20th September 2009The Malta Independent on Sunday
As the G-20 world leaders prepare for their next meeting in Pittsburgh, one gets the impression from their pre-summit rumblings that they seem to think the financial crisis that constrained them to take acute measures to save the world’s financial system, following the collapse of Lehman Brothers this time last year, was caused by excessive bankers’ bonuses and that a recurrence can be avoided merely by controlling bankers’ pay packet.
To me this sounds nothing more than politicians seeking scapegoats to cover up their own and their regulators’ failure to keep the financial system on the straight and narrow.
The remuneration paid to some ‘bankers’ remains scandalous by any standard. But one has to define who these bankers were, who were creaming off multi-million dollar bonuses, and why they were being paid so handsomely.
Let it be made clear that the vast majority of bankers earn a normal salary and modest bonuses, if any at all. The banker of all bankers, the chairman of the Federal Reserve Bank of the US, has a salary of less than $200,000 – modest compared to the bonuses paid to lesser banking mortals and rather on the low side compared to the weight of the decisions he has to take.
In reality, those bankers who helped themselves to the millions are not real bankers in the traditional definition of the term. Those who earned these scandalous millions fall into three categories. The most obvious category is that composed of very senior executives of banks who were responsible for the overall remuneration policies of their institutions. This is probably the most offensive category. Rather than controlling their underlings when it came to from excessive risk-taking with the bank’s capital, they pumped their organisation to leverage levels that any real banker would never have allowed. Jimmy Cayne and Dick Fuld, the CEOs under whose watch Bear Stearns and Lehman Brothers collapsed, were no real bankers, but gamblers who brought their experience in poker to investment banking and turned the investment banks with which they were trusted into huge un-hedged hedge funds.
The other two categories of bankers drawing multi million dollar bonuses are middle and low rank operators in the investment banking divisions. Banks without strong investment banking divisions, such as Maltese banks, do not pay multi-million dollar pay packages because, like anything else, bankers’ pay is driven by market forces and it is in investment banking where there is a shortage of talent that, unless paid well, will skip ship to competitor organisations.
The Mergers & Acquisitions (M&A) departments of large investment banks are staffed with highly talented executives, mostly in their late twenties and early thirties, who are experts in corporate finance and who are prepared to spend the best years of their life working 90-hour weeks, under the severe stress of delivery deadlines and often sleeping in a different bed every night because their duties call them to travel extensively. Generally, by the time they reach 40 they are burnt out and either retire completely or move to less demanding jobs.
These executives have never put their organisation at any risk, as they do not use its capital, merely its brand and infrastructure. They earn their organisation lucrative fees and, on a net basis, make a substantial contribution to their banks’ profitability.
Politicians have no business trying to control the remuneration packages of such executives. If they do, what will happen (it is, in fact, already happening) is that such talent will merely migrate to boutique M&A organisations, leaving their banks worse off. It is like meddling with the remuneration package of a hotel’s highly successful and skilled executive chef merely because the hotel is incurring losses in its Rooms Department, in spite of the profits made by the Food & Beverage Division. What solution to the Rooms Department’s problem can the restriction of the executive chef’s remuneration provide? More than likely it will force the executive chef to move to a more successful competitor organisation, compounding the problems of his/her present employers.
The last category of investment bankers that benefited from notorious bonuses are traders, those whiz kids who were allowed to trade the bank’s capital many times over, using overnight money to trade in complex and illiquid securitised assets, booking short-term profits leading to huge bonus claims without any regard for the fact that, in the process, they were stuffing the bank’s balance sheet with toxic assets that ultimately exploded and wiped away multi-year profits in one fell swoop.
There are traders and traders. Traders who make real profits without compromising the bank’s capital and balance sheet are a resource to be treasured. Attempting to cap the bonuses of such talent will lead to its flight to hedge funds and shadow banking organisations that escape the Regulators. We have had an inkling of this just this week, when Barclays announced the hiving off of some £12 billion of assets from its balance sheet to a “detached” vehicle against a 100 per cent loan. There is no evident benefit for Barclays in such a move, except to avoid having to mark to market such assets on its balance sheet, doing away with wide fluctuations in its profit performance. It could well be that Barclays are anticipating the regulatory tightening up of remuneration for traders’ talent and have taken early steps to transfer this talent to such “detached” vehicles, beyond the reach of the Regulators bonus controls.
Regulation of banks’ bonuses could be only a very small part of the new regime required to avoid a recurrent blow-up of the world’s financial system. It should be restricted to senior executive pay. This should be controlled through full disclosure, deferred payment, blocked stock options and claw-back provisions, rather than through quantitative limits. Of more importance for effective regulation are capital requirements, limits on leverage, the outlawing of off-balance sheet assets transactions and controls over the overall size of the institutions to ensure that none of them are too big to fail.
Failure must remain the ultimate punishment for reckless bankers, just as for any other profession. What top management pays to their individual executives should be of no concern to the Regulators, even if it were possible to control such pay polices, which often it is not – as the Barclays experience is already showing. But the consequences of bad remuneration policies should be borne by shareholders, not by taxpayers, and this is only possible if banks are constrained to a size where failure would be possible without causing systemic risk. The Regulators’ primary responsibility is to ensure that taxpayers no longer provide implicit guarantees for reckless bankers. Keeping banks too big to fail, while trying to regulate their remuneration policies, will prove to be a very ineffective solution.