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Winning the bonus lottery

There has been an awful lot of political cant offered up as argument concerning bankers bonuses. The high rates of pay in the City of London and on Wall Street are so far ahead of the average that politicians are more or less required to be critical, bearing in mind that the average voter earns so many times less than the average banker.

Nevertheless, as a banker myself, I think that the compensation offered to bankers is no longer linked to performance- it is a simple lottery. Once upon a time, bankers were entrepreneurs. Partners in their firms, they were prepared to risk their own capital and to back their judgement with their own money. Later, banks became joint stock companies, and the image of the sober-sided, respectable and responsible bank manager of the mid-20th century marked out banks as stable, prudent and safe. Of course, even for commercial banks this was not strictly true, and bankers risk models- focussed on bell curves and other fictitious ideas rarely achieved the returns that were claimed for them. Meanwhile there were also the "merchant bankers", these functioned as partnerships for a lot longer than their lending bank cousins, and maintained a tradition of taking higher risks and being involved in more innovative investments- and paying themselves more.

Yet in due course, the consolidation of the banking markets meant that even the very largest of these partnerships- now usually called investment banks- were forced to take in third party capital. When one takes in third party money, one is no longer- strictly speaking- an entrepreneur, one acquires a fiduciary responsibility. One is obliged to protect investor interests and to share investor returns. Meanwhile the supposedly staid commercial bankers aspired to investment bank returns and began to put more an more client money into instruments that were inappropriate and which they did not understand.

The collapse of the banks in 2008/9 dramatically proved the failure of two ideas: the first was the erroneous risk models that had been promoted across the the banking sector, but it also destroyed the fiduciary relationship between the banks managements and their investors. Poor risk taking led to the destruction of shareholder value on a scale never seen before. The result was that the owners of the banks saw their investment essentially destroyed, as one after another, governments were forced to bail out the failing banks in order to prevent a collapse of the entire sector, and with it the value of customer deposits.

I use the word failure in its fullest sense- the management and "risk control" of banks proved to be a total and spectacular failure. It was not just isolated errors of judgement, it was a systemic breakdown. One of the major reasons for this failure was the abuse of the fiduciary relationship by bank management. The staff were able to generate massive returns for themselves without taking any personal risk- the complete risk now lay with the shareholders. When the banks failed, the shareholders lost everything, but for many of the staff responsible, the effect was negligible- even most of those who lost their jobs were generally able to find new employment quickly.

Now, after the nationalisation or bail-out of the banks, the bank managements are seeking to return to an unsustainable model- to take the shareholder money, now provided by the state, and turn it into personal wealth regardless of personal risk. As the orders from bankers for Porsche and Rolls Royce luxury cars reach new records, it is now quite clear that the reform of the banking system can not be delayed.

Those paying themselves such large amounts of money are doing so even when shareholders- whose interests they are supposed to put first are losing money. This is not entrepreneurship in any form, and these banking bureaucrats- for that is essentially what they are- do not deserve entrepreneurial returns- still less the cock-eyed returns of huge bonuses before their shareholders receive a penny.

Bob Diamond does not get it- these huge "bonuses" are a function of a dysfunctional market- those who receive them are not entrepreneurs, they are merely lucky, not skilful. Meanwhile, the impact of the bank bail outs is severely impoverishing the average voter. Voters are angry- and they are right to be. The banking system is paying out more money than ever to its workers and less money than ever to its owners.

This is not sustainable, and it should not be sustained. Vince Cable is quite right- the banks should be broken up. Genuinely entrepreneurial operations should be able to reward real risk taking appropriately, but the vast majority of bank business is not entrepreneurial and does not earn the levels of compensation that has become the bloated norm in the sector.

Winning the bankers bonus lottery should become a whole lot more difficult- as soon as possible.

Comments

Sarunas Skyrius said…
You must qualify your position with what departments you have in mind, or else risk appearing a populist hack. If it's prop trading, investing and lending, you have a point. If it's client-paid M&A, ECM and DCM, then you don't.
Cicero said…
Ask yourself which of these businesses uses the most shareholder capital and you can see that this is implicit in my comments- M&A and CM business have a low capital density.
Sarunas Skyrius said…
Given the level of ignorance of the general populace as to what sort of bankers are there in the world, erring on the side of explaining too much is not something to be avoided at all cost.

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