Where Next for Europe?: Part 1

This is the first part of a two-part transcript in which Fool.co.uk's David Kuo chats with veteran market commentator David Buik from BGC Partners about the two main issues of the day: Europe and banks. David Buik looks at the future of Europe and the prospects for Barclays following the resignation of chief executive Bob Diamond. They also examine some of the more worrying bubbles that are forming around the world.

You can read the second part of the transcript here.You can listen to or download the full podcast here.

EDITOR'S NOTE: What follows is a lightly edited transcript of David Kuo's conversation with David Buik.

David Kuo: This is Money Talk, the weekly investing podcast from The Motley Fool. I am David Kuo, and my guest is someone who needs no introduction whatsoever. He is one of the most sought-after commentators on U.K. corporate affairs. He is David Buik of BGC Partners, and he is with me now, so welcome back to The Motley Fool, David.

David Buik: Good morning to you, David. It's a great pleasure to be here.

David K: I know. You were supposed to have retired, David. I've mentioned this before, and yet you seem to do more now than you've actually done previously. Why is that?

David B: Well, I think it's down to the fact that frankly the world's more in turmoil that it's ever been financially, and as I expected a nice, quiet pasture of retirement, it just hasn't transpired, because every time you turn your head, there's another crisis of some sort: It could be a sovereign-debt crisis, it could be a banking crisis, it could be an IPO that's gone all wrong. There are so many things that attract the public's attention, and I'm still lucky enough that people ring me up occasionally and say, do you want to make a comment on it.

David K: You know, there was a time when financial news would just be consigned to the back pages or the middle pages of the newspapers, but these days it is front-page stories, day after day after day.

David B: Yep, because we've had, you can call it a litany or a compendium, or if you prefer, bad news, one piece after another, yet through it all the resilience of people, and the resilience of the marketplace, and sometimes I think some of the financial commentators are a little bit too doomy and gloomy, and also ...

David K: Don't they have a right to be?

David B: Well, they do to a certain degree, but also our political masters slightly irritate me at the moment, because we haven't got anybody who's a flag-bearer of U.K. PLC, apart from the Prime Minister. When he's abroad and in the Far East, he's done a wonderful job.

David K: But when he does go out there to the Far East, he gets pilloried by people, who are saying, you should be at home sorting out the problems here, rather than going trying peddling our goods overseas. He can't win, can he?

David B: No, I think that's a cheap shot really, because basically we need to trade, and because we have been so reliant on Europe in the course of the last 15 years, 50% of our trade is done with the European Union. Well, no prizes for guessing that that, apart from Germany, is sagging badly, and is still, even despite the rhetoric that comes out from the bureaucrats, it's a long way from solved. I think David Cameron and the government are absolutely right, those people such as Lord Steven Green who knows the Far East very well, are out there trying to find other markets for us, so that we're not as reliant on the European Union as we have been to date.

David K: Right, I will touch on Europe a little later, but for now I want to talk about the LIBOR debacle. Now, the reason why I want to touch on that is because you and I met over the airwaves on BBC World's Have Your Say.

David B: We did indeed.

David K: And I remember the presenter saying, "Do you two know each other very well, because you were at each other's throats throughout the entire interview!" I think it made for very good radio.

David B: It's good banter, and basically you and I agree on so many issues, it's just a question of an interpretation, because I tend to look at things from a wholesale perspective, whereas you're much more interested, and quite rightly so, from the investor's perspective, and the shareholder's point of view.

David K: OK, so let's have a look at this LIBOR debacle -- there's no other way of describing it, because it is a debacle. Now, can you understand why there is so much anger vented at Barclays over its involvement in the fiddling of these LIBOR rates?

David B: Of course I can. Barclays (ISE: BARC.L) , I think strategically, maybe they were left with no option, but they decided to take the hit, and I think your listeners, in case they haven't really understood the nuance, that a high percentage of that 290 million pound fine emanates from the United States of America. It doesn't come from here. It's about 59 million pounds that has been implemented by the FSA, and the rest of it is by the authorities in the United States. It's the United States where Barclays has had its big momentum, and I think what disappoints me is, standards have clearly been lowered, because competition's become greater, as bonuses have become very, very key, and I think we've sorted out the unemployment in the rainforests over paper that's been written on this stuff that you and I needn't dwell too long on it, but when you add it all up, with the mis-selling of PPI, with the bonuses, with the mis-selling of interest rate swaps, with not enough money coming to the small- and medium-sized enterprises, you can understand why people are seriously hacked off, for want of a better expression. But this is a really wide-ranging problem, which is probably going to involve somewhere between 12 and 15 other banks apart from Barclays. In case your listeners aren't aware of what I call the machinations of LIBOR, I think we ought to spend a couple of minutes just going through that.

When something is agreed with LIBOR, which stands for the London Interbank Offered Rate, up until 2008 it was a perfectly practical way of pricing loans, and it was generally done using banks of various sizes and credit standings, totalling sometimes seven, or if a loan was particularly big, 14 banks, so there was always going to be an air of collusion anyway. But why the authorities, the FSA and the Bank of England, allowed LIBOR to continue to be used after 2008, well if you'll pardon the vernacular, when there ain't no wholesale money market, has escaped me. I don't understand it, because again, in case your listeners are under any misapprehension that markets and banks survive solely through the good nature of the central banks and quantitative easing, ladies and gentlemen, you delude yourself, because banks do not trust each other, and therefore they don't lend money between each other, apart from very short-dated money like overnight weak fix, and maybe a little bit of one month. Therefore where three-month LIBOR or six-month LIBOR is contrived from, is it plucked out of the sky, like a ripe cherry? I don't know.

David K: But why don't they trust each other, David?

David B: Because of what happened with subprime lending going back ... David, you recall the old American savings and loans problems in the 80s, which in those days, everybody's forgotten it, because everybody, apart from me, as I'm older than God, haven't forgotten it, do you know what I mean? Because it was a massive scandal at the time. These things have a habit of returning to the scene of the crime, and it will return in the form of subprime lending, that Mrs. Smith buys her bungalow in Montana, pays $100,000 for it, and the local First Bank in Boot Hill that gave the mortgage goes trotting off to Freddie Mac and Fannie May, and also to Washington Mutual and various other people, and they do some rinky dinks and sell it in small parcels to unsuspecting retail investors like D Kuo and D Buik, if we lived in somewhere like, Tallahassee, Florida, and we all live happily ever after. The fact remains that that bloke who took the mortgage out can't service the debt -- that's where the problem was. You've got a situation where debt became, because of what I call political incompetence in the United States, in Europe, in the United Kingdom, we have, even though he appears on radio and television more times than I care to think about, Alan Greenspan, who is disgracefully responsible for many of these -- you're laughing, but it's no laughing matter.

David K: I'm laughing because it's absolutely true.

David B: It's true that he encouraged, during the 2000 recession, banks to lend indiscriminately to anything they liked, without proper regulation, and we got ourselves into a fearful mess. We had a Chancellor who started off in 1997, I thought he did, he's not of my political persuasion, but I think he did a splendid job between 1997 and 2001, but then he got sucked in by what I call the Greenspan mantra, and he allowed all banks to go potty over derivatives, over-lending, allowing people ... I mean, David and I were sitting in an area where you people probably don't understand, it's probably the greatest eating street in Europe.

David K: Charlotte Street, yes.

David B: Yes, it's brilliant. So you go into Starbucks, and some spotty youth gets out, says, one semi-skimmed cappuccino, and he sticks a credit card in the machine, and I'm going, "Mate -- can't you afford to buy a coffee?" The answer is, he can't, and we've got a situation now where debt is insane, between governments, between the individual and his credit card, and banks lending to each other. Balance sheets got to a ludicrous size. The Royal Bank of Scotland (ISE: RBS.L) , at the time of the disaster in 2008, got to 2.2 trillion pounds -- bigger than the U.K. government's balance sheet. Tell me about it. And the regulatory authorities didn't say, "Hello, there -- we've got a bit of a problem here," because getting it to that size was nonsense, and that's what you call the light touch regulation. So everybody doesn't think that I'm just like Brighton rock -- chop me in half, I'm blue -- the Conservatives were equally guilty of supporting light touch regulation, so it's been a mess, ladies and gentlemen. An absolute mess.

David K: If we bring this back today now, in the case of Barclays Bank, Marcus Agius, the chairman, has resigned; Bob Diamond, the chief executive, has resigned. Can we interpret this as being just a line under what is happening at Barclays Bank, and also the other banks?

David B: No. The public pressure and the political pressure, and the public's angst and hatred toward the banks, it became clear that Barclays' franchise, or, for want of a better expression, the bald eagle had lost its gilt, was something that Bob Diamond wasn't prepared to tolerate, because he realised, by staying there, that the trust was never going to return. He was responsible, having taken over from John Varley, for 140,000 jobs. He can't be in every place at one period of time, or be responsible for everything, but the market does acknowledge the fact that Bob Diamond was chief executive of Barclays Capital before he came, where much of the loans and the investment banking come from, and therefore the LIBOR-fixing comes from. As the old expression goes, there's no hiding place. I don't think for one minute that he knew exactly what was going on everywhere, and if he did, I'm very surprised. I think that the timing of his departure has shaken me up a bit, because I thought he'd do it after his evidence at the Treasury Select Committee, which is taking place the day after you and I are speaking, on Wednesday 4 July, and Marcus Agius falling on his sword, beautifully described by a friend of mine as a rubber sword this morning, was, of course, rescinded by him returning as chairman of Barclays, and everybody scratched the back of their head, including me, and then I thought about it, and I thought, well, Marcus Agius, 34 years at Lazard, an impeccable merchant bank -- he couldn't even spell derivative when he went to Barclays; trust me -- he's that conservative, and all he was ever interested in was deals, and he comes with an impeccable track record. Now, whatever anybody thinks, and however angry anybody is, you cannot hose out your chairman and your chief executive at the same time. So Bob obviously felt that it would make a much greater impact if he went, and so Marcus Agius was reinstated as chairman, because you need a vehicle from which to select the chief executive officer, and you need some continuity, otherwise your shareholders get very worried, as we saw. Barclays' shares fell 15% when the scandal came out last week, we've had a bit of a rally. They're still, in my opinion, in terms of net asset value, a quarter of what they're really worth, Barclays, and I'm not qualified to say, you should fill your boots, but if you and I had this conversation, I'm not offering investment advice -- I leave that to you, David, but if you and I had a conversation on this subject in three years' time, I'd be very surprised if Barclays' share price wasn't significantly higher than it is today.

David K: But the thing about Barclays is that, as far as shareholders are concerned, I remember doing the number-crunching -- over the last ten years, shareholders have had no total shareholder return. In other words, if you include the dividends that Barclays has paid over the last ten years, plus any kind of share price appreciation, they have had nothing, and I think part of the anger that shareholders feel is that, during this period when they have had nothing, bankers have been rewarding themselves with bonuses.

David B: Let me try and, justify is not quite the word, but let me try and give you ...

David K: Explain!

David B: ... mitigating circumstances. The comments that David Kuo's made, that the shareholders had a rough old deal in the last five years, is 100% correct. I'm not even going to try and attempt to stick holes into his argument, because he's right, but why has it happened? I'll tell you why it's happened -- Barclays Bank, as a consumer-led bank, has been, over the last 10 or 15 years, very, very disappointing, and has really delivered to its shareholders, and has been reliant upon Bob Diamond's capital, Barclays' capital, to deliver the profits, and you, looking at me, would agree with me, and nod and say that they have delivered between 40 and 60% of the profits for the last ten years. So when the sub-prime lending debacle came, and we saw the demise of Northern Rock and even smaller places like Bradford & Bingley, and then HBOS and then Lloyds and HBOS merging, Barclays, everybody thought, they're lying -- they've got to go to the Bank of England, they've got to go and see Gordon Brown, but they never did. Marcus Agius got into hot water by organising with another gentlemen called Jenkins, of going off to the Far East and raising 5 billion pounds at a huge cost from the Middle Eastern money in Qatar, because he was determined that they would not, in the lifeboat. But the result of that meant was that, because you couldn't throw the baby out with the bathwater, or kill the goose that laid the golden egg, they had to fat up Barclays' capital traders with huge bonuses, in order to keep Barclays delivering the best kind of profit that they could. Well, as we know, David, in 2009, I think it was, they made no profit at all, but at least they held the thing together. Now, I would describe that as mitigating circumstances. Where I might go a little pink with embarrassment was, maybe it wasn't necessary to carry on paying those bonuses in 2010 and 2011, but that's the reason, I think, why it looks like the shareholder had a rough old deal.

David K: So are you saying then that the ends justify the means? In other words, doing what they did justified it, because they were actually still intact, which brings us to this question of whether or not the investment banking and the retail banking should remain intact, rather than to force this separation.

David B: Let's be candid with each other. What I want isn't going to happen, and I'll tell you what I want. I would like any bank involved in investment banking, let's choose Barclays as an example, for it to have a capital base whereby the retail banking has a certain amount of capital focused on it. Investment banking has maybe three times the amount of capital required to do the same amount of business, so there is a sort of buffer there against anything going wrong. Now, Sir John Vickers' report, which had, in my opinion, quite a few eminent people, all of them innocent, there were an awful lot of what I describe as eggheads on it, who've never got their fingernails dirty at the coalface, saying, that's not good enough -- we want this separated. Sir Mervyn King agrees, so whether I like it or not, you will find that retail banking is ring-fenced against investment banking. They will be almost separate units -- the investment banking, I think, will be a subsidiary. The fact remains is that that will happen, and then you'll say, well, that's a reasonable price to pay, even though the cost of capital is going to go up substantially, and you and I know, David, that the cost of capital going up, and who's going to pay for that? The customer, so you're going to pay more for your banking. Many of you may say, well, I don't want to go through what we went through in 2008 and 2009 again, so I'll take that, and to be honest with you, it's very hard for me to argue. I think we could do it by just appropriating extra capital toward investment banking within the same vehicle, therefore the cost of it wouldn't be so great, but I'm afraid those people in the government, the opposition, the regulators and the Bank of England, will have none of it. This wasn't supposed to come through until 2019. I'll be amazed if it's not on the statute book by the end of next year.

David K: So you think there's going to be a sea change in the way that banks operate here in the U.K.?

David B: Mm -- two things I'm really keen on, which I hope happen -- and there'll be no guarantee of -- is, one: It would be absolute financial suicide for us to be involved in European regulation, and Michel Barnier, the former egg and fish minister in the French government, we want, despite his huge charm, no part of him whatsoever. We need to get on with our own business. Why? We can recover from this. All the cynics out there who say, "Ah, I hate banks," "I'm not having anything to do with them," "loathe them," "disgusting," and all that sort of thing, you guys forget the bills that were paid, and there's nothing ... David is wearing a very, very eminent pink shirt. So am I; I've got a tie on, I've got a suit on -- who paid for that? Banks. So if anybody thinks you're going to recover without the banks, you delude yourself, and without banks, you've got anarchy. So instead of all the weeping and gnashing of teeth, and the beating yourself up, and giving people hell, I'm much more interested in saying, guys, we've got a problem -- let's sort it; whereas everybody just wants to beat everybody into the ground. That's why I get so fed up with these politicians, because they've got all the vote-catching rhetoric, but they don't actually say, there's a problem. Some of the behavior's been absolutely disgraceful -- and it has, I'm not trying to justify it, but you're talking about a few hundred people against a million people that's employed in financial services. If they're guilty, let's hose them out, let's tighten up the regulation. Let's get on with it, because that's the way it should happen, but I'm terribly afraid that we're going to throw the baby out with the bathwater by becoming over-regulated, and we're going to absolutely discourage the young and the good with their great agile brains and their technical abilities and their computer abilities. They're going to say, "I don't want to work in a sector like that, that the public's got such a low regard for." Ladies and gentlemen, it would be terrible shame, because it has created billions and billions of pounds' worth of earnings. While Europe's messing around, they can't organize what they're going to have for breakfast, let alone anything else, we should be galvanizing everybody. London is the center of the time zone; English is the international language of the world. We can get the banks to come here and do their business, despite what we've got going on with the problems with ours -- let's go for it, and we can actually be the capital-raising center of the world, for the Far East, for the West -- we've got it, because we've actually got very good people. What I'm concerned about is somebody's going to use a sledgehammer to beat a peanut.

That was the first part of a two-part transcript in which Fool.co.uk's David Kuo chats with veteran market commentator David Buik from BGC Partners about banks and the prospects for Barclays following the resignation of chief executive Bob Diamond.

In the second part of the transcript, the two Davids discuss the future for Europe and also examine some of the more worrying bubbles that are forming around the world. Just click here to continue reading.

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