Sunday, 30 March 2008

Applegarth gets a £750,000 payoff

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.

12 comments:

Anonymous said...

TUKHB: "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."

Don't forget the fellow who was risk manager for Northern Rock, I think you will find he had previous form when it comes to wrecking banks.

Alice Cook said...

Anonymous, I think we have heard the last of Adam Applegarth. He will turn up again.

Alice

Anonymous said...

People believed property was a short cut to riches. Now the party is over. We let it this mess happen.

Colin said...

Northern Rock lent to customers that are not credit worthy by any normal standards. Will they be able to sue the government for lax regulation if they are forced to sell their houses at a loss? The government is now their bank. Stranger that fiction.

Anonymous said...

The FSA is a joke. Have you heard about "TCF Treating Customers Fairly."?

It is another high profile campaign to ensure it is seen to be doing something to justify the millions spent on it each year by the taxpayer.

In reality it is a useless organisation. Sack them all now.

Josh said...

What a disgrace.

Anonymous said...

TCF? You mean WTF.

Anonymous said...

Banks are a conspiracy against their customers AND their investors. You might want to read up on how the investment banks changed gearing when they floated from partnerships to public companies and basically became hedge funds. What shocks me is how short peoples' memories are. In a couple of years people will go back to doing business with these fraudsters.

Nick

Anonymous said...

I agree with Alice's sentiment at the end. For years home owners have been enriched via the implementation of a corrupt financial system, karma has finally caught up with them and now they too have to pay for this mess. Its a tough and costly lesson.


Chefdave

Anonymous said...

Alice,

Do you have any idea what proportion of long term government debt is either (i) index linked or (ii) floating rate? Also, what proportion of total debt is short-term.

A key restraint on bail-outs and/or inflation is that with (i) the debt rises in lock step with the CPI and therefore cannot be inflated away without gross manipulation and (ii) would see interest rates sky rocket on the long end of the curve.

I think the negative real yields of t-bills in the US is misleading because that's a temporary counterparty-risk hedge.

I'm also curious where you think company pensions will be regarding underfunding of defined benefits when asset prices tumble further.

We are heading into serious balance sheet repairs at every level, I think, which can't help but create deflation.

Nick

Alice Cook said...

Nick,

I promised to answer an earlier question re: M4 and I haven't done it. I will take a look into what numbers I have and see if I can shine some light on your question.

Frankly, I don't worry too much about pensions. It is a long way away for me which means it is someone else's problem.

Alice

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