Politicians should keep their noses out of bankers’ bonuses

Nick Clegg today said that he understood bonus anger. I think that any sane person also understands bonus anger. It is therefore incumbent upon politicians to explain patiently, and with sensitivity, the realities of this situation rather than, as Cameron, Osborne and Cable have done, suggest that the anger is well founded.

Bankers’ bonuses involve the representatives of shareholders (directors) deciding to give shareholders’ money to the managers of the company. It is only rational to do this, of course, if the bonuses give an incentive for management to add value to the company. Interference in this mechanism to reduce bonuses arbitrarily would make both bankers and banks’ shareholders (pensioners, savers and so on) worse off. One might not feel very sorry for bankers as a class of people but I do feel sorry for pension scheme members in the current financial climate. Companies should not be dissuaded by the climate of opinion, or manipulated by politicians, from doing what is in their best interests.

There are some qualifications to this argument. It might be the case that corporate governance is some kind of insiders’ racket. Bloggs appoints Smith to one board and Smith appoints Bloggs and so on. Instead of the directors acting in the interests of the company, they might be acting in their own interests and the interests of senior management. If the government believes this it should provide the evidence. However, this really is a problem for companies to solve themselves – perhaps by delisting and going private – and not for government.

Secondly, it may be that the bonus packages are optimal for the company but not for society as a whole because of the implicit bailout promise that exists. There is something in this. However, the problem with the bank bailouts was not the treatment of shareholders (in some cases, they got treated quite badly) but the favourable treatment of creditors (especially the holders of bonds issued by banks). In any case, it is government policy that, as a result of the Independent Commission on Banking enquiry, orderly failure will, in future, be possible. We have, on the one hand, George Osborne conveying this message and, on the other hand, Mark Hoban arguing that banks should be better regulated to prevent failure. So much for joined-up government.

David Cameron also argued that the RBS should be laggards in the bonus season. Maybe so. However, the government has appointed UKFI to look after the taxpayers’ interests in the banks. Maybe the Prime Minister should fire the directors of UKFI and do their job himself – or perhaps it is better to let them get on with their job while he gets on with his. It is indeed possible that they are well-briefed specialists who know more about the situation that pertains to RBS than the Prime Minister with his wide-ranging role and that they are taking decisions that are in the best interests of RBS shareholders. Indeed, I believe that the Chief Executive of RBS was told when he joined that there would be no rewards for failure – in other words, his pay package would broadly be a bonus package.

Nick Clegg is right – people might be angry. But, when it comes down to it, the government has got to decide who runs Britain’s companies. It is an unnecessary distraction for David Cameron to get involved in the bonus structure of Britain’s banks. He should explain this patiently and sympathetically and get on with the business of ensuring that the legal framework exists for the next bank that goes bust to be wound up. The implications of a country whereby pay is determined not by free agreement between contracting parties but by the “wise judgement” of the man in number 10 Downing Street using principles of “justice” are enormous. We do not want to go down that route.

Philip Booth is Senior Academic Fellow at the Institute of Economic Affairs. He is also Director of the Vinson Centre and Professor of Economics at the University of Buckingham and Professor of Finance, Public Policy and Ethics at St. Mary’s University, Twickenham. He also holds the position of (interim) Director of Catholic Mission at St. Mary’s having previously been Director of Research and Public Engagement and Dean of the Faculty of Education, Humanities and Social Sciences. From 2002-2016, Philip was Academic and Research Director (previously, Editorial and Programme Director) at the IEA. From 2002-2015 he was Professor of Insurance and Risk Management at Cass Business School. He is a Senior Research Fellow in the Centre for Federal Studies at the University of Kent and Adjunct Professor in the School of Law, University of Notre Dame, Australia. Previously, Philip Booth worked for the Bank of England as an adviser on financial stability issues and he was also Associate Dean of Cass Business School and held various other academic positions at City University. He has written widely, including a number of books, on investment, finance, social insurance and pensions as well as on the relationship between Catholic social teaching and economics. He is Deputy Editor of Economic Affairs. Philip is a Fellow of the Royal Statistical Society, a Fellow of the Institute of Actuaries and an honorary member of the Society of Actuaries of Poland. He has previously worked in the investment department of Axa Equity and Law and was been involved in a number of projects to help develop actuarial professions and actuarial, finance and investment professional teaching programmes in Central and Eastern Europe. Philip has a BA in Economics from the University of Durham and a PhD from City University.

5 thoughts on “Politicians should keep their noses out of bankers’ bonuses”

  1. Posted 11/01/2011 at 13:48 | Permalink

    As someone who has some knowledge of investment banking and the recruitment process let me confirm that those getting eye watering bonus’ are very talented people. I believe most banks work on the basis that traders and senior staff are remunerated on the basis of 20% of the profits that the person generates. I have worked out that the chances of becoming a premiership footballer is about 1 in 10,000.or 0.001%, Out of the remaining 9,999 aspiring footballers about 2% will earn a living playing for nPower or semi professional leaving 98% playing for fun mostly. It is the same with working for an investment bank. Most will not have good enough to be granted an interview mainly based on academic qualifiations and those who do make it for every 1 person who makes it there will at least 9 failures.

    On a general point at RBS for example maybe it is diplomatic for the chief executive to decline his bonus but if the traders within the bank do not receive theirs, getting another job should not be too much trouble. For the future profitability of RBS this could be more than counter productive,

  2. Posted 11/01/2011 at 14:16 | Permalink

    Another thing I have problems with is the idea that Mr Cameron appears to be saying that he will tolerate big bonuses if the banks lend more.
    By this I assume he means “will lend more to people or companies than they wouldn’t otherwise have done” because such lending was risky or unprofitable.
    At least part of the genesis of the banking crisis was excessive lending by banks which were encouraged to do so by governments (eg. President Clinton’s advocacy of mortgages to borrowers with little collateral). Do we really want to go down this route again?

  3. Posted 12/01/2011 at 11:47 | Permalink

    MPs from all political persuasions raised valid and verifiable points on this subject at the Treasury Select Committee yesterday. It is a great shame that your post ignores them entirely.

    The financial benefits of the state-backed guarantees that ALL banks enjoyed should not be underestimated. “Bonus Bob” the “Diamond Geezer” or whatever the US equivalent thereof is was not quick to acknowledge this yesterday.

    The massive boost to the stock market asset values that all the banks and pension funds benefited from, caused by State-backed Quantitative Easing should not be overlooked. All the bank profits, especially in the investment banking side, which have led to individuals meeting criteria for bank bonus’ eligibility, derived from share trading in the rallying market both last year and in 2009 arose from market liquidity caused by these state asset purchases.

    The banks have moved from one extreme to the other in respect of risk and lending: ultra liberal to ultra conservative, over-heating the economy to stifling it and leaving it uncooked, rather than encouraging it to simmer gently. Bankers are frightened to lend, without quadruplicate guarantees. Some of the legacy risky commercial property deals are still sitting on some of the banks’ balance sheets and need rationalising too. Other forms of capital investment in small and medium sized enterprises have to be the way forward to alleviate the risk of continuing over dependence on risky debt. Why has Germany’s industrial and Mittelstand economy been so robust financially over such a long time? – Capital participation by financial institutions. Which EU economy is bursting with most life; rebounding from the recession strongly, despite its government’s bale outs of other EU countries and membership of the €uro?

    One of the most interesting developments of all is Credit Suisse’s reformed bonus package system, announced this week. It exposes the rhetoric about it being impossible for one country to make reforms in this or any other in banking alone, for fear of being out-done by the market, as vacuous nonsense. Unless it has been forgotten, Credit Suisse was virtually totally unaffected by the 2008 banking collapse. It employs about 6000 people in the City of London.

    It has been argued that Barclays is very lucky to still be in private ownership. If it has won the take-over battle for ABN AMRO it would be in a radically different position now – even without that it had to be rescued by a sovereign wealth fund. Barclays has benefited directly from the US Treasury secretary’s decision not to bale out Lehman Bros, by subsequently purchasing its assets at a knock-down price, following the collapse and one less competitor in the market place.

    Americans don’t do humility generally, but only time will tell, whether Diamond’s chronic lack of humility, coupled with his complete lack of judgement about sentiment in parliament and the wider general public yesterday on behalf of his company and industry will come back to haunt him. Perhaps one of the well-qualified UK banking executives, cited above by Dave Atherton should be lined up to take over already?

    It is still possible to pursue an argument of free-market fundamentalism in a mad-dog, miopic, tail-chasing sort of way. Cameron and Clegg were both voted in for “change”. Changing the financial services sector is not to be shirked. In a liberal democracy, if the market cannot be relied upon to provide change, then the elected representatives must.

    There are a number of ways that the £7bn bank bonus pool could be handed out, but giving it to top level bankers is certainly not one of them. It could be (i) handed back to shareholders (ii) given as a dividend to the UK general public, either as shares in their bank, or cash payment – it works out at about £100 for each any every one of us (iii) given to all those that have lost their jobs and incomes over the last two and a half years and had their incomes severely curtailed as a result – gone onto short time working, been made redundant etc.

  4. Posted 12/01/2011 at 17:57 | Permalink

    Philip, I think you and the politicians are addressing the wrong problem – you are under the misapprehension that banks are akin to other private organisations. As a class, they are a monopoly that the state has given the right to create money, and hence extract rent from the rest of society. Unsurprisingly they have done so, transferring vast amounts of resources to the sector which is bloated way beyond any useful function it serves to the rest of society. Not satisfied with this, the state also effectively transfers societies’ wealth to the sector through tax benefits (i.e. tax relief on mortgages and pensions contributions), through setting interest rates at below their market value and, recently, by guaranteeing their liabilities and quantitative easing. This provides the resources to pay the aforementioned bonuses. I also feel this is what people are angry about but can’t quite articulate – it’s easier to blame the bonuses.

  5. Posted 13/01/2011 at 17:26 | Permalink

    Anonymous and Nick – I have not ignored these problems entirely. I did refer to the no-bail-out problems and I believed that these problems should be addressed. Rather than saying that because the state mismanages monetary policy or insists on bailing out banks, politicians should be in charge of setting bankers’ pay, I think we should go further back up the chain and solve the underlying problem. Where do we stop, Nick, if we take the other approach? Should government ministers be setting the salaries of people who work in charities because charities receive tax relief? The government has specifically said it wishes to deal with the no-bail-out issue. If it does not, I shall post again criticising its decision.

    There is, by the way, no tax relief on mortgages these days, but I take the general point.

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