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Tuesday, 11 January 2011

Bonus killers - careful what you wish for

It was the day a friend who works at a hedge fund told me his boss was looking into buying a Harrier Jet, about 3 hours after I'd had a fraught conversation with a mother of a pupil at my old school who couldn't afford to buy him replacement school uniform that I realised something was wrong with the way money is distributed in this country. This is the prism through which we need to look at the current debate over the bank bonuses which are about to be paid out. Yet, like every issue, it is complicated, because the government intervention that is being sought could be more damaging than most realise.

Somehow, apparently, the government is supposed to 'take action' over bonunes like they promised before the election. What this 'action' is, nobody can say, apart from the idea that those who work at the banks that are majority government owned (particularly RBS) should not be paid big bonuses at all.

The reasons for this are pretty unarguable. We are, apparently, "all in this together" (Osborne, G. 2010). We are all going to be hit by government spending cuts and tax rises, and there could be job losses. If everyone really is 'all in this together' then people who work in banks should not be getting massive bonuses. After all, it was the banks who caused this financial meltdown (although they did not, repeat not, cause the structural deficit) and government money was used to bail some of them out so paying out billions of that money in bonuses seems callous and crazy.

Suggested actions the government could take include: Taxing any cash bonuses at 50%, ordering RBS not to pay bonuses over a certain figure, a windfall tax on the profit pool from which bonuses were going to be paid, forcing the banks to lend more to small businesses and first time buyers and, well, it's not particularly clear. The hope was that the banks would be 'shamed' into not paying massive bonuses. Here's why none of the above will happen:

1) Bankers get bonuses. That's it. The job actually has very little other rewards. You don't meet your clients often and job satisfaction is minimal. It's all about a number. That number is the bonus you get paid at the end of the year. To use economic language, the pecuniary rewards are all, the non-pecuniary rewards are pretty much non-existent. Your entire sense of self-worth in the workplace is based upon your bonus and if it isn't big enough you leave. I'll come back to that sentence later.

2) Banking can be done from anywhere. So, at the moment the country gets a huge amount of tax from the financial services community but the banks could easily do their work in another country such as Switzerland. If the UK put a windfall tax on banks then it has to be done in other countries or the banks will go to those other countries, and the UK loses jobs and tax revenue that it cannot do without. It may be worth looking at the profits from which the bonus pool is paid. Some of those profits could be classed as "normal" profit - which is the acceptable return on the capital employed in setting up and running a business. Some, though, could be "supernormal" or "monopoly" profits, gained because the banking sector is dominated by massive companies charging much higher fees than they would in a competitive market.Trying to tax these monopoly profit though will only work if other countries do it.

3) If a bank pays £7 billion in bonuses over £3billion of that comes back in taxes. Any bonuses that take the annual remuneration over £150,000 is taxed at 50% anyway. If the bank doesn't pay it out as bonuses then they would need to declare it as profits, which is taxed through corporation tax, about to go down to 27%. This would mean a massive drop in tax revenue receipts if it were that simple. But many banks lost so much money a few years ago that they can effectively write those losses off against corporation tax for a long time, so the UK would less get revenue. This is, in economic terms, actually the strongest argument against most of what the opponents of paying bonuses are suggesting.

4) Yes, the government own RBS. We own RBS. It sticks in the craw that we pay out so much of what seems like "our" money out in bonuses. But what would happen if we decided that RBS staff don't get the bonuses? RBS is not like a normal nationalised firm. Taking ownership of it was always a short-term option, and the clear intention is to sell it back into private hands for a profit. This would help clear the billions of pounds of debt we have. Given it was nationalised when it was on its knees, if the government can wait until RBS builds its balance sheet up to full strength again it should be able to sell at a significant profit. To do that, RBS needs to be competitive. To be competitive it needs the best employees. To have the best employees you have to have competitive pay. If bonuses are cut, those employees will leave, RBS will be less competitive, and its value will plummet. Again, be careful what you wish for.

5) Making an apparent deal to make the banks lend more to small businesses and first time buyers in return for leaving them alone on bonuses sounds like a good idea. But on lending banks have been put in a difficult position. Having been castigated for irresponsible lending they reined in their lending and are now being asked to let it out again. What if what has actually happened was that the level of lending they are at now IS the responsible lending level? I just re-mortgaged, and it was extremely hard and took a great deal of time, with far more difficulty in getting the re-mortgage approved despite a perfect credit record and not borrowing a huge amount compared to income. I was quite sanguine about this, because this is perhaps what should have happened 4 years ago when I got a mortgage for over 5 times my income. What if lending to small businesses and first time buyers on a looser basis returns us to the same problems? Who will take the blame?

All government intervention in any market can lead to government failure. Intervening in the paying of bonuses could be a great example of that. This is not to say there isn't a moral case against the paying of excessive bonuses. They distort housing markets all over London and other areas where second homes are rife.  They are also particularly difficult to stomach for those in our population not sure where their next meal is coming from.

It might be better if instead of looking for a harrier jet, the hedge fund manager at the top of this article looked for an anti-poverty charity to give to. But some people have no shame. Just a massive amount of money.


  1. Interesting about the bonuses would just like to challenge some of the points made. Bankers are already given a wage, the idea of a bonus is to reward good practice and hard work. They may work hard but gambling and plunging this country into recession is hardly good practice.

    Would the country be alot worse off without bankers is a point of contention. I would argue there practices do not create value, they mostly gamble on the stock market. Though we may miss the tax they pay we won't miss the far greater bailing out we have to do and will probably have to do again in the future when there speculative bubbles explode in there faces.

    You say that they are responsible for economic meltdown but not the stuctural deficit which i find strange. Cyclical deficits could not possibly cover the huge cost of the bailing out of the financial sector, the structural deficit is a direct result of unscrupulous and greedy actions of bankers. This is not a mere issue of the business cycle the reason that the recession has been so severe is precisely because of the huge huge often fraudelent actions of the bankers.

    As for the the fact they will all suddenly up sticks and leave, why didn't this happen when George Osbourne imposed his 25% bank tax raising £3.5 billion in 4 months. The fact is the unscrupulous way banks operate has yet to change meaning the longer these bankers remain in the country the more of a liability they come.

    As for your hedge fund manager would the world be a much worse place he he met a firing squad and his wealth was spread around bit. And my favourite things about charities is they make people like him able to sleep at night.

    The biggest irony i have found from all this is that the same credit agencies that were rating packages of sub prime morgages have the power to rate the debt of those countries who fell fowl to this very financial products. Another group who i wouldn't lose sleep over if they happened to plummet to there deaths from a great height.

    Anyway i wonder whether you will guess who has written this

  2. To be honest I'm not too bothered who has written this, it is an excellent comment and worthy of a response!

    It is important to distinguish the difference between the bailouts and other ways in which the government has overspent. The bailout will be paid back when the banks are sold - with a profit, which is why we need to keep them competitive, which is why they need to be able to retain their best staff, and their best staff will sadly demand the best money.

    I have no doubt bankers are overpaid, and unlike footballers are not exhibiting incredibly rare skills and are not short in supply (thousands of genius graduates every year). The problem is that in the short-term there is little to be gained by active intervention and a lot to lose.

    The other problem is that whilst there is a lot of stock market speculation there is also lending, which is what is needed in order for there to be any economic growth right now. Many of the operations banks undertake do create value, and most businesses today that have employees wouldn't exist without an initial bank loan. There is a reason the banks couldn't be allowed to fail and it was probably Gordon Brown's greatest triumph that they didn't (although he should have attached stringent conditions to it).

    I am not arguing for these bonuses to be paid. They are ridiculous. I am however arguing against government intervention to stop them. Those two points are different.

  3. The money may be recouped when the banks are bailed out but this won't be enough to cover the huge cost of stimulating the economy and rising unenployment as a result of there actions.

    The traditional role of a bank lending is very useful in the economy but the most profitable and risky aspects are the stock market speculation and gambling which are complete waste of human resources especially when they pull in the talents of the most gifted.

    You didnt address my point about the fact that the banks or bankers didnt leave when osbourne imposed a tax on there bonuses. Furthermore the banks will now be better off thanks to cuts in the rate of corporation tax.

    It is indeed a neccessity that there is a worldwide agreement on bank taxation whether this is posssible or not is debateable. There also needs to be increased regulation which hasn't happened yet meaning it is very likely the same thhing will happen to these banks all over again. The whole bonus culture rewards short term gains over long term prospertity encouraging huge risk taking.

  4. To take your points in order:

    1) Is the rising unemployment the result of the banks' actions? Surely their lending is how the economy will be stimulated? Also, if a profit is made on their sale, wouldn't that fund the stimulation of the economy? I have argued elsewhere that some of the unemployment is the result of the previous government sanctioning the creation of jobs that it couldn't afford to pay for. I guess what you are saying though is that had the financial collapse not happened then much of the unemployment wouldn't have happened? Well if the growth funded by the banks lending hadn't happened many of those jobs might not have been created in the first place? Who was complaining about that "false growth?" (apart from allegedly Vince Cable)

    2) Yes, you are right, taking extremely smart graduates away from medicine and science and more worthy employment so that they can earn money from the gambling and speculation they talk about is not in this country's best interests

    3) I wasn't talking about the employees leaving, and corporation tax only went down by 1% (you could argue it should go up but remember it is paid by small businesses too who are the lifeblood of the economy and need to be encouraged to retain profits for investment). I was talking about the banks relocating their headquarters, like HSBC have moved to Hong Kong, for tax reasons. They can do that without much upheaval. The UK would lose a massive amount of tax revenue if that happened.

    4) Agree with all that. Without a global answer we would just be cutting off our nose to spite our face. Agree also we need to reward long term gains.

  5. 1)Can you elaborate on how previous high government spending is causing unemployment now? I would like to distinguish between lending sectors of banks, which is of course important and necessary and more speculative areas. Finance growth is false growth as its not an increase in real and quantifiable output. Growth could/should have been done in other real areas when instead significant resources went into the finance sector. Just because few were complaining about this growth apart from vince cable and marxist. economists doesnt mean it wasn't q negative thing.

    3)"To be competitive it needs the best employees" here you are talking about employees leaving. Are we not better off if they move there HQ's as we don't have to bail them out when they inveitably go to the wall again. If we combine realistic taxation with regulation this will no longer be a concern as they will not need bailing out. The USA seem likely to follow suit if we taxed our banks and i'm sure other would follow. Those who didn't will learn there lesson when there unregulated banks need bailing out again.

  6. 1) Imagine you created a business with 10 employees. In anticipation of future demand (read: tax revenue from economic growth) you take on 20 more. That demand doesn't happen, so revenue doesn't happen, and the owner of the business has to make many of those 20 people redundant. They become unemployed.

    The government received a lot of money during the period of growth and could have put that into its savings and built up a budget surplus, which could then have been used to ensure no redunancies were needed when the recession came. Instead, they kept on hiring people in anticipation of increased tax revenue (assuming an 'end to boom and bust') and when that didn't come people are losing their jobs. Responsible management of the economy would have stopped many of the job losses that are happening now.

    2) Yes, finance growth is false growth but it pays over 20% of the UK's tax revenue so it's very important. It also meant, as I think you are rightly suggesting, that the government thought everything was OK for the future so no investment was needed in other areas such as manufacturing etc. Turns out the period of economic growth was built on a false bubble, which is why it is even more problematic that the government at the time didn't build up a budget surplus during it ('mend the roof whilst the sun was shining') so such desperate measures weren't needed now. We went into the recession with the 2nd worst budget deficit of all OECD countries.

    3) If they move their HQs we don't get their tax revenues. That would be a problem. You are again right that what should have happened was proper regulation. Instead Gordon Brown created a tri-partite regulation system where none of the organisationg knew who was regulating what. He boasted about our light touch regulation, and if we keep that light touch regulation then you are right the banks will go to the wall again.

    4) What I'm not sure about is that "others will follow" if we tax our banks. It's a bit like saying that if we introduce stringent environmental regulations others will follow. No they won't and no they haven't. Asian countries in particular will see it as a great opportunity to get all the banks to locate there. The USA certainly wouldn't follow suit as the structure of Congress now means that would just not get through the legislative process. Sadly, even if we introduce more regulations, other countries need to do so too. This is where Gordon Brown was right, without global regulations nothing we do can actually work in a globalised world

  7. Just to quickly dip into the argument; here is a little something on the Tories and there love for not taxing banks or huge businesses

  8. Not much I can add to that. Why aren't the opposition making more of a fuss about it though?

  9. They don't want to be seen as too left wing, but also as a party in our political system they represent the interests of the ruling class and those who will benefit and so don't care as long as its not a well known public issue.