Sunday, 15 February 2009

Why do banks pay bonuses.

I really liked this comment from Asteve, who left it on one my recent blog posts. I think this is a deep insight into how banks really work.

Bonuses are not, in my opinion, about "retaining talent" (for that, it would be best to compete on salary.) I think bonuses are both a bribe and a threat to employees to keep quiet about anything they see that looks dodgy - since, otherwise they may lose personally.

It encourages employees to be complicit in any fraud they discover... and, what's more, by making the bonus culture pervasive within the industry, it encourages a even those with ethics to consider their colleagues before blowing the whistle.

20 comments:

yudansha said...

"...since otherwise they might lose personally."

Do you know - I'm so used to seeing the word 'lose' erroniously spelt 'loose' that I thought this was wrong at first ?

(Also 'brought' instead of 'bought'.)

ZED said...

so that is the famous bonus culture; mostly fear with a little greed.

CharlieMcMenamin said...

Falkenbloghttp://falkenblog.blogspot.com/2009/02/righteous-bonuses.html doesn't agree. According to him big financial firms have to pay their dealers excessive amounts, including obscene bonuses, 'cos otherwise the traders just have an incentive to 'give away' securities to friends thus 'building up a set of favors for his next position.' Management can't control this because they don't have the time or technical skills to do so, but, nonetheless, get awarded a cut of the trader's performance in the form of their own obscene bonuses. By this account, then, the financial sector has fallen prey to wholesale provider capture and there is no obvious way out.

John East said...

I consider myself to be honest, but if offered a £1M bonus to suspend my critical faculties and get on with the job I'm sure my honesty would be put on hold until next year. Anyone saying otherwise, especially the lame brains joining the hue and cry against the bankers now, are fooling themselves.

The real villains, who will take every opportunity they can grasp to stoke the hatred against the bankers, are Brown and his incompetent shower who failed in their responsibility to regulate effectively.

dearieme said...

Ah, so it's "hush money"? That hadn't occurred to me. Nice one.

Sureseam said...

The other comment on this that cracked me up was Peter Schiff (approximate quote follows):

"The first thing they did with the TARP money was to pay retention bonuses. Who exactly was going to poach these people? The only institutions with money to do the poaching are the ones that received the TARP bailouts."

Anonymous said...

Of course it is less conspiratorial but surely a more obvious reason is that it prices new entrants out of the market.

Exactly what dodgy things do you think the banks have done? By dodgy, I mean actually criminal as opposed to "criminally" stupid?

phd said...

I have seen traders leave desks over the slightest of slights. In a pampered world, no one can live without their Pampers.

If *you* were given a big bonus, and then next year it was taken away "for the good of the market" the first thing you would think of doing is leaving for another firm who did not have such an "enlightened" policy.

A trader walking away with client confidential information to a competitor can also be damaging to your bottom line, hence the existence of very expensive garden leave.

You do not need a conspiracy of silence to explain high bonuses in an industry which rakes in billions during the good years.

marksany said...

Replace the word "bonus" with the word "bribe" and all becomes clear:

http://stumblingandmumbling.typepad.com/stumbling_and_mumbling/2009/02/bonuses-power-and-inequality.html

Anonymous said...

A trader walking away with client confidential information to a competitor can also be damaging to your bottom line, hence the existence of very expensive garden leave

Or worse: Take the information the tax office and serious fraud office!

aSteve said...

Pleased you liked it, I'd have polished the wording if I'd expected it to become a blog post. ;)

The context for the comment was that Lloyds had just attempted to justify bonuses by saying that many were for ~£1,000 and paid to employees earning ~£20,000. I thought, there has to be a reason these employees aren't given a 5% pay rise...

Anonymous said...

Anon @16 February 2009 09:39 - again you have any actual evidence of any actual crime? I am sure once the fuss dies over just like it did post junk bond bust, post dot-com bust, post 1929 bust, post 1907 bust, post enron bust that it turns out that virtually none of the banks committed any crimes and a minuscule number of people are convicted of some trivial misdemeanor which is trumpeted as "socking it to the banks".

aSteve said...

I'm sure that there have been a vast number of crimes committed - but also recognise that the statute is not inadequate.

Every individual who misrepresented their income (which has been widespread) is guilty of fraud. Every advisor who decided not to ask embarrassing questions in order to meet their sales targets has been guilt of conspiracy to defraud. Every investment advisor who described AAA-rated CDOs and MBS as being "as reliable as gilts" is guilty of fraud - and every ratings agency who took payment to back up this pitch are guilty of conspiracy to defraud. The risk managers and their superiors at banks have been proved to have debased Sterling - this is, by definition, treasonous.

There's been plenty of criminal activity - but it has been clever criminal activity - the kind that it is very difficult to prosecute.

aSteve said...

corrrection
...
but also recognise that the statute is inadequate.
...
(Doh! Edit error.)

Anonymous said...

aSteve I am sure there is plenty of fraud being committed **against** the banks.

As for the AAA ratings that is because people didn't really understand what that means or didn't care. The rating is default risk which is that the MBS or CDO will not meet is contractual obligations but as the coupon and principal repaid is variable based on underlying performance then it is next to impossible for them to default. If I promise to pay you 0% coupon and 0 principal then that is a rock-solid AAA investment because i can NEVER default. If you are dumb enough to invest in it then that is not a crime. With regards to the real-life CDOs, the coupons where dependent on the underlying cash flows and again these CDOs didn't default, they are simply paying out far far far less in interest and losing a large portion of their principal but because this is allowed under the coupon definition they did not default, hence the AAA rating is justified.

The other place AAA was useful was for people like pension funds and money market funds who can only invest in "investment grade" and due to our genius chancellor keeping interest rates so low these guys needed yield hence the explosion in origination. But this is not "fraud" simply a regulatory arbitrage.

"Debased sterling" is SOLELY at the feet of our brilliant leader nothing to do with the banks.

As expected, lots of claims but no real evidence.

aSteve said...

Hmm, anonymous... I'm not sure what point you're trying to make.

Deception is endemic within the financial system - and, hence, so must be fraud. Prosecuting this fraud, of course, is another matter entirely. Evidence is, as you observe, either very sketchy... or the fraud so commonplace that it defies any attempt to address it directly on specific terms.

I agree that Brown has a lot about which to answer - but I'd strongly argue that the banks debased currency - facilitated by Brown disbanding BoE regulation of financial institutions and erecting the FSA as a body incapable of regulating effectively. The banks, however, are not blameless... the banks themselves were responsible for their own free-market solvency and for establishing business plans for the long term. The perverse incentives and inappropriate regulatory regime played their part - but no participant was faultless.

It is the fact that so many are implicated - throughout government, the civil service, banks, financial and non-financial corporations... that makes it almost impossible to recommend suitable sanctions or legal redress.

Anonymous said...

But you aren't "strongly arguing" you are simply stating it as "fact". The only deception "endemic" in the financial system is self-deception. I will guarantee that ALL of the risks you seem to claim are not stated actually are in any contract you sign, just that most people don't bother to read them. People refuse to accept that if you are getting more than the risk free rate then you must be taking risk.

How EXACTLY did banks debase the currency? I see negative real rates, I see an economy overly exposed to the current crisis, I see a PM spending like crazy having already piled up a huge debt, I see him guaranteeing debts left right and centre, I see an inability to take any responsibility rather a desire to be seen to do anything as the SOLE cause. By stoking inflation, lowering interest rates and spiking the investment risk Crash Gordon is behind this collapse in the Sterling, no some secret society of silenced bankers.

The main people to blame for the mess are the general punter, who wanted toys now and didn't want to pay, who wanted "excess return" but couldn't be bothered to examine the concomitant risks, who are now whining that no one told them and demanding someone else pay for their own greed and stupidity.

aSteve said...

Banks debased currency by failing in their obligation (implicit in their holding a banking licence) to lend responsibly. There were many mechanisms - the simplest being to lend against houses to drive up house prices to use the inflated house valuations to support a claim of sufficient collateral. This recursive dependency resulted in the accounting of false value and misrepresentation of risk.

I understand your argument that the investors should have smelt a rat - and that borrowers should have been more circumspect - they should, but this misses the point. Consider, for example, a teaser loan... while any borrower expecting to earn sufficient to repay the loan may act responsibly, any number of otherwise border-line insolvent (or simply uneducated) speculators can be mis-sold assets. This skews asset prices to the detriment of the whole of society. The responsible individual looks on at other people who will inevitably face bankruptcy... but, in the interim, the responsible are priced-out of markets and marginalised... the reckless hoard resources and enjoy elevated creditworthiness as a reward. In time, assuming the prudent are not coerced to directly fund the reckless, the reckless will default and significant losses will be shouldered by someone... most likely the prudent solvent taxpayer previously marginalised in asset markets.

If losses at banks had been financed by investors, I'd see no ethical problem in the preposterous mess that has emerged... but where banks force governments' hand to re-capitalise... I see this as evidence that the cost of pervasive reckless behaviour has been socialised. This, I feel, is ethically unjustifiable.

Anonymous said...

That is just about the most arse about backwards argument i have ever heard. The people who "drove up prices" were NOT the banks it was the general punter and this doesn't "debase currency" rather it makes the currency stronger because it attracts investment - whilst the bubble stays inflated - and certainly made it stronger than the relatively low interest rates we had.

There was simply NO false value accounting. The only fair value of something is it's market value and exactly what risk was misrepresented? and to who? to Fred Goodwin who rode the value of his shares down to the bottom or Dick Fuld who did ditto? So many things incoherent in your argument, your desparate pathetic attempt to fob this crisis off onto the big bad banks.

Anonymous said...

"The only fair value of something is it's market value and exactly what risk was misrepresented?"

Well, actually, fair value being market value is based on a set of assumptions mostly revolving around liquidity. An asset is worth what you can sell it for right now, sure. But the last value at which that asset traded is not what you could actually unload all of your holdings at if you have a substantial amount of them because you will move the market while unloading them. And hence, market value is not fair value. It's generally higher than fair value.