Success in the UK was always been recognized and rewarded, but what of failure? What happens when someone makes some really bad decisions and things fall apart? What is the price of failure?
We received an answer to this question today.
Last year, Adam Applegarth failed big time. As CEO of Northern Rock, he drove the bank into the ground. He gambled on the housing market and lost.
The Bank of England had to step in and cover the bet. It had to pump £32 billion of public money into the bank to ensure that it did not bring the entire UK financial system down. It also had to guarantee around £100 billion of bank liabilities. If Applegarth had won the bet, he and his shareholders would have become enormously wealthy. However, he lost and cost the country billions.
What was the personal price of this staggering failure? When he finally left the wreckage of NRK last December, Applegarth received a £750,000 pay-off, which is more than what the majority of people in this country earn in their entire lives. Moreover, he will also be entitled to a pension of about £2.5 million at the age of 55. So when he finally puts his banking-wrecking days behind him, he will live comfortably on a payout of £200,000 a year.
It is all to easy to rage against Applegarth and this kind of payout. However, it is better to calm down and ask a couple of more important questions. How does this kind of payout affect behaviour within the financial sector? What does it imply about incentives?
The answers to these questions implies something nasty about the financial system in the UK. Incentives conspired to ensure that banks like Northern Rock and their managers brought the UK financial system to the edge of disaster. Banks had every incentive to rapidly increase their loan volumes, shift risk to others in the financial system and over-inflate asset prices. Banks has every incentive to leave the household sector drowning in debt, which would ultimately push the economy to the edge of a recession.
Today's news confirmed some lessons for the financial sector. First, it doesn't matter what risks a bank might take, the Bank of England is there to pick up the pieces if things go wrong. Second, profits are always a private matter, but losses should be shared with the taxpayer. Finally, success is rewarded, but so is failure. So it doesn't matter what kinds of risk a bank takes on, the CEO always wins.
So I am not angry at Applegarth. He only did what any sensible person would do when faced the incentives embedded in a typical UK Bank. Instead, I am angry at the FSA for failing to properly supervise Applegarth and Northern Rock shareholders for letting him get away with it.
I am also angry at UK taxpayers. We let this mess happen, we should have held people to account, and we should have known that double digit house price growth would end up in some serious financial sector difficulties. We brought this mess upon ourselves. Perhaps it is right that we should all collectively pay for this failure.