How do you solve a problem like a banker’s bonus?

By Chris McCarthy

The popular sport of ‘bashing bankers’, which has been such a ubiquitous feature of global societal discourse over the last 18 months, is gearing up for a fresh season as many of the world’s largest financial institutions announce their year end profits and compensation packages.

The Wall Street Journal estimates that the world’s 38 largest banks and securities firms are likely to pay employees a record $145bn for their performances in 2009. Many have been left wondering how a sector that owes its survival to the reluctant generosity of taxpayers, could have the audacity to award what President Obama labeled “obscene” bonuses, during his announcement of a 10-year “financial crisis responsibility fee”.

On British shores, news that former Chief Executive of the Royal Bank of Scotland, Sir Fred Goodwin, has been appointed in a consultancy capacity by the architectural firm RMJM – his first job since his departure from the troubled bank 14 months ago – has come as an unfortunate reminder of an unsavoury period for those keen to draw a line under the periodical discussion on remuneration in the City.

Does over-zealous attention on the moral propriety of large bonuses in a sector that for a while looked to be fatally sick, threaten to distract from the larger, potentially more meaningful discussion of how we reform the global financial industry so that we are all better prepared for such crises in future and that measures are put in place to avoid such profligate excesses happening again?

Fleeing the City

In this regard, British Chancellor Alistair Darling’s decision to impose a one-off ‘super-tax’ of 50% on any individual bonus paid above £25,000 can be seen as a populist move designed to pander to the anger and resentment of the UK tax-payer, while doing little to tackle the underlying, systemic causes of the financial crisis.

With estimates that the tax could raise somewhere in excess of £550 million, an inconsequential drop in the ocean of government debt, and the Chancellor failing to provide sufficient evidence for how the Treasury can prevent banks from rolling bonuses into base salaries, it is difficult to see the long-term, meaningful benefit of this policy.

Some have raised fears that the one-off levy will contribute to a hostile environment in the City, one of the world’s most vibrant financial services centres, and that financial and human capital will drain away or stay away. Major of London, Boris Johnson, has recently come under attack for his remarks in a letter to the Chancellor, opining that the ‘super-tax’, coupled with the new 50p rate of income-tax, will “risk damaging London’s competitiveness”.

One of his economic advisers, Harvey McGrath, admitted that there was an element of ‘bluster’ to the claims that several financial institutions were considering closing-up shop and moving elsewhere. But given the parlous state of the country’s finances, with the total budget deficit forecasted in the Pre-Budget Report to hit £178 billion for 2009/10, should the Treasury be playing a game of ‘call-my-bluff’ with a sector that provides a disproportionate percentage of Britain’s GDP?

JP Morgan is soon expected to make a decision on whether to go ahead with a planned new £1.5bn European headquarters in Canary Wharf, with Darling’s ‘super-tax’ said to be a factor in the considerations. Some may rejoice at the thought of the bank deciding to take its money and staff elsewhere but there is an element here of shooting the goose that laid our golden egg.

Furthermore, this venom clouds our judgment in recognizing the benefits such a move brings in terms of intellectual capital and government revenue, in addition to the jobs it would support in the construction, retail, legal and accounting industries. Human capital is a fluid commodity and unless charges and levies on the banking sector are applied with global agreement, it makes poor business sense for companies to continue to run their operations in countries where they face costs that could be avoided in Zurich, Singapore, or Madrid. The large hedge fund, BlueCrest, have already confirmed they will be moving many of their operations to Geneva and Brevan Howard are reported to be considering doing the same.

Squeezing the profitability of banks

Resentment of bankers and their large bonuses is understandable but tangential to the more critical issue of reforming banks so that they act more responsibly in how they price risk. President Obama’s decision to apply a levy of 0.15% on the liabilities of those institutions with assets of more than $50bn (£30.7bn) is expected to raise at least $90bn (£55.4bn) over the next 12 years and could encourage banks to be more prudent in how they raise their capital.

However, the proposal offers no assurances that banks will not simply pass the cost on to customers and the amount is comparatively small when you consider both the TARP (Troubled Asset Relief Program) money and the cost to the taxpayer of underwriting the banks bad debts in their totality. Of greater concern is whether the levy might actually reduce banking activity, preventing small and medium businesses getting the vital capital they need. The arteries of lending might not turn into the baron wasteland they did during the height of the financial crisis, but pinching them tighter might prolong our emergence from this mire.

A similar criticism can be levied at the President’s proposal that banks should be split-up and have the ‘riskier’ elements of their businesses siphoned off from their retail arms. Closer analysis of results from those banks that have announced their results in the last week will show that it is the retail division of banks that are hemorrhaging money. They are being kept alive by intravenous drip from their symbiotic investment banking brethren. We could cut off our noses in moral protest but we would only be spiting our fragile faces.

Taxpayers across the world contributed trillions of dollars in propping up not only the banking sector but industries such as car manufacturing as well. It is not unreasonable for governments to argue that the extraordinary measures they undertook to prevent an even greater global catastrophe should be repaid by those who benefited from their provision.

Repayment of loans and guarantees is probably the least the British and American taxpayer expects from their banks but it misses the wood for the trees. Bonuses on Wall Street and in the City are obscene; they are out of touch with much of the rest of the working population, they have been for decades and they will remain so. However, while large remuneration packages rewarded what we now know and should have known at the time were risky investments, heaping opprobrium on them and imposing draconian regulations will do little to help prevent future crises and may exasperate the one we have yet to emerge from.

Have Britain and America led the way in reforming the banking sector or will their proposals encourage financial service providers to consider taking their business and capital to more welcoming environments, thereby threatening their own fragile economic recoveries? Perhaps bankers’ bonuses are not the most pressing problem that needs solving.


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