Sunday, 16 January 2011

Our hypocritical bankers

It is bonus time again for bankers. This week, the financial sector arrogantly instructed the rest of us to get over our sense of envy at their multi-million pound payouts. The great risk takers of the modern age need to be rewarded. Otherwise, these top performers may feck off abroad and leave us to fend for ourselves.

Before the crisis, it was not uncommon to hear financial sector types sing lyrically about the merits of the free market. They would complain about heavy taxation, excessive regulation and how it held back entrepreneurial dynamism. The failing welfare state was "the problem", discouraging work and creating a dependency culture within low-income groups.

These arguments contains a kernel of truth. There is much that is wrong with the UK tax and the welfare systems.  However, this sage advice wasn't something that the financial sector wanted to apply to itself once it ran into difficulties. The social safety net had to be extended to include bankers as well as single mothers.

As such, there was always something Janus-faced about the financial sector's commitment to free enterprise. The callous lash of the market was something that had to be applied to others and not to them. The government would always be there for the banks should anything go wrong.

The last four years have been a deeply painful and costly learning experience. We now understand more clearly how the financial sector works and how it generated two decades of huge profits. The trick was a simple one; excessive risk-taking which generates huge profits in good times. When things go pear shaped, the government and the taxpayer is there to pick up the tab. This business model has now developed into a popular adage; all profits are privatized, any losses are socialized.

This extreme risk-taking was facilitated by dangerously low capital levels -the financial buffers for absorbing bad loans. Banks were also dangerously illiquid -they kept insufficient amounts of cash. With each passing year, banks pared down their capital, increasing their leverage ratios, while at the same time, cutting back on their cash reserves.  Banks became more profitable, but less able to absorb any potential losses. Finally, it only took a slight nudge to send the banks over the edge. A rise in the US trailer park mortgage default rate was sufficient to bankrupt the UK financial system.

This is why a return to huge bonus payouts would be so contemptible. Banks are still under-capitalized and balance sheets remain weak. Furthermore, the financial sector continues to struggle to find stable funding. The threat of further bank failures remains, particularly if the economy were to slow again. The banks are not in a position yet to absorb a further round of losses.

In any event, financial sector profitability has been de-facto guaranteed by massive state intervention. Without the current environment of near zero interest rates, the stock of bad loans would overwhelm the financial sector. As an aside, this low interest rate policy imposes huge costs on the rest of society. It has already generated significant inflationary pressures. Real interest rates are now negative and therefore erodes the real value of pensions system. In a very real sense, those bonuses are stolen from our bank savings and pensions.

The plain truth is that those bonuses are disconnected from performance. Without state intervention, those grifters in the financial sector would be unemployed. If anyone deserves those bonuses, it is the monetary policy committee. After all, it was the MPC low interest rates that created the profits.

The primary argument against bank bonuses is not that we feel envious. No doubt, many of us wish that we were receiving multi-million pound payouts. While this reaction is understandable, it should not be allowed to obscure the central and irrefutable argument that these bonuses should not be paid. Bankers should not receive these payments because it is not in the public interest. If there is any spare cash in the financial sector, it should be directed towards recapitalizing banks and making them more liquid. It should be used to repay tax payers, and wean banks off government support.

However, the public interest rarely wins in a head-to-head struggle with the banking sector. Within a few weeks the lap-dancing bars of East London will again be full of flabby cash-soaked bankers. Meanwhile, the rest of us will continue to pay dearly for their mistakes.


Anonymous said...

I know bankers have ruined the UK and paid themselves massive amounts of money while doing it but try not to get too worked up about their pay and bonuses.

If it's any consolation to you there are lots of other people earning lots more. They do this by raising their prices under the guise of this "inflation" thing. Apparently some "costs" have gone up so they are raising their prices.

In the Tesco 2009 Annual Report it states:

"The maximum potential bonus was 250% of salary for the Group
CEO , 300% of salary for the US CEO and 200% of salary for other
Executive Directors"

Oh... by the way... the CEO's total earnings allegedly went up by 71.4% from £9.1m to £15.1m in 2009 according to this article:

It's obviously a misprint in that article about someone allegedly having an increase that year from £36.8m to £90m. I mean nobody could earn that much in one year could they?

Anonymous said...

"After all, it was the MPC low interest rates that created the problem"

Couldn't agree more.

Anonymous said...

Several odd aspects to this as very many of us have an indirect and very real interest through occupational pension plans/unit trusts … our money … where the bankers' premises/practises for high rem. are rarely challenged; the only activist pension group I know of is Calpers who have challenged to effect big change.
As elsewhere observed, there can be few sectors where the managers make off with the spoils, at little risk to themselves as we have seen, created from shareholders’ funds whilst rewarding them with relatively little yet saddling them with the risk (e.g. RBS, HBOS and Lloyds shareholders, etc.). This is perplexing and ought to be contrary to fund-managers' self-interest if they were behaving accountably. Yet IBs have a policy of paying big-time, indeed Macquarie were explicitly proud of putting 50% of the profit to employee “reward”.
The other sector with similarity is property development: both are populated by what one may describe as smart barrow-boys after the main-chance and willing to take risk. The main difference is IB types as a whole are generally cognitively very smart and tend to be technically well –educated with ability to deploy those skills.
So my question is, what needs to happen for the risk takers with my money to be held to account by the people I implicitly rust to manage them? Yes, I know, obvious answer, it is in my hands but …

Anonymous said...

superb post. It says exactly why these bonuses should not be paid.


Electro-Kevin said...

"The great risk takers of the modern age need to be rewarded."

I'm sorry ? What risk ?

I've never seen a flabby banker in a lap dancing club.

Alice Cook said...

"I've never seen a flabby banker in a lap dancing club."

Actually, nor have I. In fact, I have never been to a lapdance bar. It was just my imagination running away with me.


Alice Cook said...

I don't particularly want to debate the point, but I find the idea of lap dancing bars quite grotesque. Since I find bankers also grotesque, the two were naturally associated in my mind.


dearieme said...

The Uk has been ruined by Blair and Brown. Neither is yet a banker.

Anonymous said...

Rhyming slang dearieme.

A David