The nun from Kensington who saw the great banking crash coming

Chris Blackhurst
15 Apr 2009

In 2006, a book was published that said: "Derivatives have quantifiable benefits but unquantifiable risks. In part this is due to lack of transparency and complexity, together with the dynamic nature of the risks which can spill over into many markets. This is compounded by the market structure and the moral hazard of volatility, whereby the financial sector can generate more business and make bigger profits if assets have a volatile price."

Continued the author: "Whole economies can be destabilized by speculative cross-border capital flows, often in the form of derivatives..."

The author wasn't Warren Buffett or Vince Cable. No, this prophet was a Kensington nun, a member of the Congregation of the Religious of the Assumption called Dr Catherine Cowley.

She used to work in banking before becoming a religious sister and an academic at Heythrop College, the philosophy and theology college of the University of London. Her thesis was entitled The Application of Catholic Social Teaching to Business Ethics with particular reference to the Finance Sector. And it was this study that provided the basis for her 2006 book, The Value of Money - Ethics and the World of Finance (published by T&T Clark).

We're meeting for lunch in Wodka, a Polish restaurant round the corner from Heythrop. "My doctorate was in ethics in the finance sector, looking specifically at derivatives and risk. I entered the convent at 30, then did the doctorate. I actually wrote the doctorate in 2000 - which makes it even more prescient."

Her eyes sparkle as she says: "My section on risk, risk measurement, risk evaluation - actually most of it is there, most of what happened is there." She adds: "I read my chapter on risk recently and thought, 'Catherine, you were absolutely right'."

She talks in a forthright, confident manner - as well she might for someone who came closer than anyone to predicting the financial disaster of the last two years. At the heart of her book is an explanation of the danger of risk and the fact too little attention was being paid to it in the pursuit of profit.

Cowley gained her motivation from being there, from seeing for herself how the City behaved. At the time too, in 1998, she witnessed the collapse of Long-Term Capital Management, or LTCM. The hedge fund's spectacular failure - it went down, owing investors $4 billion - and aftermath carried uncanny parallels with today. Cowley observed that the industry merely shrugged and moved on, that nothing changed. "I saw that no lessons were learnt and realised, 'This is the issue'."

Years later, speculating on financial instruments created by bundling together subprime loans in America was to blame, but to suppose that ending their trade creates a totally safe market is, she says, wrong. "Searching for a risk-free life is a nonsense doomed to failure," she says. "The risk of derivatives has to be measured against the risk of any alternative that would replace them. I don't think a risk-free system exists."

Critical in any reshaping is our treatment of money. "The very nature of money, the way that it brings distance into relationships, the way that it supports particular understandings of independence, autonomy, freedom - whatever word you want to use - and the way that can feed into relatively young, therefore relatively emotionally immature, financial practitioners."

Traders were dealing in derivatives that were "so complex no one understood them". As a result, "no one knew where the risk actually lay. It was assumed it was dispersed, but even as far back as 1999, the Bank of International Settlements, in one of its documents dealing with highly leveraged institutions, was pointing out the possibility of risks actually being amplified through the system rather than contained by the system and dispersed by the system". That formed part of her "beef" as she puts it. "I argued that there were some derivatives which were inherently so complex and dangerous they should not be sold, and I would maintain that still. If you do not understand what you are doing you should not be doing it."

The banks, she says, "didn't know who was bearing or buying this risk and therefore their own positions were unstable. If you don't know who the counterparty is and what risk that counterparty is bearing, how can you possibly assess how much risk there is in the system, in your little slice of the pie? We saw that with AIG [the giant US insurer] with their great default - no one realised how dependent on AIG was the entire market".

The regulatory framework was inherently flawed. Great store was put by the Financial Services Authority on the requirement to prove the "integrity" of the bankers. "What do they mean by integrity? How do you measure integrity? What factors within the finance sector - employment practices, its remuneration packets, pressures - militate against integrity? Yes, you can get people who are honest, who are trustworthy, but they haven't had time to develop integrity - integrity takes time. So it's not surprising if you get people sailing close to the ethical edge."

Her sense of disappointment in others is palpable. "There's been a lack of certain virtues - for example, justice - and a lack of understanding of certain virtues - for example, prudence." She shakes her head, laughing. "Prudence has had a slightly distorted life since Gordon Brown became Chancellor. When Aristotle wanted to give an example of the prudent person he chose a successful general, because prudence involves looking at all your options and working out what the most effective means are to what one wants to achieve. So the good general will deploy troops in an effective way.

"It's got nothing to do with over-cautious bean-counting. That is not prudence. I think the way we have lost sight of what prudence originally meant means we can't develop prudence very easily."

When her book appeared, some readers accused her of being too detached. Reminded of this reaction, she almost yelps: "I try to expunge insults from my mind! The gist was I was naïve... What they were also contesting was my analysis of the situation. So that what I was saying about the complexity of derivatives, what I was saying about risk, what I was saying about misapplication of resources, they were saying was wrong." She shrugs: "People were patronising."

There can't be many nuns who relish the daily Alex newspaper cartoon, about the trials and tribulations of a City slicker and call upon it to defend their corner. Cowley does. To the question as to how the sort of virtuous, pure banking she espouses can hope to succeed, she says: "I was reading Alex, about a very boring bank which said it was so far behind the curve it didn't get anything, and then in the other frame that bank was now the fourth-biggest bank in the world."

She adds, grinning: "Competitive, aggressive, macho banking was around for the last 20-25 years. I'm not sure it will be around for the next 25."

Cowley knows it's funny, that if only the testosterone-fuelled bankers had bothered to listen to a nun, they might be better off.

●A fuller version of this interview is in the current issue of The Tablet.