How the bailout feeds bloated banker pay

August 13, 2009

jamessaft1— James Saft is a Reuters columnist. The opinions expressed are his own —

Rising pay in the finance sector in the wake of the global financial crisis is no surprise and is driven partly by the government’s bailout itself and the underwriting of banks that are too big to fail.

News that some financial firms benefitting from government largesse actually increased the share of revenue they pay their employees sparked a lot of outrage but more heat than light.

The good news is this new bulge in pay may not be sustainable.

The bad news is it will probably only be stopped by further regulation, regulation which may never come.

To understand what is going on you need to understand the economic concept of “rents”, essentially the extra money a given individual or industry is able to extract from its clients above what it would be able to if there was perfect competition.

A monopoly will charge a very high price for goods or services because, well, they can. Needless to say economic rents are not a good thing, unless of course you are in receipt of them.

Workers in financial services have been huge beneficiaries of economic rents in recent years. They sell products which are complex and poorly understood by clients. They have been very lightly regulated, and it has been hard in many areas for start ups to compete with large firms and drive down prices.

A study by economists Thomas Philippon of New York University and Ariell Reshef of the University of Virginia found that about 30-50 percent of the extra pay bankers get as compared to similar professionals is attributable to rents. <>

In other words, banking is able to overcharge its customers and bankers are able to capture a huge portion of that for themselves. Why? Because they don’t face enough competition, their products are too complex for clients to be able to understand and bargain effectively, and crucially because regulation allows for this state of affairs.

Rising complexity, in my view, has probably been fuelled at least in part because it drives margins and tilts power away from bank clients and shareholders and to employees.

“The more complicated the product the easier it is for people to hide the risks,” Reshef said in an interview.

The study shows that excess pay in banking is very closely linked to lax regulation, as opposed to higher productivity or early adoption of technology.

Relative compensation in finance in the early part of the last century peaked not in 1929 before the crash but several years later just before the more stringent regulations kicked in. Relative compensation began to climb again in the 1980s as deregulation happened and rose like a rocket since 1990.


The economic crisis, far from undermining circumstances that allow for rents and excess pay, has in some ways cemented them.

One area of complexity, asset backed finance, has been eviscerated but many others still sail on relatively unaffected.

Most importantly, the doctrine of too big to fail has confirmed and reinforced the superior market position of those banks and investment banks which still survive.

The U.S. has essentially made it known that the current players will not be allowed to fail. These banks had an advantage already based on their size, that advantage is now greater and carries an implied government guarantee.

Ladies and gentleman, this is your banking recapitalization program: an unfair playing field. I might be able to swallow that as the economy needs a banking system. But, if you believe Reshef and Philippon’s data, a goodly part of the essentially unearned money that should be going to recapitalize the banks is ending up instead overpaying the bankers.

It is true that part of the reason banks are paying their best people so much is that a tectonic shift in banking will place a higher premia on the most talented. Fair enough, but only if we see a shrinking pool of compensation money being tilted towards a smaller elite.

The rise and rise of the rents extracted by bankers from the economy will only really be stopped by government intervention, since, given we have a system of bank insurance, it only really can exist with government connivance.

You could make good progress controlling excess compensation and banking rents by placing limits on size, by taxing complexity (which after all hasn’t really served us well), and by limiting the use of leverage within the parts of the system that can make a call on the taxpayer.

If you look at the Great Depression, this process will take about four years. We’ve not made a very encouraging start.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. )


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Well, if you think about it – maybe they do deserve more money than before. After all, the bankers and the media had a stellar performance hyping up the “meltdown”, and subsequently were rewarded with fantastic bailout programs (the exact details of which is a subject for a whole other discussion). Thus, not only did the bankers avoid the “noose”, they did so *without spending a dime of their own money*. With a great success like that can you really blame them for paying themselves more?

Posted by Andrew | Report as abusive

Some of the things mentioned I agree with and some conclusions drawn appear to be guessed at. I do believe that business people who have their own money and their own assets on the line can expect to be rewarded by a good salary. The bankers and CEOs are using other peoples money and should not get high salaries because they bear very little of the risk. The stockholders and the people who put up the money for the investment should recieve the greater share. I think that the excuse of having to pay high salaries to retain people is overstated. You have to pay a decent wage, with decent benefits, plus profit sharing if applicable. You cannot throw ethical conduct to the wind by tying bonuses to performance. This encourages cheating, greed, and illegal behavior. I think that the people who caused the banking meltdown should be prosecuted to the fullest extent of the law. This is what the people of the United States are angry about. They are just taking it out in the Healthcare meetings.

Posted by f belz | Report as abusive

After Five (5) Years of unemployment and the unavoidable separation and divorce that followed a Blacklisting as a Whistle-blower, my parents who have allowed me back under their roof after a Three Year homelessness.

As so I can have renewed hope of being an effective parent despite massive economic insecurity they have bought me a book for parenting my 5 year old daughter over an issue:

Whining (3) Steps to stopping it before the tears and tantrums start by Audrey Ricker Phd and Carolyn Crowder Phd.

I suggest President of the United States Obama and his Pay Zar, Treasury Secretary, SEC, US DOJ and US Federal Reserve Chairman Bernanke read this book.

After which the United States Congress and Senate should pass that 2009 for any company having received government funds in tax year 2008-2009 shall be a ZERO BONUS YEAR.

Then, the US BANKS should take that (“PRESERVED FUNDS”) and use them for TRUE ECONOMIC STIMULUS for ENTREPRENEURS, who have been unreasonably treated by the (“Whiners”).

And thereby recognize those of us who are fighting for our democracy and its preservation of capital opportunity for all classes and races of people through not establishing a ‘RENT’ but the Creation of Opportunity. That is the American Way.

When I was a kid, you didn’t whine, you got up and tried again, you worked harder, you worked longer, you thought bigger, you sweated, you toiled, you did not cry and you most certainly never WHINED. You were an American, no matter what the odds – you could prevail through persistent, intelligent and sustained effort.

There was no RENT, there never was a RENT, there should never be a Social Rent of Control of Capital in America.

It is time for the President, the Congress, the Senate and the US Judiciary to teach the bankers the difference between Whiners and Winners.

Posted by james reginald harris, jr | Report as abusive

It’ll be interesting to see how much tax money (national earnings/wealth) will available to be milked out of the bankers’ farmed politicians next year… mind you I guess if there is a short-fall they’ll be print up some fresh stuff and give the next generation a bit more indebtedness.
At least when the “bail-out bubble” bursts (as it surely must) those who have learned to trim their expenses should suffer less than those who are still addicted to excess.

Posted by Peter H | Report as abusive

It’s a captured industry. Further regulation will only benefit the connected players. It all comes back to the federal reserve… really.

Posted by dvictr | Report as abusive

Game Over ?

They have until October.

Politics always trumps Free Markets and it’s all calculated!

If this fiasco hasn’t turned-around by then, the O-Team will send in “The Cleaner” and the Election Cycle will rein.

– misallocated Capital encouraged overcapacity and the Social Contract with Labor is null & void
– End of ’09, Bargaining & Hope is lost and Anger causes heads to roll (i.e., B.B., L.S. and T.G. are out as the nation moves closer to socialism)
– 2010 will bring Depression and will end with Acceptance
– 2011 re-election campaign kicks in with promises to Labor of a “Road to Recovery”
– 2012 Capital gets the backseat, Labor is in the driver’s seat. O-Team is re-elected with a majority in the House

The fate of capitalism as we know it, will forever have changed!

Election Cycles:
…note election year Novembers, the February following election year Novembers has been an excellent indicator as to whether the election year November would mark[s] an important top. In every case since at least 1968, when February following election year November moves to a higher high than the January following election year November, the market has proceeded to do very well.

Conversely, when the post-election year February is unable to move higher than the post-election year January, a significant market decline has always followed. This may be coincidence but it has proved prescient for at least the past 40 years.

Posted by Peter | Report as abusive

You forgot to mention the government guarantee of liabilities through the FDIC which distorts the allocation of capital in favor of banks. Trading activities should not be subsidized or encouraged by the federal government as they are today.

Posted by Richard | Report as abusive

The financial wizards who have reeked such havoc to the world economies have the guts to reward themselves on the pretext that they are its saviors.In any other age they would be tried and condemned as saboteurs and by the amount of harm they did to the trusting humanity also as “scourge to humanity”.

Posted by SC | Report as abusive

Is it any surprise? The only thing they did right was to pay out the stimulus package for citizens. We were paying down our debts and putting money into savings. Both things would have helped the banks out a great deal. But the banks argued that they would loose profit if they weren’t allowed to drag this whole thing out by denying money to the people who really needed it, thus generating more profits via interest on unpaid debt.

The government (your representatives and mine) bought this line of crap and gave seven hundred billion tax dollars to the banking industry directly. And none of it went towards your debt or mine.

It’s funny how we so readily accept socialized debt. They screwed it up and we pay the bill. But when Obama mentioned spreading the wealth around a little. people were “offended”. Idiots.

Posted by Benny Acosta | Report as abusive