Commentaries

Now raising intellectual capital

The social cost of runaway bank pay

August 18, 2009

If only the economy were bouncing back as fast as banking compensation.

Even as the first anniversary of the collapse of Lehman Brothers draws near, bankers and traders are now grabbing a larger share of their institutions’ net revenue than they did during the boom years. The leading U.S. banks are on track so far this year to pay their employees $156 billion — more than in sunny 2006.

Politicians have focused mostly on whether the bonus structure can be changed to discourage bankers from making reckless bets with their shareholders money. But a bolder solution to excessive banking pay is necessary. It starts with a simple question: Are bankers paid too much? The answer is a resounding yes.

Everybody enjoys a bout of cathartic outrage over the pay of reality TV personalities and sports stars. At root, however, we must accept that these salaries are determined by the free market. The same is not true of investment banking.

Even those banks not currently financially dependent on the largesse of the federal government clearly benefit from an implicit guarantee. Governments of every political hue have clearly demonstrated that they are unwilling to let large institutions fail. This enables financial institutions to take risks that a toothpaste manufacturer could not. Bankers took full advantage of this subsidy before the crisis and are starting to do so again.

A report by London-based Smithers & Co., while issued before the crisis, shows how that dynamic continues to work. Smithers found that the median nominal return on equity in banks towered above those in other sectors.

“With higher leverage than other industries they could achieve 20 percent returns compared to an average of 8 percent elsewhere,” Andrew Smithers said in a telephone interview. The downside of the banks’ high returns is high risk, much of which is born by taxpayers. This has become more dangerous since offsetting regulations limiting risks were dismantled.

The opaque nature of the business also makes it easier for financial professionals to capture a “wholly disproportionate share from the returns in the productive economy”, says Paul Woolley, an academic at the London School of Economics who set up the Center for the Study of Capital Market Dysfunctionality.

Before the crisis, financial services peaked at around 40 percent of total corporate profits. “Financial services are by far the largest item in most people’s budgets,” Woolley says.

Since the fees are hidden or opaque, however, this causes little resistance. For example, various layers of management fees reduce by at least half the gross returns that investors
would otherwise reap from equities. (Research by Kenneth French at the University of Chicago suggested that investors spend about $100 billion a year trying to beat the market.) Consumer financial products are seldom more transparent.

Nor, Woolley argues, do the activities of the financial sector add as much value as they claim. The boast, for example, that financiers funnel savings to their most productive use is overdone. As fund managers compete to beat the market they are often forced to follow trends. This momentum trading causes an over-allocation of capital to frothy sectors — as seen during the Internet bubble.

Realizing that as a society we overpay for financial services is the first step. The second is proper regulation. A study by Thomas Philippon and Ariell Reshef for the National Bureau of Economic Research concluded that the premium paid to bankers compared with similarly qualified workers in other fields gradually disappeared after the introduction of strict banking regulation in the 1930s.

The premium — between a third and a half — only returned after these controls were relaxed in the 1990s. Forcing banks to hold enough capital to pay for their own risks is the key. A powerful Consumer Financial Protection Agency in the U.S. could also ensure that financial professionals are not being overpaid simply because their products are difficult to understand.

Woolley also makes a strong case for a Tobin tax on transactions — reducing the wealth-destroying churn of financial assets.

Excessive banking pay is a social ill. The sector has long sucked in far too much of society’s brightest graduates — putting them to tasks which often have little social value and at worst are parasitic. Politicians should not regulate bank pay directly. But lower compensation for bankers will be a sign that regulatory reform is working.

Comments

One year on from Lehman Brothers and the near collapse of the world financial system, have the bankers greedy ways changed?

My answer to my own question is no!

While the governments of the world have taken tax payers money in hundreds of billions(without I may add, asking the tax payer if it’s happy for his/her money to be spent in this way) and saved the Bankers businesses and jobs, the bankers have said, thanks very much now we will pay ourselves a big bonus, and carry on where we left off.

It seems to me that governments are incapable, inept or in collusion with the bankers and the way they do business.

If manufacturing businesses can go to the wall and any other type of business for that matter, and all that governments can do is wring their hands and say, well that’s market forces. Why are the banks treated so differently? Why are they allowed to keep the money they have leached from their businesses over the years? Why are they allowed to pay themselves massive bonuses out of the money the tax payers has given them in order to survive? Why are they allowed to give themselves enormous pensions. Why are they allowed to pay themselves so excessively for massive failure due to greed and incompetence?

Am I alone in thinking like this?

Why haven’t governments stepped in to stop the excessive pay and bonuses?

They stepped in quick enough (with our money) when it all went pair shaped a year ago. They gave our money to these people. People who had ripped us off blind for years they appear to have been told to, “carry on boys and have some more cake and eat it, till it comes out of your ears”.

Are we the general public to be used and abused in this way for ever? If our Governments won’t stand up for us against these modern day robber Barron’s, then we the people of the world must unite to say, “enough is enough, we will not stand by while our money is used in this way”. “We will not stand by while bankers, gorge themselves at our expense”. “They need to be told that they are lucky to have a job, let alone a bonus of millions”.

I don’t know how we can stop them, but stop them we must.

Our public services are going to be decimated by the debt our government has go us into, in order to save the banks. Swinging cuts are going to be the order of the day. Unemployment is going to rise to levels we haven’t seen for decades. The Labour, Conservative or any other party seem happy to make us (the people) pay for the bankers greed.

Well, I for one, am not happy to pay for the bankers unjustified enormous salary and pension.

They need to be humbled, and the arrogance and contempt they show needs to stop. The public who are suffering and are going to suffer as a s result of their actions need to be assured that the banks appreciate what we have done for them, and they need to show some gratitude and contrition for the mess they got the world into.

I am not a communist but I want to use a phrase form that era. Not workers, but “people of the world unite” and lets change what’s happening, before we have to do it all again. Don’t let the pain and suffering they have caused pass by without using this moment to change what, and how they do their business. 15/09/09 by The anti corporate greed crusader

 

Much is made of the large bonus’ payed to bankers, because apparently they take huge risks. Do they? I would suggest they take no risk at all as all their actions are underwritten by the tax payer.

I found this: scroll half way down to see the image -sums up what I feel about bankers.

http://www.saatchi-gallery.co.uk/showdow n/index/233180

Posted by sj | Report as abusive
 

Post Your Comment

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/
  •