A former chief executive of Barclays Bank spills the beans...

From a splendid article which appeared in the FT in late 2009

There are three types of bankers: those that can count, and those that can’t...

Observers of financial services saw unbelievable prosperity and apparently immense value added [in the years leading up to the crash]. Yet two years later the whole industry was bankrupt. A simple reason underlies this: any industry that pays out in cash colossal accounting profits that are largely imaginary will go bust quickly. Not only has the industry – and by extension societies that depend on it – been spending money that is no longer there, it has been giving away money that it only imagined it had in the first place. Worse, it seems to want to do it all again.

What were the sources of this imaginary wealth? First, spreads on credit that took no account of default probabilities (bankers have been doing this for centuries, but not on this scale). Second, unrealised mark-to-market profits on the trading book, especially in illiquid instruments. Third, profits conjured up by taking the net present value of streams of income stretching into the future, on derivative issuance for example.

In the last two of these the bank was not receiving any income, merely “booking revenues”. How could they pay this non-existent wealth out in cash to their employees? Because they had no measure of cash flow to tell them they were idiots, and because everyone else was doing it. Paying out 50 per cent of revenues to staff had become the rule, even when the “revenues” did not actually consist of money.

Via HPC, who got it from a link from a link this article, which went back to this article, which in turn links to the one in the FT.