The government has decided it can’t, or won’t, do anything about the huge bonuses being paid out by investment banks. This comes as no surprise. High taxes and state intervention in companies are among the Conservatives’ worst taboos. Regardless of what they said in opposition, the Tories were never going to use the power of the state to stop banks paying out high bonuses. Instead, they hoped that stern words and moral pressure would shame the bankers into doing the right thing. Of course, attempting to shame people who know no shame was never going to work.
But surely, even if the government can’t do anything about the banks it doesn’t own, it can exert some control over those in which it holds shares. Here, once again, things get difficult. The UK’s approach to bailing out its financial sector was to give cash and insurance guarantees to the banks in return for equity. That way, when the banks returned to profit, the government would get its money back. But, while this gives the taxpayers some security it also ties their interests directly to those of the banks.
Higher capital requirements? OK, but that will reduce profitability and the share price so the taxpayers will have to wait longer for their money. Increased regulation? OK, but that will reduce profitability and the share price so the taxpayers will have to wait longer for their money. A cap on bonuses? OK, but all our best people will leave – which will reduce profitability and…well, I think you get the picture. The government dare not hammer the banks too much for fear of damaging its own assets.
Is there any substance behind the bankers’ shroud-waving? Will the best people from state-owned banks really leave if they don’t get ever-increasing bonuses? Are the other banks really that willing to recruit them? Would the banks which are not state-owned really relocate to Switzerland or Shanghai if bonus caps were introduced or taxes became too high? The truth is that no-one knows because no-one has ever had the nerve to test any of this out.
It is over a decade since I worked in comp and ben for an investment bank. Back then, the bonuses seemed stratospheric but were paltry, even in real terms, compared to the current payouts. As bankers went from firm to firm, each time increasing their pay and getting their new employers to buy out the golden handcuffs which were meant to chain them to their previous employers, remuneration levels ratcheted up by the week. People said that the merry-go-round couldn’t go on. A seasoned City pro I used to drink with assured me, “It can’t last; eventually it will all become too expensive and the shareholders will rebel.” He was half right. Remuneration did become a whole lot more expensive but the shareholders kept quiet.
Consequently, the compensation ratios (the percentage of revenue paid out in remuneration) of the investment banks continued to rise. As this list shows, last year they varied from 26 percent at Deutsche Bank to a mind-boggling 81 percent at UBS. Unsurprisingly, this is starting to have a significant impact on payments to shareholders. According to research by Financial News, over the past five years, investment banks have paid their staff nearly three times more in pay and bonuses than they have made in profits for their shareholders. In some cases, you have to wonder whether its worth running an investment bank at all if most of your revenue goes straight out of the door in pay and bonuses.
Despite all this, there has been little dissent from the shareholders. As the Telegraph’s Tracy Corrigan says, it wouldn’t happen anywhere else:
I would like to suggest another question that concerned fund managers might like to pose, namely why banks favour staff over shareholders to such an extraordinary degree, something that does not occur in any other functioning industry.
Yet, as she also acknowledges, there is little sign of it changing. As William Wright says in the Financial News, bonuses have just become part of the furniture. There is no link between firm performance and the size of bonuses and little difference between good years and bad years. Bonuses, it seems, just are.
[T]he swings in bonuses are far less violent than those in performance: when you look at individual pay as a proportion of revenue generated per employee or as a multiple of pre-tax profits per employee, you see that in a bad year, pay just eats up a higher percentage of revenues and shareholders act as a “bonus buffer” to keep staff happy.
This lack of concern for the link between pay and performance was best shown by the banks’ collective reaction to the restrictions on bonus payments: if more of the bonus has to be deferred, just double the base salary to keep everyone happy and stuff the shareholders.
On that basis, far from being a variable incentive scheme to reward performance, high bonuses and remuneration have instead become part of the furniture.
Shareholders are not prepared to take the risk of curbing pay levels for fear of a provoking a talent exodus and destroying the value of their assets. They will put up with some serious piss-taking on pay from the bankers in the hope that they will not quit, join the competition and, in doing so, destroy the value of the bank.
Governments, either as regulators or, now, as shareholders, show the same reticence. As the Tories did, Labour talks tough now it is in opposition but when in government it proved just as diffident.
No-one is prepared to challenge the received wisdom that bankers will leave banks if they are not paid the earth and banks will leave countries if taxes and regulations get too heavy. Unless someone puts this to the test, nothing is going to change. Call the bankers’ bluff, said Simon Jenkins in yesterday’s Evening Standard. Governments and shareholders alike have proved very reluctant to take that risk.
The assumption that bankers will get high bonuses, come what may, has become deeply embedded in the culture of investment banking and related financial services. The defence of the bonus culture is fierce enough to scare investors and regulators alike. It will almost certainly need concerted action by shareholders and governments to change it. Until that happens, massive bank bonuses will continue to be part of the furniture.
A good piece from Luis Enrique last year came to a similar conclusion:
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).
As did The Economist’s recent Bagehot column, though with slightly less enthusiasm for state intervention. (It is The Economist after all.):
[C]alling the bluff of bankers by paying them much less would amount to a big bet. Shareholders have a right to place such a bet. Indeed, shareholders should arguably have been much tougher over bank remuneration in recent years…..But for a British government to bet that the City would survive a populist onslaught of the sort that might satisfy angry voters: that is surely a gamble too far.
I liked this bit too:
[I]f you want to understand the venom of some British press coverage of bankers’ bonuses, you need look no further than the fact that a lot of London journalists were at university with people who they consider to be duffers, yet who earn 10 or 20 times more than the average reporter.
Meanwhile, the CIPD reports that British banks won’t be rushing to follow Credit Suisse’s decision to pay 70 percent of bonuses in shares. This will be an interesting test-case. Will the Swiss bank’s best people walk away because they can’t be arsed to hang on for shares that might drop in value? We shall see.