October 15, 2009 10:05 pm
Strong third-quarter results make this a good week for bankers’ bonuses: Goldman Sachs set aside $5.35bn, almost one-half of revenues, for compensation. Stay tuned for another swell of public outrage.
The FT is usually content to treat bonuses as a matter best left to a company’s owners and its employees to work out. But in the case of banks, the public has two good reasons to be annoyed.
After massive government bailouts, banks are still enjoying government guarantees, implicit if not explicit. Policymakers have, moreover, slashed the cost of liquidity. Bankers’ handsome compensation is, therefore, in large part underwritten by public money. Second, even before the crisis, inadequate competition failed to whittle away large profits – as enormous returns on equity showed – and therefore outsize compensation, unlike in other industries.
This is damaging to the public interest, even though many bankers do important and even vital work. Before the crisis, the financial sector gobbled up an increasing share of corporate profits in many countries. But rewarding what should be an intermediation industry with more and more of national output is a sign of an economy’s waste, not its efficiency.
And today the wider economy remains hostage to the banks, since it needs them to be profitable enough to build up capital. But the largesse of bankers’ compensation skims the cream off this process.
The problem is not limited to the bonuses on which political debate has unhelpfully focused. It is widely agreed that variable pay must be designed to discourage risks to the economy. But current plans for regulating pay will not limit the total amount bankers extract from profits, which could instead be added to capital.
In principle, other planned regulation – strong insolvency regimes and risk-sensitive capital requirements – can limit banks’ profits from risks underwritten by others. But it will take years before these are credibly enforced.
Meanwhile, intrusive regulation is justified: in the short term, to suppress bidding wars over pay between banks with (even implicit) government lifelines, so that capital builds up as fast as possible; in the long term, to contain risk-taking properly. Such regulation requires international co-ordination. Sadly, G20 countries offer more talk than action.
If bankers react to such rules by going off to hedge funds, so be it. We have no objection to huge rewards – or losses – on truly private money.
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