missing bullet point is in the middle of his touting the fact that the UK’s “light touch” regulation (a phrase he did not use, though Blair did in his speech) makes the City the location of choice for the world’s banksters.  As with the famous 18 1/2 minute gap in Rose Mary Wood’s transcript of the Nixon tapes, you have to wonder how incriminating, embarrassing, and revealing that passage was to drive such a redaction.