Saturday, 3 March 2012

Bashing of the bankers

Bonuses and performance 

It’s not very popular to be a banker these days.

There have been a lot of attacks against the bankers worldwide. The responsibility for the financial crisis and the recession rests solely on their shoulders (and the rest of the finance industry, but it is less convenient for the general public to call out hedge fund managers) The bankers (mostly investment bankers) took on too much risks, almost ruined their banks, only to be bailed out by the taxpayers, and now, as a result they are stifling lending and thus crippling the recovery. No wonder everyone is mad at them. 

But the story goes a bit different than that. First of all, the bankers only took risks they were allowed or even encouraged to take. It is silly to blame European banks for holding Greek, Italian, Portuguese or Spanish debt since they were instructed to do so by the Europe’s banking regulatory authorities. All these debts were perceived as risk-free assets. The MBSs in the US were given only the finest investment grades. It was a regulatory rule to have these in the bank balance sheets. As a result this created an artificial demand for such assets which paradoxically increased instead of decreasing the systemic risk of every bank holding such assets. 

So, banks weren’t greedy and risk-loving – they were, as always, risk-averse and careful. But even by knowing this piece of information, one still cannot shake the fact that the bankers received huge bonuses for their focus on achieving short-term profits. Even though bonuses and remunerations of managers in all private sector companies were rising very high (with the average wage of the economy mostly stagnating – see the figure below), this was more due to globalisation and the fact that all these companies, banks and the financial industry in particular, became global players. They have surpassed the national market and their managers are operating in a global environment, which is reflected on their wages. Company employees still remained in their national environments so this, naturally, didn’t reflect on their wages.

Figure 1. United States CEO earnings versus the average wage.
Source of data: Piketty and Saez database, table B4, availlable here.
Another reason for high wages was higher competition for top managers and CEO. In a global competitive environment you must ensure to attract a unique talent of a certain manager with a proper severance package. Otherwise you risk losing him or her to a company that is willing to meet their demands. It is the similar story with wages in sports, particularly team sports such as football (European and American) or NBA. If you have a wage cap on football player’s salary or cannot afford to pay him with respect to his talent, you will lose him to a bigger, richer club. The individual player has a goal to earn enough money now for the rest of his life, so between club loyalty and a higher wage he will almost always choose the later. Even with highly loyal players, the owner of the club needs to raise their salaries to meet a certain standard to keep the player in a club. And yet, no one finds this insulting. As long as they entertain us, who cares what their salaries are. 

But there is a crucial difference; sport clubs, if they go under won’t be rescued by the taxpayers – maybe the club fans, but this is also very unlikely. However, banks need to be in order to prevent systemic chaos. So the taxpayers have every right to be angry for having to do this – and they tend to think of system injustice and how the bankers are living off other people’s hard work, and how it isn’t fair that they can get paid so much, while everyone else gets so little, particularly since they drove their companies to the edge of collapse.

But the answer isn’t to control their bonuses or control their wages. Governments and the public sector in general don’t have a goal of acquiring profit. Private sector companies strive on this ability. If they lack it, they will go under, but if the government lacks this motive, they will just be reimbursed with more taxpayers’ money if things start looking badly. This is why it is wrong for a government to control a bank or to set its long-term or short-term goals.

Don’t let the financial sector flee the country. Don’t over-regulate it and destroy its innovative skills. Both in the US and the UK, the financial sector is a big net exporter (yes, services too can be exported). The financial industry and services are the industries of the future. This doesn’t mean we should all end up in this sector and have no one working in manufacturing. Besides, even if this does happen, there will be an increased demand for qualified labour in manufacturing which would be filled up – maybe not immediately though. Just look at London. Once the bearer of a proud and strong shipping industry (many former London docks still stand as proof), now has completely restructured into a world financial giant. What was once shipping and mining is now finance, forex trading and insurance. And why should anyone stop this buoyant industry with constraining regulation and high taxes? The effect will be that it will leave London. The same can be applied for New York. The younger talented generations of financers will go to Hong Kong or Singapore. They won’t put up with constrains on their lifestyles. 

The finance industry is not the enemy. It is the crucial line of support for the real sector, and the more diverse and developed it is, the better it is for the economic growth of a country. However, competition must be restored in the finance industry. My worries aren’t based on big performance bonuses, short-term or long-term; rather I’m more worried about the problem of oligopoly in banking which is currently keeping high prices on lending for small businesses. In addition, a lack of competition will do what every monopoly or oligopoly tends to do – lead to a big distortion of prices in the market. This was the problem in the first place, along with misguiding regulation that led to the downturn in the market. Big bonuses just exacerbated the public anger.


  1. Bonus culture is the problem, but certainly not the main one.

    Since the bonuses get tied to short term performance, this was what gave boost to risk taking. I'm quite sure they wouldn't have taken nearly as much risk hadn't their bonuses been tied to short term performance and if they had more shareholder control.

    I support any policy that will give the shareholders more power over the managers to eliminate the moral hazard problem.

  2. the reason of their high salaries is a combination of short-term performance bonuses, lack of competition among the banks, bank lobbying for favourable positions, and globalization of wages and bank activities. So, the chance to resolve this by giving more power to shareholders will only get rid of one reason. I call for a fully pledged bank reform to address all these problems at once, and once and for all - the Vickers Banking Commission is coming close to resolving this. We need a similar thing for all other private sector CEOs.