Hypocrisy piled on humbug

February 6, 2012

The row over bankers‘ pay and honours has presented the depressing spectacle of British public life at its nadir, with hypocrisy piled on humbug.

On the one hand, we hear bankers and their apologists arguing that their rewards are required to keep them from running off to sunnier climes, which prompts a number of questions. First, when bankers claim that they have to be paid a fortune in recognition of the size of the organizations they run, we may well ask: how many banks of this scale are there in the world today? How many are so hungry for skills like those of Britain’s bank bosses that they are willing and able to offer these sorts of rewards?

Three or four, maybe, at most – after all, several of the world’s largest banks are now owned by the Chinese Government, so they are unlikely to want a British boss any time soon, and the others do actually have a full management complement anyway. By definition, the number of vacancies at this level is extremely limited, so the danger of an exodus of top British bankers is much exaggerated.

In any case, does it really matter?

After all, even before the crash, there was quite a lot of sniping at high City payoffs and we were told at the time that the outrageous salaries and bonuses were needed to secure the services of people like (Sir) Fred Goodwin et al – and since then we have had ample opportunity to assess the true value of their high-price expertise.

Is it really being suggested now that the banks collapsed because pre-crisis pay rates were insufficient to attract competent CEO’s?

Or is the argument that, if they had paid less astronomic salaries, the banks would have lost even more money than they actually did in 2008-9?

Both propositions are totally implausible.

The truth is that bankers were able to pillage their institutions with impunity because of the total failure of corporate governance, which meant they effectively operated unrestrained by any meaningful shareholder oversight, leaving them free to pay themselves grotesque salaries and bonuses and, even more damaging, to build the bloated empires which could then be cited as justification for their inflated remuneration packages.

Much of the blame for this state of affairs lies with the largest shareholders, the investment institutions who sat on their hands while the banks leveraged themselves to the hilt so as feed the limitless egos of their senior managers. For example, it is hard to believe that the Royal Bank of Scotland’s institutional shareholders could not have exercised an effective veto on the bank’s fatal takeover bid for ABN-Amro, and indeed some hedge funds do appear to have indirectly voted against the deal by shorting RBS stock, but alas – too little, too late and too indirect.

(Note that it is typical of the EU’s regulators to pillory the hedge funds for their supposedly destructive role as short-sellers, when in fact they are guilty of being nowhere near bearish enough at the stage where shorting might have been able to head off disaster.)

Right now, there is one institution which has shareholdings big enough to give it overwhelming power in the UK banking sector. That institution is, of course, HMG, with its 82% share in RBS and 60% in Lloyds-HBOS , a fact which immediately begs the question: why on earth are they so nervous about exercising control, at least where executive salaries are concerned?

Since I am as committed as anyone could be to free market capitalism, I find state ownership of commercial banks highly unpalatable, and I cannot wait to see the Government selling off its shares in RBS and Lloyds-HBOS, ideally after breaking them up (though I realise the banks shot that particular fox long before the last election, in spite of support from no less a figure than the Governor of the Bank of England).

But, given that nationalisation has happened (and in circumstances which made it more or less inevitable), I want to see the Government behaving the way private sector shareholders should – that is to say, using their voting power as owners to ensure that management delivers maximum possible shareholder value, which involves minimising what economists call agency costs – excessive outlays of all kinds, unnecessary management perks, expenditure on empire-building etc. etc.

Instead, we have had a cynical tit-for-tat political confrontation.

On one side, the Government is shamelessly exploiting the harlot’s prerogative, using every power at its disposal to get the current RBS CEO to give up his bonus, while disclaiming any responsibility for the decision.

On the other side, the Opposition have turned from lambs into lions. Having fawned on the bankers for years before the crisis and been easily cowed into accepting business as usual after it, they are now baying for blood, even if it means overriding a contract to which they themselves were a party.

Whatever they imagine they are achieving for their own benefit, the politicians are managing to get the worst of both worlds for Britain, giving the impression of a country where the authorities are so capricious that even a signed contract counts for nothing. It is a deeply depressing spectacle.

The answer to anyone who says that bankers’ pay is outrageous is twofold.

First, it is an issue for shareholders alone, which means the Government on behalf of the public at large in the case of RBS and Lloyds-TSB, but in the case of the other banks, it means those who own the shares directly or indirectly. The fact that shareholder control has broken down is a problem which goes far wider than the banking sector, and one that needs addressing urgently, possibly by forcing the financial institutions, who own such a large proportion of the corporate sector, to consult their own shareholders before exercising their right to vote (or indeed to abstain) in ballots held by companies in which they have invested. As things stand, the relationship between big business and the investment institutions is far too cosy for the health of the economy, resulting in gross misallocation of resources, a disincentive to savers and widespread mistrust of the City, the corporate sector more generally and, in some quarters, of capitalism itself.

Second, excessive pay simply reinforces the argument for separating the investment banks from the deposit-taking institutions.  The former should be left free to pay as much as they like, but with the understanding that bailouts are ruled out, at least on anything other than confiscatory terms. That would leave the high-street banks smaller, less complex, less risky and easier to manage than they are today, all of which would mean that management would need far less spectacular rewards.

Those who oppose the break-up of the banks need to answer the following question: in a post-Vickers world, where a bank’s investment division is supposedly banned from exploiting its deposit-taking role in any way, how can there be any synergy between the two activities? Why would any bank want to retain both activities under the same ownership under this sort of restriction?

The obvious answer is that they can see very little difficulty in scaling, burrowing under and/or bypassing the Chinese walls between the two divisions. In fact, they have probably already worked out a number of schemes to do just that. In the past, this sort of operation to undermine regulatory defences served to inflate bank profits, justify bankers’ wage packets and ultimately to bring the financial system to the point of total collapse.

Readers may have the impression that I have wandered away from the point at issue: bankers’ salaries. And they are absolutely right. One of the most damaging aspects of the furore over the millions of pounds in bankers’ pay packets is that it has distracted attention from the billions and trillions at risk in global finance, where all the regulatory activism – stress tests, higher capital adequacy ratios and so on –  cannot hide the basic reality, which is that, in 2012, risk is far more concentrated than it was in 2007, the institutions which were deemed too big to fail then are in most cases even bigger today, and the resources available to deal with a new crisis have been drastically depleted in the last few years.

The key question is: how does bankers’ pay give them an incentive to avoid a rerun of 2007-8? Any other focus leaves us penny wise and pound foolish.

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