Bankers and bonuses


1:42 pm - February 12th 2009

by Luis Enrique    


      Share on Tumblr

Listening to the Today Programme the other morning, it seems a consensus has been reached: the problem in the banking industry is big bonuses, and if the politicians can command the banks to stop paying big bonuses, then the “bonus problem” will be solved.

Why are big bonuses are paid in the first place? Unpleasant as they may be, the reasons described by Chris Dillow cannot simply be wished away. Individual bankers generate huge quantities of revenue, and if they walk out the door they take the revenue with them, giving them bargaining power that (partially) explains their incomes.

We – the taxpayer – own some banks now, and our interests will not be served if the revenue generators walk out the door and take the business with them. The general impression appears to be that big bonuses exist simply because bankers are greedy and like paying themselves lots of money, as if people in other industries wouldn’t pay themselves lavishly if they could.

Please do no confuse this with a “defense” of big bonuses – I’d love it if bankers were paid less. That would amount to an increase in productivity – more output at less cost. I would also love it if footballers were paid less – that would mean we’d have to pay less to attend games and to watch the games on television. But what popular opinion appears to be pressing for now is the equivalent of nationalising Manchester United and imposing a £500,000 annual salary cap. And then asking Arsenal and Barcelona not to poach our star players. Everybody knows that to make that work, we’d need a global cap on footballer salaries. The co-ordination problem is the same in banking.

This is not to dispute the corrosive effects of big bonuses that rewarded short-term performance – the existence of “perverse incentives” is one of the strongest explanations for the crisis. We’d all like to see a system where the incentives in banking are better aligned with society’s interests, and where salaries and bonuses in the industry are lower. A lot of people are asking why the bankers didn’t foresee the consequences of their actions; all I am trying to do is foresee the consequences of ham-fisted attempts to cure the bonus problem.

One response to this argument is that as things stand, even the “rainmakers” won’t be able to find work, if they respond to bonus cuts by walking out. I don’t think that’s correct, but even if it is, it’s beside the point. Reforms to bonus systems need to work when the banks are making money again (which we want them to do, because we own some of them) and when the “reasons” why banks found themselves having to pay so lavishly, will be as strong as ever. It’s quite common in banking for entire trading desks or analyst teams to quit en mass and go elsewhere, and these guys will have no problem finding seed capital to set up new shops if they can escape the salary caps imposed on the banks that have received tax payer investments. They can get around wage and bonus legislation by setting up partnerships and paying themselves dividends.

Fixing this problem is going to take some carefully designed, far reaching legislation that will also require global co-ordination (to prevent the banks simply relocating to countries with lax legislation, and carrying on blowing bubbles as before). Either that or we solve co-ordination problems via state monopolies[2]. The bottom line is that we must not be satisfied with some legislation that caps salaries and bonuses in banks that have received tax-payers’ assistance; that’s just not good enough.

[1] Why are the sums involved so high? Why don’t banks compete on price, like say supermarkets? How can they charge so much for what they do? Here’s part of the answer: imagine you are a company looking to sell yourself on the stock market. One investment bank charges £500,000 in fees, but another, staffed by “star” corporate brokers, analysts, and traders, charges £2,000,000 but can add 10p to the price your shares will sell at, raising an additional £10m[3].

[2] Chris suggests nationalised banks existing alongside private competitors. I don’t think that would work for investment banking, for the reasons given above.

[3] One big weakness of this piece is that I fail to distinguish between retail banking, business lending, mortgage provision and investment banking. Most of what I say really applies to the investment banks, which is where I reckon the seat of the problem lies. I don’t know why retail bank directors get paid so much – probably just because they set their own pay. See here.

    Share on Tumblr   submit to reddit  


About the author
This is a guest post.
· Other posts by


Story Filed Under: Blog ,Economy ,Foreign affairs

Sorry, the comment form is closed at this time.


Reader comments


Just a quick response. I think this entire issue is becoming incredibly confused. So here are a few thoughts.
Firstly – a key point in the article – One big weakness of this piece is that I fail to distinguish between retail banking, business lending, mortgage provision and investment banking. Most of what I say really applies to the investment banks, which is where I reckon the seat of the problem lies. I don’t know why retail bank directors get paid so much – probably just because they set their own pay.
Lloyds is certainly a retail bank, but what about Barclays? It gets more revenue from investment banking ansd trading than vanilla retail banking. What about RBS? Sure – they are retail bank, but they also have RBS markets and bought the London operations of ABN Amro.
The key problem here is that it is now almost impossible to distinguish between retail and investment banks.
Retail bank CEO’s get paid too much as all CEOs get paid too much. Eric Daniels of Llods TSB earned £900,000 in 2008. Ian Livingston of BT earned £850,000. Frank Chapman of British Gas earned £960,000 basic plus a bonus of £1.1mn. Terry Leahy at Tesco earned £1.3mn.
Secondly – again on the article – One response to this argument is that as things stand, even the “rainmakers” won’t be able to find work, if they respond to bonus cuts by walking out. I don’t think that’s correct, but even if it is, it’s beside the point.
How can this possibly be, ‘beside the point’? If they could not get similar pay elsewhere (i.e. the market they hold to be so precious, does not think they are worth that much), why should WE pay them that much?
The point is also correct – jobs are vanishing. Firms are cutting staff and markets are not healthy – where do these people expect to work?

More generally, speaking as someone who works in the city and who has received bonuses of over 100% salary – most of these people are not worth it (myself included).
No other profession demands bonuses for doing their job.
I sometimes think people don’t realise how common bonus culture is. It is simply not the stars who get mega rewards. In the last few years a new graduate could expect a salary of £40,000 and £30,00 bonus!

Duncan,

Thanks for your response. It is only “beside the point” to the extent that it is a short term thing, and we need long-term solutions. If it remains the case, in the long-run, that competing banks without salary caps, or start-up partnerships, won’t poach “rainmakers” by offering higher pay, then no problem. I doubt that, though. I am not saying that the recipients of these bonuses are “worth it” in any wider sense, other than in the sense that the banks that pay £30k bonuses to graduates found it commercially worthwhile to do so.

I am not sure how quantitatively import these concerns are. Say the response we end up with is legislation that caps salaries and bonuses in banks that have received tax-payers’ assistance. How would banks and bankers respond to that? How much business would the banks, that now owe the tax payers money and/or are owned by taxpayers, lose? I’m just worried the potential consequences are, from what I can see, not being given much thought, in public at least.

Very interesting post.

I would just say:

(1) obviously the UK government has no influence on (the vast majority of) investment banking bonuses as the vast majority of investment banks are not UK owned – and we know what the problems are here – mostly a question of inadequately long payment deferral periods to ensure that traders do not wipe out earlier profits for which they have already been paid

(2) agree to some extent on the “rainmakers” (different from the traders) – the Merrill team which helped RBS buy ABN may have helped destroy RBS but they made lots for Merrill – but such people never have and never will sit well within a retail banking culture which is why HSBC and others have had several aborted attempts to build such investment banking businesses

so IMHO

(3) any bank which takes UK public money should be made to ditch its non-retail activities and revert to what seems to now be called “utility” banking which has in any event historically generated a similar return on equity to investment banking so the taxpayer need not worry too much about missing out on future profits – whether this means temporary or Dillow-esque permanent nationalisation I’m not sure

(4) as we don’t therefore need the rainmakers all bonuses should therefore for now be zero (except when cast-iron contractual) – the argument about the lower paid tellers is nonsense as I’m sure that they will be grateful enough to still be in owrk or not suffering salary cuts like staff at Woolworths, Honda and countless other firms

ie – the main point in response to your post is that over time retail banking has as profitable as investment banking so we need not worry too much about the loss of “rainmakers” – very few of whom work for UK owned banks anyway

Erm, does anyone care if banker scum are driven out? Given that they’ve brought us to our knees, any country that is mad enough to want the thick bastards is welcome to them.

They are getting too easy a treatment from the traitor Brown, not too hard.

Erm, does anyone care if banker scum are driven out?

Well, yes, if that means – as Luis is asking – we don’t get our money back, or get less of it back than we otherwise would.

“Erm, does anyone care if banker scum are driven out? Given that they’ve brought us to our knees, any country that is mad enough to want the thick bastards is welcome to them.”

Typical emotionally reaction of a person refusing to engage with reality. The financial services sector is important to our economy. Even if it wasn’t it would still bring in money. The better the people who work for it, the more money the country makes. The more money the country makes, the more prosperous we are.

Because they’ve been so successful at enriching us all over the last 10 years and are in no way responsible for the state we’re in.

I don’t see the overall point?

You are making a massive assumption that those who are making the kind of bonus they are, will still receive those bonuses elsewhere, assuming that they are that good everyone will be head-hunting them.

Simply put, and I mean simply – banks are way too big.

The encouragement of the last 30 years of Tory policy has all been about making more money, and if you can make it from nothing – then do that.

The status quo is STILL looked upon as the norm. What needs to be done is the banks should be nationalised and then sold off in small increments. Break them up so they no longer wield the kind of power they have now, so much so they can bring the whole world to its knees by idiotic decisions in the name of making a quick buck from thin air.

10. Luis Enrique

Will,

I’ll try to express myself more clearly: now that we own the banks, we own their problems. Including revenue generation and staff retention. Even if we split them up into smaller units, we don’t want the banks we own to shrivel because, for example, they lose business to competitors unrestrained by salary caps [1]. I don’t think it’s a “massive assumption” that, if not now then soon enough, individuals who bring in revenue will be able to sell their services to the highest bidder. I’m doing two things here: 1. pointing out that the popular debate on bonuses appears to be oblivious to these potential problems, and, in light of these problems, 2. arguing for a more far-reaching reform than just salary caps in tax-payer assisted banks. This is not an argument for the status quo or for a system based on making a quick buck.

And it’s not just about the banks we own, it’s about whether, when the economy recovers, things go back to how they were before, in terms of the incentives in the system. I guess I’m saying little more than the system isn’t going to be changed by imposing salary/bonus caps in the few banks the received taxpayer assistance. I’m not really saying much new here – plenty of people want to see more fundamental reform, which means paying attention to co-ordination problems.

[1] But, the more I think about it, the less sure I am that the banks the taxpayers own face these problems. If we owned Barclays, perhaps. But RBS, HBOS, etc. aren’t investment banks, and I’m not sure how many of those receiving big bonuses are in a position to take revenue with them when they leave.

Listening to the Today Programme the other morning, it seems a consensus has been reached: the problem in the banking industry is big bonuses, and if the politicians can command the banks to stop paying big bonuses, then the “bonus problem” will be solved.

I cynically predict that big bonuses, at least in nationalised banks, will be replaced by bigger salaries, which are harder to cut when times are tough.

Many thanks for that helpful article. I agree with the vast majority of the sentiments. There has been too much rubbish along the lines of “They work for us now” and wishful thinking nonsense from people who see the banks as a state social policy playtoy (the Observer was full of it).

Not only does the state have a massive investment to protect but there are still minority shareholders who have rights. The banks can not suddenly be used to give soft loans to small busineesses, not repossess houses come what may or be re-mutualised in a giant hand out.

The employees can always go somewhere else and will do so – very, very fast. Barclays with no state shareholding could start to look very attractive. Alternately you could go to the US, Russia, France, Germany or just work for their banks here.

And British based investment banks matter. If they wither then so does the plethora of financial services based industries, lawyers and accountants to execute the deals they originate, City PR, share dealing etc.

I am afraid that if you give a banker a choice of hairshirt from Saville Row or Bonus from abroad then….

That’s not to propose “do nothing”.
Bonuses need to be more share based and longer term.
Internal controls need to be improved.
Lead banks lending debt must be tied to holding a minimum percentage and not syndicating all risk away.
Tax policy on acceptable debt levels needs changing to impose real limits rather than an arms-length, anything goes basis.

PS I have never had a bonus of more than 10% of salary. I have often sat in rooms with bankers and added most value whilst being paid least. I have lost more than I have gained and I am as bitter as the next person. But I still have a job…..this week.

Why don’t banks compete on price, like say supermarkets?

Haha. Well, here comes the kicker.

One bank was very aggressively competing on price. They had this crazy idea that the secret to success was to build up massive market share – as many current accounts and mortgages as possible.

This bank was called HBOS. They got wtfpwned by the death of the international wholesale credit markets and got sucked into Lloyds – bypassing all anti-monopoly laws.

Pretty much the only bank that was competing on price is now a) enemy number one and doesn’t actually exist any more.

Just when you thought things couldn’t get any murkier, eh?

The employees can always go somewhere else and will do so – very, very fast.

This is hardly true, except maybe for a select few with particularly valuable skills. There are after all rather a lot of out of work bankers for them to compete with. And most people are hardly going to look for work in France, Russia or Germany.

16. jasper richardson

I’m angry about banker bonuses

That’s why i’ll be at the March for Jobs, Justice and Climate on 28 March (www.putpeoplefirst.org.uk )


Reactions: Twitter, blogs
  1. Liberal Conspiracy

    New blog post: Bankers and bonuses http://tinyurl.com/dbfytf





Sorry, the comment form is closed at this time.