In praise of hedge funds
Every ecosystem needs its scavengers and its bottom feeders. They clear up the mess that others leave behind, extracting nutrients from decaying corpses and leaving only sterile bones behind. We are revolted by them, but without them the world would be a much more unpleasant place.
So it is with hedge funds. They are the financial system's equivalent of slime moulds and flatworms. They buy up distressed companies that no-one else will touch and extract whatever profit they can from them. In many cases they leave only empty shells behind, but they sometimes turn failing companies around with ruthless restructuring programmes, in much the same way that some kinds of maggot were used in field surgery to clean up suppurating wounds. In short, they may be revolting but they serve a useful purpose.
Hedge funds taking an stake in a company is rarely an indicator of a company in good shape. So it is worrying that the largest shareholder in the recently-privatised Royal Mail is the hedge fund TCI. Either the share offering was seriously mispriced, or the Royal Mail maybe isn't such a good bet after all. We will soon find out - it seems the National Audit Office is to examine whether the share offering was good value for money for the UK taxpayer.
But of course the other UK company in which hedge funds have recently taken a significant stake is the Co-Op Bank. And many customers are not happy at the prospect of their "ethical" bank being run by vultures. The results of a poll in the Guardian suggested that 63% of Co-Op Bank customers are considering moving to another bank.
"to make sure the Co-operative Bank sticks to its principles and – eventually – comes back into full co-operative ownership where it belongs."
This is, of course, factually incorrect. The Co-Op Bank plc has never been in "full co-operative ownership". It's a public limited company. Yes, it's a wholly-owned subsidiary of a mutual, but wholly-owned subsidiaries can be sold. And that is what has happened to it. It's been sold.
It's worth remembering, too, just WHY it has been sold. The Co-Op Bank went into a disastrous merger with the toxic debt-laden Britannia Building Society in 2009, and almost certainly did some pretty unwise lending of its own. For three years it concealed the true state of its finances from its customers and investors. When it was finally forced to disclose the mess it had made of its balance sheet, the price of its securities crashed as many of its investors sold their holdings. The hedge funds saw distressed debt coming on to the market and bought in. That's what hedge funds do.
To protect its own balance sheet, the Co-Op Group attempted to bail in subordinated debt holders to plug the £1.5m hole in the bank's balance sheet. None of the subordinated debt holders were happy with this idea. Institutional investors questioned the figures, and representatives of 15,000 small bondholders orchestrated a campaign to get a better deal. The Co-Op Group - which, remember, really IS a mutual - treated them all with disdain, telling them that there was "no Plan B" and they either had to accept what was for many of them a terrible deal or allow the bank to go into regulatory administration, in which case they would lose everything.
As far as I can see, the Save Our Bank campaign's statement is wide of the mark. Neither the Co-Op Bank nor the Group seems to have much in the way of principles to stick to. For the former CEO of the Co-Op Group to say that the bank "no longer deserves the ethical label" is, shall we say, mendacious. It hasn't deserved it for a long time. It may have done some ethical investing, but it hasn't behaved ethically.
The Save Our Bank campaigners are clearly worried about the future of the bank and angry that "their" bank could be forced to abandon its ethical stance. But the aim of their campaign is completely mistaken.
Threatening hedge funds with a bank run if they don't do what customers want simply plays into their hands. Save Our Bank don't seem to appreciate that the hedge funds don't really care whether customers stay or go. They only want money. If customers stay, the company could return to profit - after a painful restructuring - in which case the hedge funds get what they want. If they go, the hedge funds will sell the remaining assets and liquidate the bank, in which case they still get what they want. There is no way this campaign can possibly succeed.
But there is an alternative approach. If customers really care about "their" bank and don't want it owned by hedge funds, they should get together, raise the finance and buy them out. Then the bank will for the first time in its history REALLY be owned by its customers, who can appoint their own management and establish whatever ethical principles they want.
I suspect this is not what the Save Our Bank campaign wants, though. They want some altruistic benefactor to provide the money to buy out the hedge funds, then distribute the shares free of charge to customers so they "own" the bank. Could it be that these customers want their bank to be "ethical", but aren't prepared to put their money at risk to ensure that it is? There is a name for this attitude. It's called rent-seeking.
The Save Our Bank campaign is correct that the fate of the Co-Op Bank lies in the hands of its customers - but not in the way that they expect. Customers can indeed save it. But they can only do so by risking their own shirts.
Under the Radar - Coppola Comment
The "ethical" Co-Op - Coppola Comment
Stand By Your Bank - Coppola Comment
The lure of gold, the deceit of silver - Coppola Comment
Co-Operative Bank coverage - FT Alphaville
Picture: Dog Vomit Slime Mould, courtesy of KeresH at Wikimedia Commons