Could anyone point me towards any evidence that suggests large bonuses were responsible (in any way) for the financial crisis?

Could anyone point me towards any evidence that suggests large prevented the financial crisis?

Could anyone point me towards any evidence that suggests large bonuses prevented the financial crisis?

@3

Hi Neil, I’m not sure I understand your argument.

I’m pretty sure that bankers wearing pinstripes didn’t help to prevent the financial crisis. However, this doesn’t mean that there should be government regulation of work attire.

Perhaps a better way of asking my question is; is there any evidence that banks that had a bonus structure in accordance with forthcoming government regulation were better able to avoid financial collapse?

As fun as banker-baiting is, it’s a sideshow compared to the question of how we extricate ourselves from our economic dependence on big finance. Much like the Saudis and their oil, the banks will continue to make a fortune until we adopt serious alternatives. Everything else is just posturing.

Jimmy Hill:

Perhaps a better way of asking my question is; is there any evidence that banks that had a bonus structure in accordance with forthcoming government regulation were better able to avoid financial collapse?

No, but the idea behind bonuses is that they are a reward for good performance. If bonuses are paid even when performance is disastrous, this suggests that the bonuses may be unjustified. The normal counter-argument is “that’s none of our business, it’s between the employer and employee”, which I’d normally accept. The problem is that we, in many cases, own the employer or have supported the employer directly via loans, guarantees and other forms of subsidy. This entitles us to an opinion about remuneration policies. If paying staff lots of money wouldn’t prevent disastrous financial loss, maybe we should be paying them less money, since we’re getting disastrous financial loss anyway.

The point is that we’re not talking about government regulation. We’re talking about an exercise of shareholder power, given that we (collectively) are the largest shareholder in many of our major banks.

@ 6

Those are some very fair points. However, as shareholders why don’t the government just push through these changes at the various AGMs?

Presumably the point of the legislation is to regulate the pay structures of banks that are not (majority) state owned. Here we are slipping into the “non of our business” territory.

The legislation then seems to only be justifiable if it is thought that regulating banker’s pay will prevent further crises.

The point is that we’re not talking about government regulation. We’re talking about an exercise of shareholder power, given that we (collectively) are the largest shareholder in many of our major banks.

I think it would be entirely reasonable as major/majority shareholders in these banks, for the Government to be represented on the remuneration committees. That way they could, without tearing up the major principles of contract law, determine precisely how taxpayers’ money gets spent.

Unfortunately, and this is why they won’t do this, if the taxpayer-funded banks impose severe restrictions on pay and bonuses, the best staff at them will walk to other banks where these restrictions are not in place. I know some people here don’t like it, but there is an extremely active market for bankers, traders and the like. Goldmans, Santander, HSBC and Barclays would be delighted if Lloyds and RBS were to have their hands tied behind their backs in this way. And ultimately, that’s not good for shareholders. Which is us isn’t it?

Goldman Sachs didn’t cause the credit crunch. Goldman Sachs were largely able to avoid getting caught up in the carnage wrought by the US and UK governments, largely by ignoring them and listening to its own, smart, people.

Tim J -

Fair points. However, it gets a bit messy here. The argument could be made that all banks have benefited directly from government subsidy. Goldman Sachs is a good example; they received a fairly small amount of US TARP funds, which they have since paid back. But they benefited hugely from the US bailout of AIG, without which Goldmans would have lost a fortune. The collective actions of various governments, including (disproportionately) the British government and Bank of England, have averted catastrophic losses for many banks. Where the losses could not be averted, we ended up actually owning the banks themselves.

I suppose the argument could be made that given the unprecedented nature of the situation, there wasn’t time to work out a perfect way of resolving the banking crisis so we simply shoveled large amounts of money at them on the understanding that once the dust had settled, we’d expect some changes. Some banks were unfortunate enough to wind up in public ownership, but even those who didn’t still needed our support in the darkest hours. If we now determine that the price we’d like paid for our support would be pay restraint, would that be so unfair of us?

Squaring this with contract law is an issue I’m not qualified to address. But I don’t recall the banks being too concerned with process, dotting t’s and crossing i’s during the depths of the crisis either.

I know some people here don’t like it, but there is an extremely active market for bankers, traders and the like. Goldmans, Santander, HSBC and Barclays would be delighted if Lloyds and RBS were to have their hands tied behind their backs in this way. And ultimately, that’s not good for shareholders. Which is us isn’t it?

In which case, it’s our mistake to make. If the hypothesis that ‘bankers are paid too much’ is false, perhaps we should test it? If, after a couple of years, it becomes obvious that £100k/year isn’t enough and £500k/year (or whatever) is what it takes to get some banking done around here, we’ll just have to admit it and you’ll be proved right.

@ 10

“Some banks were unfortunate enough to wind up in public ownership, but even those who didn’t still needed our support in the darkest hours. If we now determine that the price we’d like paid for our support would be pay restraint, would that be so unfair of us?”

Perhaps not (in the eyes of some). However, this isn’t the argument that the government is making. If their real motivation is payback they should say so, instead of waffling on about preventing future crises by fiddling with people’s pay packets.

In the meantime may I recommend shares in Goldman Sachs for your pension fund?

Could anyone point me towards any evidence that suggests large bonuses were responsible (in any way) for the financial crisis?

Read Gillian Tett’s Fool’s Gold.

In a nutshell. Bonuses ecouraged excessive risk taking in financial products that weren’t properly understood by investors. Lots of blame to go round of course- regulators asleep on the job and credit rating agencies handing AAA ratings for sliced and diced mortgage backed securities which were almost worthless. But bonuses were a key element.

1. Goldman isn’t a state bank, so pay is its own business.
2. Goldman got out of the property bubble, so they deserve to pat themselves on the back with their own money.
3. If they pay lower bonuses, they either (a) give more money to their partners or (b) charge lower prices to their wealthy clients. There really is no issue of redistribution of wealth here.
4. “[T]he idea of unlimited economic growth is a fantasy” – oh come on. Technology is the cardinal source of economic growth. For all intents and purposes, the potential economic growth from this source is unlimited, until we reach technology on the molecular level. This is only really a pertinent argument among those who have an interest in stopping investment in capital, viz. believers in the religions of Marxism, Greenism and Anglicanism.

“may I recommend shares in Goldman Sachs”

Only if you show us your FSA registration.

In which case, it’s our mistake to make. If the hypothesis that ‘bankers are paid too much’ is false, perhaps we should test it? If, after a couple of years, it becomes obvious that £100k/year isn’t enough and £500k/year (or whatever) is what it takes to get some banking done around here, we’ll just have to admit it and you’ll be proved right.

But that isn’t the hypothesis we’d be testing. We’d be testing ‘the market in bankers is a flexible one’ hypothesis. Because if you can get three of four times the money for the same job at a different bank, that’s what everyone will try and do. We could either do this domestically (by restricting pay packages at the tax-payer owned banks) or internationally (by doing it to all UK banks).

15 – no, he’s fine. He’s not doing it as a business, so he’s not caught.

The key problem with bonuses was not their size, but their triggers. They were paid to reflect short term results with no weight granted to long term risks or the likely impact on future profits.

So those looking to boost bonuses had no reason to not to ignorantly jump on any immediately profitable bandwagon. (Like bundled packages of bad mortgage lending).

Worse, because the bosses judged performance by the same yardstick as they paid bonuses, they got rid of people who saw that such bundles were at best highly risky, and in some cases just bad investments. Those people were sensible investors, but their banks thought they were performing badly – and so of course those people then ignored their own common sense and joined in.

Sensible bonus schemes should thus be bound by sound business practice and restrictions placed by the owners of the bank on the activity of their employees.

Unfortunately the owners, or at least their primary agents in control of their banks day to day, were often tied into the bonus structures themselves.

When bonuses are so vast, wages become a meaningless aspect to income. And with that any stake in long term employment with an institution collapses.

And hence the banking buble and collapse.

Or at least that is as I understand it.

The Government has no place intervening in the market for bank employees.

However nor should it have used public money to resue failed banks- the banking crisis should have been allowed to run its natural course. Not all banks would have failed- only the ones that had taken stupid and greedy decisions- and they would have been quickly replaced by better, smarter institutions.

And there is a strong argument that, if the US Government had kept its nose out of the US housing market, the crisis would never have been generated in the first place.

@17 – how do you know?

@18

“The key problem with bonuses was not their size, but their triggers. They were paid to reflect short term results with no weight granted to long term risks or the likely impact on future profits.

So those looking to boost bonuses had no reason to not to ignorantly jump on any immediately profitable bandwagon. (Like bundled packages of bad mortgage lending).”

That all sounds very plausible. If it is true though, it would be expected that banks that used long-term incentives would have come out of the crisis better than those that didn’t.

According to this paper the relationship does not hold.

As Critical Review suggests it appears that bankers were simply ignorant of the risks they were taking: 81% of mortgage based investments were AAA rated and the rest mainly AA. In other words these were, officially, the least risky investments.

20 – I think it’s hard to argue that giving mock stock tips on LibCon under the name cjcjc counts as the course of business.

What?
Is no-one going to pay me for such excellent advive?!

I wonder how much tax they can get from the banks, employees and major companies that have left the country …

“I think it’s hard to argue that giving mock stock tips on LibCon under the name cjcjc counts as the course of business.”

Well, as the righty-astroturfing scandal goes to show, you can’t be too careful…

Jimmy Hill

The research paper you link to only looked at remuneration for CEOs, who make up a very small part of the problem, and the use of shares as an insentive for long term thinking.

Firstly CEOs are a tiny number of people and so the sample size it too small for good analysis. Secondly, share ownership only works as an insentive to think long term if those shares are going to be held long term. CEOs therefore have an insentive to follow the market, benefit from short term share price rises, and cash in big time before it goes wrong.

Thirdly – and this is more important – it isn’t the CEOs who make the investment decisions. They just set the agenda with rules on acceptable business practice, and with incentives for staff to behave in a way that suits their aims. Many failed to do this well – in the first part through incompetence, and in the second part because of an incentive culture that was entirely bad.

Some CEOs got it right, and some got it wrong. At Morgan Stanley for example, their CEO (and other execs) wisely discouraged heavy investment in mortgage bundles. At RBS the same was not true.

But the problem is not CEOs (and remember, share options as bonuses are not a an incentive for long term

Pagar

Trouble is, letting banks fail is very very very expensive for the taxpayer. Far more so than nationalising them. And it leads to confusion within the economy, which is not to be welcomed during a downturn.

Remember – before the cricis – anyone with savings at Northern Rock (a relatvely small bank in terms of deposits) would have had to have the first £30,000 of their savings returned to them by the government.

This law (now pushed up to £50,000) exists to ensure confidence in otherwise possibly transitory institutions.

So the government loaned Northern Rock Money and nationalised it. This cost money up front, but the eventual privatisation, and Northern Rock’s already substantial repayment of those debts mean it won’t be so expensive as having to fork out to depositors after letting the bank go under.

The government thus effectively acted on market forces.

Goldman Sachs was 48 hours away from going bust like all the rest of them.
Now it enjoys an unlimited state backed guarantee that it can never go bust.

Therefore a contract between its remuneration committee and a member of its staff is underwritten by us, the taxpayer. We are entitled to our say.

Pagar @19 is wrong that not all banks would have gone bust had the bailout not been organised, they most certainly would.

But is now the time to revisit the received wisdom that there was no alternative to bailout as it was carried out at the time? If all the banks had been wiped out in a day as they would have been, it would still have been possible for the state to have guaranteed all deposits held in banks and to have restored order by using the police to secure premises & computers, and requesting the ex-banks’ staff to reopen cash machines etc within a day.

@ 26

Thanks for your response.

[i]Firstly CEOs are a tiny number of people and so the sample size it too small for good analysis.[/i]

Fair point, studies that look at bonuses at all levels are needed before conclusions can be drawn. It would make a great PhD!

[i]Secondly, share ownership only works as an insentive to think long term if those shares are going to be held long term.[/i]

That’s true, but is that what CEOs actually do? It’s pure speculation, but I suspect that most hang on to their shares rather than flog them quickly after receiving them.

[i]CEOs therefore have an insentive to follow the market, benefit from short term share price rises, and cash in big time before it goes wrong.[/i]

If this is the case, why didn’t the CEOs of failing banks do this? Were they just caught out? Or, was it because they were thinking long-term but got it spectacularly wrong?

[i]Thirdly – and this is more important – it isn’t the CEOs who make the investment decisions. Many failed to do this well – in the first part through incompetence, and in the second part because of an incentive culture that was entirely bad.[/i]

However, as you say Morgan Stanley got it right. Is this because they have a bettered structured payment and bonus system? If so, is it like the one that the government wants to bring in? It could be that Morgan Stanley just back a better horse!

Goldman Sachs hasn’t taken one penny of UK government money throughout the credit crunch – they took $25bn of US money from the TARP scheme (thrust on them by the Fed) and promptly repaid the lot.

The taxes paid by the bank in the UK and far more significantly, their employees, probably amount to several billion pounds. Few of these bankers need to be based in britain, most of their work is for clients outside the UK, based in Europe or the middle-east but they are sat here and pay tax here because of London’s status as a financial centre. Be bloody grateful that they are here supporting our sprawling state and not leaving the UK for more favourable and sunnier climes abroad.

And before you say it, almost none will be engaged in tax avoidance. The treasury (quite rightly) sewed up those loopholes for tax residents and UK employees some years ago. These people are on PAYE where there aren’t loopholes and YOU are the beneficiaries.

Goldman hire the best and work them around the clock under enormous pressure. Their productivity is enormous (if you haven’t managed a trading book or closed a billion-dollar deal do you really know what that means?) If you do understand that and still dont like what they are paid you are guilty of infantile envy.

Finally – I dont work there and never have.

Yes, I agree, we should thank God for blessing us with Goldman Sachs.

Neil, don’t thank god and don’t thank Goldman. Thank the City of London for its status as a leading financial centre, thank Maggie for the de-regulation and big-bang that kept it that way and most of all thank the (former) low-tax regime and historic legal and accounting infrastructure that attract these productive people to living and doing business here.

You’re a po-faced, humourless one, aren’t you Andy?

What is it with righties, eh?

Neil, our country is fast going broke under the weight of the sprawling public sector and the collapse in living standards that will surely follow doesnt seem that funny to me

In today’s Guardian :

“The Organisation for Economic Co-operation and Development today warned Alistair Darling that he could not afford pre-election giveaways, as official figures revealed that last month was the worst October on record for the public finances.”

Finally – I dont work there and never have.

Obviously not. I’d suggest that the closest you’ve ever got the business end of a bank is watching Wall Street every night on your mum’s vhs.

Taking another lunch hour are we, Andy Jarm?

Larry Teabag – I do work for a bank

As I explained to Neil earlier (who spends his days blogging rather than working), you might hate us bankers but as 31% of UK GDP comes from financial services you need us far more than we need you. Slag us off all you want but re-industrialising the UK would take 10 years and you wouldn’t see tax revenues for another 5 after that. In the meantime if you dont want to kiss goodbye to the NHS and welfare state you had better dearly hope we dont all fuck off to somewhere else.

“who spends his days blogging rather than working”

You don’t grok irony, do you?

“our country is fast going broke under the weight of the sprawling public sector”

Is that the sprawling public sector that has mysteriously ended up holding the baby for all those unfathomable toxic assets and bad loans that big government was so responsible for?