We were sat pretty high up in a tower that houses a global law firm, and in a bid to be ranked higher in a directory I researched for, two partners were explaining the skill and creativity involved in putting together a novel type of securitisation.
You could, they said, combine sub-prime debt with other debt obligations that were a better bet for repayment to create debt-backed securities which attracted a decent credit rating from a rating agencies.
Magic.
But I doubt you’re reading that description and thinking how bowled over you are by the brilliant creativity of it. The wands that were waved over such bad debt did not eliminate what are known as the ‘frictions’ within the product, and their failure kick-started the 2007 global financial crisis.
I mention this now, because financial creativity is creeping back into fashion.
Cutting a dash on this particular catwalk is Bim Afolami, economic secretary to the treasury (a position also known as minister for the City). Towards the end of last year, Afolami was sounding rather pro-creativity. Speaking at the FT’s Global Banking Summit, he said regulators ‘need to realise that if you’re regulating a market, in any area, there’s no point in having the safest graveyard’.
Drifting into what we might call occult market theory, the minister warmed to his subject: ‘Animal spirits need to be there, we need to drive growth and initiative.’
Such reformist animus is not just rhetoric. Government has ordered financial, competition and accounting watchdogs to promote UK growth and competitiveness.
The short-term attraction to government in promoting this approach is obvious. The wider economy is flatlining; the North is determinedly not levelled up; trade agreements post-Brexit have proved decidedly low rent. At least a square mile/City boom in transactions would give an appearance of some ‘zip’.
But lawyers should be wary of creative instructions from banks. I haven’t named the firm this article began with, as linking them to the work they were once so proud of would now raise libel concerns.
Given it is still such a sensitive topic, I’d argue that lawyers cannot afford to be insufficiently curious about the underlying safety of products twice in a decade.
In his 2014 book Law as Engineering, my friend, the academic David Howarth, reminded us that lawyers ‘legally engineered financial innovations: securitised mortgages, the recombination of securitised mortgages into collateralised debt obligations, higher levels of recombination of collateralised debt obligations and eventually the invention of instruments that effectively allowed betting on movements in the value of the recombined obligations’.
We know where that led.
Banks and funds of course could do more to support growth. They can do it by being close enough to existing or potential customers to spot where credit could unlock growth, but has not.
One example is female-led startups and enterprises that struggle to obtain finance – a gap that some smart private equity funds have noticed, and seek to fill.
That involves making judgements about the real economy. And assessing the correct risks, returns, security and sense in backing those enterprises are the unshowy building blocks of sound banking that supports growth – on terms pinned down by solid lawyering.
‘Creativity’ in finance can rather unhelpfully serve to distract the eye from such basics.
As for ‘innovation’ in financial services, I think king Solomon, who might have made a good City minister, had it about right. ‘The thing that hath been, it is that which shall be… and there is no new thing under the sun.’
Innovation, creativity and animal spirit should be the preserve of entrepreneurs – not bankers, and certainly not financial regulators. And it’s worth remembering, some of the most impressive legal advice of the past decade was not that which enabled innovative financial products – it was the advice that helped clear up the mess they had created.
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