How to end the banker backlash
There was a whiff of the lynch mob in the UK last week. Stephen Hester, the current Royal Bank of Scotland boss, was bludgeoned by politicians and the media into foregoing his bonus even though he was brought in to clean up the largely state-owned bank. Two days later his predecessor, Fred Goodwin, was stripped of his knighthood. While Goodwin bore much of the responsibility for RBSâs near-bankruptcy, removing his title flouted normal procedures. Not only is such a dressing down traditionally reserved for criminals; the prime minister, David Cameron, prejudged the verdict of the committee which reviewed the knighthood. The week was capped off by the leader of the opposition, Ed Miliband, calling for a tax on bankersâ bonuses.
While the UK is currently the epicentre of the backlash against financiers, the phenomenon is widespread across the Western world. Francois Hollande, who is likely to be Franceâs next president, has said that his main adversary isnât Nicolas Sarkozy but a faceless, nameless, opponent â the world of finance. And across the Atlantic, the only serious setback in Mitt Romneyâs presidential campaign so far came when he revealed that in 2010 he had paid only 13.9 percent tax on his $21.7 million of income, most of which came from his time as a private equity baron.
There is certainly something ugly about the way politicians â who themselves bear some responsibility for the economic mess â have turned bankers into a scapegoats. But the public isnât in the mood to show sympathy to bankers these days. The issue is not so much the amounts they are paid. In the same week that the banker backlash was gathering force in the UK, Facebook announced its initial public offering. Nobody batted an eyelid at the prospect of Mark Zuckerberg, the founder, being worth over $20 billion. The difference is that people think Zuckerberg deserves his billions but the bankers donât deserve their millions.
The belief that bankersâ compensation is unfair operates at several levels. At its most basic there is the argument that, since bankers were the ones who got the world into its current mess, they shouldnât still be coining it. This is simplistic. The mistakes made by banks were only one factor that fuelled the crisis â and many individual bankers were innocent of the mistakes.
There is, though, a more sophisticated critique: that the whole system has been rigged in financiersâ favour, allowing them to earn more than they merit. Few people complain when entrepreneurs make millions. They are seen to have come up with brilliant ideas, taken big risks or worked extremely hard. Thatâs how capitalism is supposed to work. But bankers have benefited from one-way bets that make a mockery of capitalism.
The system has been skewed in bankersâ favour in two main ways. First, individual traders were paid on short-term performance. That encouraged them to spin the roulette wheel. If their bets paid off, they did well; if not, their employers picked up the tab. Second, banks in general were highly leveraged. This magnified earnings and bonus pools during the good times; but when the crisis hit, many banks were bailed out.
Over the past four years, regulators have been trying to remove these one-way bets. Much has changed in the way individual bankers are paid. A bigger slice of their bonuses is paid in equity which they cannot sell for several years, tying compensation to institutionsâ long-term performance. In some cases, bonuses can be clawed back. Whatâs more, banks have been required to cut their leverage. This, combined with the dire economic environment, has reduced earnings and so squeezed bonus pools.
But compensation hasnât come down as rapidly as it should have. Just look at bonuses in the City of London as measured by the Centre for Economics and Business Research. These actually rose slightly in 2007/2008 to 11.6 billion pounds after the first shocks of the crisis. Although they fell to 5.3 billion pounds after Lehman Brothers went bust, they rose again the following year to 7.3 billion pounds as the benefits of the bailout started kicking in.
For the year just ended, City bonuses are forecast to be 4.2 billion pounds. Even so, compensation is still too high. One way of seeing this is to compare how well bankers do to how well their own shareholders fare. Last year, for example, Goldman Sachs cut its pay 21 percent. But earnings applicable to shareholders tumbled 67 percent and the bankâs return on equity was a measly 3.7 percent.
The publicâs concern, however, should be for taxpayers rather than shareholders. Although steps have been taken to make the system safer, the changes are far from complete. Banks are being given several years to build up fatter capital buffers so that they are better able to withstand losses. Plans to enable regulators to pack banks off to the knackersâ yard rather than bail them out when they get into trouble are still on the drawing board. Meanwhile, the industry enjoys special treatment. Just think about the 500 billion euros that the European Central Bank lent to the industry in December at a measly interest rate of 1 percent. Entrepreneurs would die to be able to borrow money at such a rate.
The sad fact is that most banks are still too big to fail. Until that changes, the system will remain rigged in bankersâ favour â and they will be vulnerable to the kind of lynching suffered by Hester and Goodwin last week.