Bankers’ bonuses

Date: January 18, 2010

Everyone else is commenting on this, so I thought I would add my thoughts:

Bankers were allowed to over-stretch their businesses, relying on too little capital to fund lending on a prodigious scale. As they competed with each other they took less and less consideration of the risk of the assets against which they were lending. All this was compounded by the moral hazard of the implicit government guarantee on depositors’ cash.

When the pack of cards came down it was right to lend the enormous sums of money to prop the edifice up otherwise everyone would have suffered much more (you don’t cut your nose off to spite your face and this would have been more like cutting your head off). What followed next was a massive reduction in the cost of money with interest rates being dropped to practically zero. Banks still had to borrow at much higher rates, but the margins they started to make on lending money grew from 10 to 20 basis points to 100 to 150 basis points overnight. This was an intentional part of government policy around the world (not that they talked about it) the idea being to allow the banks the opportunity to re-capitalise their balance sheets with the extra profits.

The problem is that you can’t re-capitalise your balance sheet with profits if you pay it out in bonuses. Have banks forgotten that they lost more money in 2007/2008 than they made in the ten years prior to that? Making a profit in 2009 is wonderful, but how about making up for the losses incurred the year before? Tax-payer rescue has come in the shape of emergency loans and cheap money and tax-payers want their money back.

So the problem is culture. Banks are run (captured even) by employees, not owners. As employees they get to be in the top jobs for a short period and the worst that can happen to them is they get sacked (sach-ed) with bags of gold. There is therefore little incentive for them to behave with altruism, dignity, foresight and leadership. Lacking leadership, the motto is “everybody for himself”.

If banks behaved in the interests of the owners, they would not have risked everything on foolish loans, nor would they pay out such vast proportions of their profits in bonuses. Individually, most bankers know this (and in my experience are decent people) but it is mob rule at the moment. Bankers at the moment resemble nothing so much as a flock of sheep in golden fleeces charging towards a cliff.

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