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Bonus Envy
February 2009

According to the FT, the Financial Services Authority would in future monitor executives' pay and reprimand organisations where inappropriate payment incentives were deemed likely to lead to excessive risk-taking. A so-called "bonus culture" was alleged to increase the danger that key institutions would run into losses and need to be bailed out by the state. As Martin Wolf, the FT's chief economic commentator, famously remarked, the financial sector was good at "privatising gains" and "socialising losses".

Is the regulation of pay really necessary? No one disputes that banks which take in retail deposits are in a special kind of industry, in that they promise to repay deposits at 100 pence for every pound they take in. Regulation of business practice to limit risk may be necessary, as business and finance are severely disrupted if banks cannot honour the commitment to repay at par. But throughout the 20th century, Britain's banks consistently repaid deposits in full, without civil servants telling them how to pay their senior staff.

Of course, there are many other types of banking, notably the securities underwriting and trading of the so-called "investment banks". Here, competition remains intense, even if it is less fierce than it was in the boom conditions of 2006 and 2007, and the principle of "survival of the fittest" determines whether a particular company can cope with challenging times. The disappearance of several of these organisations since mid-2007, and the collapse in the market capitalisations of those that remain, make a mockery of the idea that losses are socialised.

In the current financial crisis losses have fallen heavily on managements and shareholders who are very much in the private sector, while depositors everywhere continue to receive back 100 pence in the pound, 100 cents in the dollar or whatever. If an investment bank continuously gives unjustified and excessive bonuses to its staff, it will go bust in just the same way as any company in any industry. Why should financial regulators meddle particularly in pay and not look at all the other relevant costs?

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TDK
February 10th, 2009
9:02 AM
The bonuses were paid out of the short term increase in Capital value. In the long term the value collapsed. Bonuses attached to short term performance will skew the market to favour behaviour that creates value in the short term over behaviour that obtains a smaller short term return in favour or a larger longer term one. The banker with the bonus doesn't care if the long term bubble collapses - he won't be there. I'm not averse to large bonuses but there must be a control that a. Prevents bonuses being paid out of a speculative bubble. b. Rewards genuine performance that benefits the ultimate customer. As an example of (b) I note that investment banks take the same fee regardless of whether shares go up or down. Now I understand that the banks have to have some fee to survive in a down time but the incentives should reward the desirable behaviour.

Tom
February 6th, 2009
2:02 PM
Opera singers did not cause economic collapse. Greed and stupidity from bankers did.

Anonymous
February 4th, 2009
11:02 PM
The answer to this question is simply that the payment to a banker will encourage the taking of risks and associated social ills. No such side effect occurs when the same sums are paid to footballers/movie personalities.

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