In his article for the BBC in 2009 titled ‘Why bankers aren’t worth it’, Mr Peston refers to a speech by Andrew Haldane, who is now the chief economist and the Executive Director of Monetary Analysis and Statistics at the Bank of England having worked there since 1989. Mr Haldane looked at the returns generated by UK banks and financial institutions since 1900, to see whether shares in the financial sector had performed better than the market in general. The data showed that from 1900 to 1985, the financial sector produced an average annual return of around two percent a year, relative to other stocks and shares. So for 85 years investing in bank shares was “close to a break-even strategy” in the words of Mr Haldane.
But in the subsequent 20 years, from 1986 to 2006, returns soared: the average annual return rose to more than 16 percent, which was the best performance by financial-sector shares in UK financial history.
Mr Peston pointed out that pay for top bankers followed this trend and rose to “stratospheric” levels.
This was followed by a catastrophic plunge, however, as the financial crash brought these returns back down to earth.
In fact, the gains from 1986 to 2006 had been almost eradicated completely, with return on financial shares less than three percent for the whole period of 1900-2008 – almost identical to the market as a whole.
Mr Peston, with the help of Mr Haldane’s analysis, highlighted how bankers made so much money in the 20-year period preceding the crash, and why their methods contributed to the huge economic crisis in 2008.
Mr Peston explained the gambling bankers indulged in prior to 2008 with a simple example.
He said: “Suppose a bank has lent £1,000 and earns a one percent net return on this, or £10.
“If that £1,000 is backed by £50 of shareholders’ equity – which is a leverage multiple of 20 – the return on equity is 10 divided by 50, or 20 percent (which, for what it’s worth, is a handsome rate of return).
“Now, suppose another bank lends £1,000 on a leverage multiple of 50, or supported by just £20 of shareholders’ equity. In this case, the return on equity is 10 divided by 20, or 50 percent. So the return to shareholders is a stupendous 50 percent.
“Or to put it another way, increasing leverage is a simple and automatic way of increasing returns to shareholders. And as I hope you’ve noticed, there’s nothing terribly clever about it.
“But if all you care about is fat returns, and you’re not interested in how they’re earned, you’d give the boss of the highly leveraged bank a cigar, a bottle of Krug and a £5million bonus.”
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From 1986 to 2006, bankers had made so much money “gambling” with capital because they had simply increased “leverage” on their assets, with Mr Peston adding “there’s nothing terribly clever about it”.
While this proved a useful tool when things were going well for the banks, Mr Peston explained that when the trend reverses, “it is the fastest way to lose money”.
The journalist hit out at the “reckless gamblers”.
He said: “It’s uncontroversial that we all paid something of a price, in the form of the worst global recession since the Thirties, when the bankers’ luck ran out, when the wheel spun to red.
“Which means that we all have an interest in preventing bankers from repeating these reckless gambles.”
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