Long-term incentives no panacea for City
SLOWLY but surely, the US and the European positions on regulating bonuses are becoming more similar. At the risk of courting unpopularity, it is therefore worth injecting a few facts into a discussion which to date has been characterised by hysteria and demagoguery rather than reason.
It is true and deplorable that some bankers were incentivised according to excessively short-term targets. This must change. But tens of thousands of employees at Bear Sterns, Lehman Brothers, Merrill Lynch, RBS and HBOS owned stakes in their firms and had reinvested their bonuses. This was especially true of many of the top decision-makers. Bear Sterns and Lehman had been diligent in promoting employee share ownership – around 30 per cent of the total equity in each case – in a bid to encourage long-termism. It wasn’t a great success.
Even Lord Turner said as much in his Report: “many top managers of financial firms which suffered huge losses during the financial crisis (and, in the case of Lehmans, complete failure), were very large shareholders in their firms, and in several cases had voluntarily chosen to invest large proportions of cash bonuses in their firms’ equity. But these large stakes in the long-term profitability and stability of their firms did not seem to result in any greater awareness of or concerns about the risks the firms were running.”
All of this shows that the bankers in question destroyed their banks because they made errors and faulty judgments on a colossal scale (for which they deserved to be wiped out) – not because they were deliberately betting the bank in a bid to make a quick buck. They were mistaken, not evil or deliberately reckless.
Consider the bonus scheme in place at AIG-FC, the infamous subsidiary of American International Group responsible for using credit default swaps to insure sub-prime mortgages (and whose disastrous London operations were based in Curzon Street in Mayfair). Traders had to defer around half of their pay every year into company shares: their interests were aligned with that of the firm as a whole, the kind of “good practice” that many rightly support.
Rewards for failure are wrong. I have long campaigned for a better compensation system which punishes those that fail and rewards those who succeed. Any top banker or chief executive who fails should be sacked. There should be a shareholder vote on the pay of all directors at all quoted companies ever year. But pay’s role was merely tangential during the current boom and bust – and for that matter, in all previous bubbles.
The main drivers were the ridiculously low interest rate policy pursued for years by a Fed obsessed with preventing all recessions; the crippling East-West imbalances in savings and investment flows (about which the Bank of England has a good paper out today); global rules which promoted low capital reserves for banks, with many loopholes; and a giant intellectual error which thought that bubbles were impossible, that house prices would never fall and that statistical models had allowed bankers and regulators to control risk completely.
All the restrictions on bonuses being dreamt up by the Fed or G20 would have done nothing to stop the bubble. We would have had sub-prime and CDOs. Life is not that easy; what a shame nobody wants to know.