Bonuses are peanuts

Yes, hitting bankers over the head by capping their bonuses is very satisfying. It´s positively mad that there can be so much money floating around in one sector of business that people can be rewarded with bonuses of millions of pounds, dollars or euro.

But hang on, how come there are these enormous amounts of money floating around in that one sector? Because these sums really are enormous – in 2011 the European banking sector held assets of €45 trillion which is roughly 350% of the combined EU GDP (Interestingly, the number for the US banking sector was around 80% of the American GDP).

Something must have happened while most of us were looking the other way. During the last decade, the European financial sector grew in size by more than 85%. The rest of the European economy grew in average by 1.3% yearly.
Somehow banks managed to put their hands of billions and trillions of society´s combined fortune without giving all that much back in terms of products or services.
No wonder they can afford to pay million dollar bonuses to their employees.

Now, there seems to be a general agreement on keeping this system whereby we all entrust our money to a number of private businesses called banks and then count on them to act as middle-men or go-betweens so as to make the economy run smoothly.

Well, it hasn´t run that smoothly for a while. Surely we should rein them in a bit, seeing as they got a bit too excited last time around?

Capping bankers´ bonuses will hardly do that. The bankers have already demonstrated how very clever and creative can be, so they will no doubt find ways around bans on high bonuses (as soon as they´ve stopped complaining about it).
So maybe we could forget about the bonuses for a bit and concentrate our minds on three other opportunities to claw back some control over the banking sector.

The first opportunity is basically lost already. In fact, the very directive of which capping bonuses was a small part, tackled the important subject of how much capital the banks should be made to hold in reserve, so that next time they do lousy business, they can cough up rescue money themselves, instead of asking it from tax payers.

This directive (agreed upon this week at Ecofin) is a watered down version of international rules (Basel III) which earned the European Union open criticism from the Basel Committee on Banking Supervision for being too soft on banks.
By the way, the international version was in itself watered down, so much that bank shares hit a high on stock markets when the rules became known.
The bigger banks already fulfill the requirements, six years ahead of the deadline. The smaller banks have plenty of time to adjust.

The second opportunity, a future Banking Union introducing a much needed discipline on European banks, is being lost in negotiations. We may well end up getting the lamest of systems; A centralised (non-partial, non-nationalist) supervision while leaving to national governments to intervene if a bank gets in trouble.
Not so different from today then, where we´ve seen national governments hide their heads in the sand until the situation becomes absolutely impossible, dragging everybody else with them.
But the really, really scary bit is that we are about to miss the third opportunity to take control of the sector. The EU commission is reported being swayed by EU governments not to propose a proper separation of banking activities. As the Liikanen report of October 2012 rightly pointed out, as long as banks are allowed to use our savings for speculation, we will have a hard time avoiding having to bail them out when they crash. He suggested that banks should separate activities so that securities trading was kept apart, risking only the bank´s own funds when they felt like taking risks.

This is seriously bad news for all of us. We will be stuck in a system where banks profit in good times and hand over the bill to the tax payer in bad times.
Bank bonuses are peanuts, compared to this.

  1. #1 by jon livesey on March 6, 2013 - 9:41 pm

    Yes, it is correct to say that bonus amounts are small compared to total money flows, but what really matters is that bonus awards ought to align the int4erests of managers and traders with the interests of the shareholders and creditors of the institutions they work for.

    And as usual the EU have come up with a very bad non-solution to a problem that was solved long ago.

    In Silicon Valley, where I work, most employees receive non-cash benefits in the shape of options in the companies they work for, and it take four years, usually, for those options to vest,

    So, if you want your reward, you have to stay around for a significant length of time, and make sure you don’t make decisions that are negative for the company you work for.

    The EU system of capping bonuses has nothing going for it except the grim satisfaction of “bashing bankers” in a very public way. In fact, it is literally worse than useless, since it will simply lead Banks to increase base pay, and base pay doesn’t vest. Instead it is paid out monthly, and cannot usually be reclaimed, so this does not act as a correct incentive.

    It is unfortunately completely typical of the EU that they would ignore a good existing solution and insist on coming up with a bad one of their own.

  2. #2 by jon livesey on March 7, 2013 - 1:20 am

    “Somehow banks managed to put their hands of billions and trillions of society´s combined fortune without giving all that much back in terms of products or services.”

    By the way, I think you need some correction in fairly elementary finance. Bank assets are – mostly – not cash, and they aren’t “society’s combined fortune” either.

    Banks create assets any time they create an instrument someone can buy, and they acquire assets from one another.

    If Bank A lends $100 to Bank B and Bank B lends $100 to banks A, they have increased the amount of *total* assets by $200, but the amount of *net* assets hasn’t changed at all.

    Moreover, Bank A now owes $100 to Bank B, so its liabilities have increased by $100, the same amount its assets increased. So even Bank A’s net assets have not changed. Same story for Bank B.

    Talking about total gross assets without counting liabilities is – quite literally – a meaningless thing to do.

    You are searching for an explanation for the Banking crisis, but the growth in assets isn’t that explanation. What really happened in the Banking crisis is that assets the Banks created from, say, mortgages, and then sold on to other Banks – correctly, since that spreads risk – turned out not to be worth as much as was thought, because a lot of individuals took on mortgages they could not pay, and eventually defaulted on.

    And the crisis got even worse because in the end no-one could put a price on mortgage backed assets, so the Banks found themselves holding asset they could not even sell, since there was no market – which is where Governments stepped in.

    In other words, the problem isn’t rapacious Banks getting hold of society’s “fortune” but societies “fortune” turning out to be worth a lot less than the Banks paid for it.

    I keep feeling I am being very rude to you, but these issues have been discussed and explained over and over in the past five years, and yet here you are, a financial(?) journalist, writing down a completely wrong-headed analysis.