Banking Misbehaviour: Then and Now
by Ken Gibb
“The opinion expressed by bank managers is that a more reckless course of gambling with other people’s money was never pursued by any body of managers or Directors and that such engagements as these could never have been entered into had there not been either the weakest or most wilful sanction of these four firms, coupled with a negligent system of supervision which is hardly short of criminal”.
This is not a quote from the Banking Commission and is not a judgment on RBS, Lloyds, the FSA, etc. It is actually a quote from the New York Times (October 3, 1878) and refers to the collapse of the City of Glasgow Bank the day before – until Northern Rock, the biggest and most serious banking disaster in the UK1. However, the parallels are fascinating and since I am writing a paper for a conference about housing in Glasgow in the late 19th century I thought I might share some of the story2.
The urban context of the city around the time when the bank collapsed was a high density, overcrowded city of often dreadful insanitary and unhealthy tenements. Glasgow housed more than a million souls by 1912 and endured regular, endemic economic volatility. The main sectors driving the economy were mineral extraction, textiles, chemicals, engineering and, of course, shipbuilding. The city was a ‘walking’ city prior to the later introduction of the tram so people lived in the shadow of where they worked. Duncan Maclennan and Andy Gibb (in their 1988 paper Glasgow: no mean city to miles better) indicate that population grew every decade of the 19th century by at least 10%. The economy relied on waves of large- scale rural migration from Ireland and from the Highlands.
Jobs and housing oscillated widely with changes in international (British empire) markets. Writers like Alexander Cairncross suggested large swings in occupancy rates, rents and investment. Indeed, the collapse of the Bank in 1878 pre-empted a decadal long collapse in housing investment. At the same time both an officially sanctioned improvement trust and the municipal corporation were demolishing thousands of the worst units and putting tin badges on properties setting maximum occupancy levels in an unsuccessful attempt to regulate away overcrowding.
The City of Glasgow Bank had 133 branches and was heavily exposed to speculative investment in North America, India and Australasia. When it collapsed it had liabilities of £12.4 million and assets of only £7.4 million. The Bank’s owners had unlimited liability (1500 were bankrupted including families, businesses and specific ventures associated with lending from the bank). There was no formal statutory external audit of banks in these days and, according to Rosenblum, it later transpired that there had been gross management errors, large loans made on dodgy security and that speculative investments had been made in order to make up for bank losses already incurred (with falsified balance sheets and profit and loss accounts).
The Bank collapse had a series of enduring repercussions. The banking sector moved rapidly to limited liability as the predominant form of corporate governance. It also led to the adopting of the convention for commercial banks to apply prudent capital ratios to underpin the sector’s viability. It also led to law to guarantee external auditing of statutory accounts. And, in an echo of the contemporary post GFC debate, the Directors were tried in the High Court in Edinburgh. They were found guilty: two served full 18 month sentences and five other Directors served 8 month sentences (also without any remission). The media and the chattering classes in had a field day as several of the Directors were worthies in the ‘wee Free’ Church3.
Was the fraud and base financial criminality associated with the 1878 collapse (and in the cruel setting of unlimited liability) comparable to the moral hazards and behaviour of our generation’s banks? Is excessive risk taking, gambling or rate-rigging as bad, worse or not in the same league? These seem to me to be qualitatively different but price-fixing does and should attract the large fines that do from time to time get levied. A second matter is whether we might see similar extent of fundamental reform as followed 1878. Probably not – and the worry that regulatory reform prepares for the last battle rather than the next war is, I think, a real concern. Periodic large-scale booms and busts in financial systems have regularly recurred over the last 150 years and beyond. Perhaps the best we can hope for is the mitigation of their effects and stronger incentives to reduce investor and banker animal spirits. But people have been saying this since at least 1878.
- Rosenblum, L (1933) ‘The Failure of the City of Glasgow Bank’, The Accounting Review, Vol.8 (4), pp.285-91.
- Gibb, K (2013) ‘Speculation, sub-division, banking fraud and enlightened self-interest: an alternative account of the making of the contemporary Glasgow housing system’, incomplete paper in progress for ISA RC43 Conference ‘At home in the housing market’, University of Amsterdam, July 2013.
- Guy McCrone wrote a trilogy of novels (Wax Fruit, published by Pan) about a 19th century middle class Glasgow family directly affected by the Bank collapse.