Warnings from history

“BUILDING societies again are now firmly established in all great centres of industry, Liverpool, Manchester, Leeds, Birmingham,” noted the authors of an 1867 book called “Progress of the Working Class”. These new fangled societies had sprung up in just 20 years. One group had received millions of small deposits. Yet “not a penny had been lost by error or default.” Astonishingly, this was achieved by groups among whose managers “there are not more than two or three middle-class men and not one of the upper classes.”

These stolid working-class institutions, which were formed not only to pool savings and grant loans but also to build homes and develop tracts of land, mushroomed. By 1910 there were 1,723 with more than 625,000 members; by the 1970s they dominated the residential mortgage market. Their decline has been even quicker.

The most recent departure from the ranks of the mutually owned is the Co-operative Bank. Although not strictly a building society, it was owned by its customers and had become the flagship for not-for-profit banking. Yet weak management (epitomised by a chairman who was unable to tell within an order of magnitude the value of his bank’s lending, then was arrested as part of a drugs investigation) and an ill-timed acquisition of a dud building society sunk those aspirations. At the end of November investors in its bonds approved a debt restructuring that will fill a huge capital hole and transform it from a mutual into one owned by private shareholders.

That is a spectacular flame-out; but mutuals have been in decline for more than two decades. The first big shock came in the 1990s, as customers of big building societies voted to “demutualise” them in exchange for shares. This gave them both the value the society built up during their period of ownership and that created by earlier generations of customers.

Though few voted against, this change in ownership did not serve customers particularly well. Most institutions quickly pushed up their lending rates and lowered savings rates to boost profits. Nor were many of these new firms sterling examples of shareholder capitalism. Some, like Woolwich and Halifax, were taken over by bigger banks. Others—most famously Northern Rock—collapsed during the financial crisis.

The crisis was just as hard on the remaining mutuals. Over just four months in 2009 no fewer than six building societies were pushed into rescue mergers. This was largely because some had expanded into high-risk lending against commercial property to offset declining margins on residential mortgages, but regulators also share some of the blame. Rules restricting the derivatives they could use to hedge themselves against risk and the products they could offer, such as loans to small businesses, made it difficult for them to compete with bigger banks or diversify the risks of their exposure to house prices.

There are a few exceptions. Nationwide, Britain’s biggest building society, narrowly escaped demutualisation in 1997 and has since expanded to become one of the country’s largest mortgage lenders. The government, which wants more such exceptions, is thinking about easing some restrictions on building societies. The model is worth preserving. Mutuals have tended to offer better customer service; on average, they generate fewer complaints than other lenders. The fate of British mutuals notwithstanding, studies by the Bundesbank and the IMF suggest that, overall, mutual banks are more stable than their more commercial counterparts.

The impetus to preserve them has been knocked by the Co-op’s blunders. Few of those blunders would have been entirely surprising to the authors of the 1867 book. They praised building societies for helping working people buy homes, but were less pleased about them lending to pubs and beer shops: “they are apt to become mischievous in proportion as they depart from their title and become mere channels for investment.”