The death of Bob Diamond's dream for BarclaysJuly 30, 2012: 5:00 AM ET
Caught up in the Libor scandal, the star investment banker and American CEO of the British bank was forced to resign. His departure represents the end of an era for big banks.
FORTUNE -- By the time the call came, Bob Diamond knew his tenure as CEO of Barclays was at an end. It was 9:30 p.m. on Monday, July 2, and Diamond had just gotten home from the office when the bank's outgoing chairman, Marcus Agius, and lead director, Sir Michael Rake, phoned to say they were on their way to Diamond's townhouse in the tony London neighborhood of Belgravia. They didn't say what the visit was about, and they didn't need to. Diamond knew that they'd just been in a meeting with Sir Mervyn King, governor of the Bank of England, and that they would tell him he had to resign after just 18 months on the job. In fact, he'd already made that decision for himself. He planned to tell the Barclays board the following morning.
The day had started with a typical burst of Diamond optimism. Despite the Libor scandal raging around him, the 61-year-old CEO reckoned he'd be running Barclays (BCS) -- a 322-year-old institution whose assets of $2.4 trillion rank second in Britain, behind HSBC, and sixth in the world -- for years to come. On Friday he had secured the endorsement of his board and his large shareholders. On Sunday, Agius had decided to step down, partly in an effort to save Diamond. When Diamond arrived in the office that Monday, he got a phone call from Andrew Bailey, chief of the Financial Services Authority's banking unit, and discussed the news about Agius. Diamond told Bailey that his board was behind him and that he had no intention of resigning. Bailey expressed no objections.
But as the day wore on, evidence mounted that the British regulators were about to throw Diamond under the lorry. The biggest clue was Agius's call from George Osborne, the Chancellor of the Exchequer, about a story in that day's Financial Times. The story examined a conversation that Diamond had held with Paul Tucker, deputy governor of the Bank of England, at the height of the financial crisis and whether Tucker had implied that Barclays could rig Libor without fear of punishment -- a suggestion that Tucker has strongly denied. Diamond was soon scheduled to testify before a parliamentary panel investigating Libor abuse. (On, of all dates, July 4 -- his 16th anniversary at Barclays and the perfect day for British lawmakers to give an American his comeuppance.) And Osborne wanted to know what Diamond was going to say about Tucker when he testified. It began to look as if the regulators would force Diamond out before he made them look bad.
Agius and Rake arrived at Diamond's townhouse around 10 p.m., and the three men stood and talked in his kitchen on the mansion's ground floor. The directors informed Diamond that King was effectively demanding his resignation. Though he'd already made his decision, Diamond expressed dismay that the regulators had turned on him so quickly. The two visitors said that while their first impulse was to fight for Diamond, the regulatory authorities were just too powerful. They left after just 10 minutes.
So ended the career of a star banker who spent a short, controversial term as CEO but leaves a legacy as a great franchise builder. "He deserves a place in the pantheon as one of the few to ever build an investment bank virtually from scratch," says Robert Steel, a former Goldman Sachs vice chairman.
Diamond's fall carries far broader significance than the demise of a single talented executive. It may, in fact, signal the death of his dream. That dream is the model of the universal bank -- one that spans the globe, combining an investment bank that sells securities for corporations and trades them for institutions with retail franchises offering everything from credit cards to small-business loans. Diamond, and his similarly surnamed rival, Jamie Dimon of J.P. Morgan Chase (JPM), have been the leading champions and architects of the model on each side of the Atlantic.
But their vision, which dominated the financial world from the repeal of the Glass-Steagall Act in 1999 until the crisis of 2008, is now under siege. The new Basel III global rules are forcing banks to raise their margin of safety by holding far more capital than in the past. That is severely lowering their earnings. The Volcker Rule in the U.S. will eliminate the banks' ability to make speculative investments with their own capital. Europe is pondering a rule that would cap bankers' bonuses at no more than their salaries. And the shock surrounding the $5.8 billion trading loss by Dimon's J.P. Morgan Chase earlier this year is heightening calls for ever tighter regulations -- and is a further blow to the moral authority of big banks.
Nowhere is the weight of new regulation heavier, or the public view of banking more hostile, than in Britain. The government of Prime Minister David Cameron is endorsing a proposal to separate, or "ring-fence," the retail from the investment banks. Under ring fencing, each franchise would have separate balance sheets -- meaning it would need to fund its investment and retail banks separately. The rationale is to protect taxpayers by ensuring that the government, which insures deposits, wouldn't have to pay if the investment bank encounters problems. The regulation would still allow investment and retail banks to remain under the same corporate umbrella.
Still, ring fencing would dramatically raise the cost of funding for the riskier side, the investment bank. "The government's view now is that investment banking is not a place where banks should expand, that it is not socially useful or vital to the economy," says Simon Adamson, an analyst with CreditSights.
The reason for the incredibly harsh climate in Britain is basic: The U.K. suffered a banking cataclysm even more wrenching than the crisis in the U.S. In 2007 and 2008, most of its national banks failed. Britain effectively nationalized two of its biggest lenders, Royal Bank of Scotland and Lloyds TSB, at a cost of $100 billion. The Cameron government is asking British citizens to accept a painful regime of austerity that includes cuts to education, health care, and pensions. In such a period of sacrifice, stories about bankers continuing to pocket millions of pounds have made executives targets for the outrage of politicians and, increasingly, regulators. And to many in England, Bob Diamond became a symbol of excess.
In early June this writer started working on a story about the challenges Diamond faced as an American running a universal bank based in Britain. By late June it was overtaken by the Libor scandal. Before the scandal broke I had interviews with Diamond and other Barclays executives. After the Libor revelations I spoke with a number of people familiar with the events leading to Diamond's resignation, none of whom would speak for attribution. The picture that emerges is that of an executive who believed that he could rally wary regulators and an angry public to his side, but who misjudged the brewing political storm.
Barclays is hardly the only big bank to be caught up in the Libor scandal. The three agencies that brought the actions against Barclays -- the U.S. Commodity Futures Trading Commission, the U.S. Justice Department, and the FSA -- resulting in fines of $453 million, have stated that they are now investigating several large institutions for the same alleged offenses, including universal banks such as J.P. Morgan, Citigroup (C), and Deutsche Bank (DB). (None of the three agencies implicated Diamond in their investigations.) Murky legal issues make it hard to forecast the size of future damages for the banks. What's certain is that the Libor affair is the worst blemish on the image of the world's big banks since the financial crisis.
Libor stands for "London interbank offered rate." It's an estimate of the rates at which many of the world's largest banks lend to one another. Here's how it's calculated. Each morning the British Bankers Association -- an industry trade group -- asks the banks to submit an estimate of their borrowing costs on money-market instruments in more than a dozen currencies. After eliminating the highest and lowest numbers, the BBA calculates the average for each security and posts it publicly.
Libor is one of the most crucial numbers for the world's borrowers. It serves as a benchmark for $10 trillion in mortgage, credit card, and corporate loans, and an additional $350 trillion in interest rate swaps and other derivatives.
In the settlement documents Barclays acknowledged two types of abuses of Libor. First, its traders tried to swell their profits and bonuses by asking "submitters" on their desk who filed the daily Libor estimates to fudge the numbers, and the submitters regularly complied. The e-mails disclosed in the settlement even show collusion: Traders at rival banks successfully pressured friends at Barclays to rig the Barclays numbers so they'd book bigger gains on their own securities. "Dude, I owe you big time! Come over one day after work and I'm opening a bottle of Bollinger!" exulted an outside trader who'd just gotten Barclays to cook a Libor estimate. U.S. and British regulators are expected to bring indictments against certain individual traders.
Second, during the strife of 2007 and 2008, regulators closely examined the Libor rates that banks were submitting to judge their financial health. If a bank's rates were far out of line with the averages, agencies from the FSA to the Fed would have pounced. The settlements state that banks submitted rigged rates to make themselves look good. E-mails show Barclays traders advising "to keep our heads below the parapet" on its estimates.
But Barclays was far from the worst offender. The bank generally entered estimates higher than the average, and regularly complained to regulators that since virtually everyone else was cheating, it was getting penalized by trying to be honest. The New York Fed, led at the time by U.S. Treasury Secretary Timothy Geithner, alerted British officials to the abuses in 2008. Today the heated finger-pointing centers on whether the FSA and Bank of England actually knew the fudging was widespread and ignored it -- even, perhaps, providing a knowing wink.
Diamond's 18-month tenure as CEO is too short a period to judge him as a leader. Barclays' share price fared even more poorly than that of most banks in that span, dropping 36%, to less than $11 a share. Still, Barclays' board had good reason to believe in him based on his ability to build a world-class investment bank, a franchise that now ranks fourth in the world in revenue behind J.P. Morgan, Citigroup, and Deutsche Bank.
Diamond succeeded by making highly contrarian bets. He's also, friends and colleagues agree, an energetic and inspiring leader. As New York Mayor Michael Bloomberg says, "He's a guy who's always 'up,' who never gets depressed and makes things work. Look at Lehman: All the potential acquirers thought about it, and he did it."
It's a fair question whether Diamond's charm -- his success in persuading people, one on one, to make deals, his ability to coax assurances from regulators in private -- may have led him to severely underestimate the speed and power at which the political tide was turning against him.
Diamond grew up a world apart from the City of London, in western Massachusetts, the second of nine children. His parents were both high school teachers; his father later rose to become principal of Nantucket High School on the island off the coast of Massachusetts. Today Diamond has a home there. In high school Diamond volunteered for two unpopular positions on the sports teams, catcher and pulling guard. "Not everybody wanted to be catcher, and the line for quarterbacks was long," says Diamond. "My goal was always to make the team."
After graduating in 1974 from Colby College in Maine, Diamond earned an MBA from the University of Connecticut, then joined a medical supplies company in the IT department. When his boss took a job at Morgan Stanley (MS) installing a new trading system, Diamond followed and quickly became enraptured by trading itself. He took a pay cut to start as a lowly trader on the money-market desk.
Diamond first went to London with Morgan Stanley, rising to head the bond trading desk for Europe and Asia. In 1992 he departed for Credit Suisse (CS), and four years later, at age 40, moved to New York as chief of global fixed income. His next move was typically unconventional. Instead of jumping to, say, Goldman Sachs (GS), Diamond chose to join the tweediest of old-line British banks -- Barclays. Within a year, Barclays had sold its second-tier equities business, and Diamond was promoted to run the entire investment bank, which consisted solely of a fixed-income franchise that operated almost exclusively in the U.K.
Diamond, however, reckoned that combining a strong commercial lender with a top-tier investment bank would form the model of the future -- the universal bank. What he needed was a way to grow Barclays' small, provincial investment bank. Most banks focused mainly on the glamorous fields of equities and M&A. Not Diamond. "My strategy was to create a major bank as a fixed-income specialist," he recalls. "No one thought it could be done." At the time, most European companies relied on bank borrowing. The bond markets were mainly small and fragmented, since each country had a different currency. Diamond predicted correctly that the introduction of the euro in 1999 would create an enormous liquid bond market in the single currency that would rival the reigning dollar market.
In 2002, Barclays gave Diamond a second job as head of asset manager BGI, an indexing specialist that pioneered ETFs under the brand name iShares. Its CEO, Patricia Dunn -- later chair of Hewlett-Packard (HPQ) -- was pressing Barclays to sell BGI to a private equity firm. But Diamond and the board recognized potential. Barclays forced Dunn to step down, and Diamond replaced her. By 2009, BGI's earnings had soared 15-fold, to $1.5 billion. In 2009, Barclays sold BGI to BlackRock for $15.2 billion, a crucial step toward bolstering its depleted capital.
From 2000 to 2007, Barclays' investment bank expanded revenues and earnings at 23% a year, making it the fastest-growing franchise in the world. Diamond's pay matched the best of Wall Street at around $20 million a year and attracted derision from the London tabloids, which branded him "Diamond Bob" and the "P.T. Barnum of British banking." But with the banks thriving, the mockery did little damage. It was only later that Diamond's pay would become a political flash point. After his resignation he announced he would forgo severance worth as much as $31 million.
Diamond wanted to expand into equities, but only at a bargain price. In April 2008, Steel, then a Treasury official, called Diamond. "I said, 'Bob, if there were a time when people focused on Lehman, I would suggest you think about it,' " recalls Steel. Diamond began studying Lehman's businesses. "We concluded they had a great equities business, but it only made sense if we bought it in great distress, in the single-digit billions," says Diamond.
Waiting for distress proved sage. In September 2008, Barclays famously bought Lehman out of bankruptcy for a bargain $1.75 billion. It was the only bidder. The deal included only Lehman's jewels, its equities and M&A franchises. The integration went smoothly: Barclays kept 80% of the 10,000 employees it inherited, and most of its senior executives remained, including the chief of investment banking, Skip McGee. Lehman also kept its clients. Today it's the fourth-ranking equities business in the U.S. But the past lingered: The 31st-floor offices of former CEO Dick Fuld and his lieutenants, the notorious "Club 31," remained mothballed, the furniture covered with plastic, for four years. The space was recently renovated.
Diamond sprang into action again in October of that year. "The British regulators told us that the game had changed, that we'd need far more capital," says Diamond. So he immediately flew to Qatar to negotiate a big capital infusion from Sheikh Hamad Bin Jassim, chief of the Qatar Investment Authority, and other UAE investors. He managed to raise $10 billion -- at an extremely expensive 13% interest rate. "Sure, it was expensive," says Diamond, "but it was just about the only capital raised by any bank for the next year." He received a box of Sheikh Hamad's personal brand of Cuban cigars as a memento. Diamond used to offer them with pride to visitors.
Given the shocking arrogance of Barclays' traders in trying to rig a once-trusted benchmark that sets home and school loan payments for millions, Diamond's only real choice was to step down. He set his reputation on building a new culture of investment banking. The incendiary boasts in the traders' e-mails show that he fell short. Still, Diamond argues with some justification that regulators who praised his leadership to his face abandoned him when the political storm engulfed Barclays.
Diamond has expressed frustration that Adair Turner, chairman of the FSA, now alleges that Barclays was contentious and uncooperative on regulatory issues. Turner claims that Barclays clashed with the FSA over the FSA's order earlier this year that it raise capital faster than previously required. But Diamond actually resolved the issue quickly, and far before the deadline, by selling Barclays' 19.9% stake in BlackRock, a move he would have preferred not to make.
It's one of the untold chapters of the Diamond drama that before deciding to take the CEO job, he held in-depth talks with King, of the Bank of England, and Osborne, of the Exchequer, about the future of British banking. Diamond wanted to know if they really wanted a global bank based in the U.K., since they had often praised small banks and vilified big ones. The regulators reassured Diamond that, indeed, they valued the contribution of Barclays and the model it represented. Suddenly, Diamond is gone, and the vision he championed is dying.
--Additional reporting by Marilyn Adamo
This story is from the August 13, 2012 issue of Fortune.