When they released their five rules for bonuses, I was worried that they were getting involved in a hate-auction rather than trying to design sensible policies.

Ben Chu of the Indie took the other view, saying “I think I prefer it when sales people are paid a fair wage and have some professional pride in the quality of the goods they’re selling – not when they’re desperate to make the tills ring in order to pad out their salary”.

My general view is relatively hands off; in 99% of cases, how employee X is paid has no wider social impact and is just a tussle between shareholders and staff.  Classic principal-agent.  There are reams of MBA thought on how to do this well.  To little avail. Clearly they still often screw up, and it is a mystery to me how shareholders get it wrong so often.  My favourite example is always Bob Nardelli, accused of having an obsolete management style and yet still cleaning up.  But investors were furious there, and it was their problem, their money (like Dillow, I have long thought this was about power).

But sometimes you need pay structures that move flexibly, rather than being nailed to some mast called “fair”.  [Fair from whose point of view?  When employee A thinks he is paid less than B who is a dufuss, A thinks it is unfair.   Telling him he is paid in the top 1% doesn’t help.  I know. ]  It shifts the risk onto the employee.  It doesn’t necessarily make them do the sort of near-criminal things that Chu links us to.  Intelligent management and a reasonable deferral of bonuses, equity participation, and a good culture ought to diminish outrageous scandals – and is in the management’s interest to do so.

But Nick and Vince clearly think this area needs the government to help the shareholders along.  As the Financial Times writes,  “his polemics against bankers – “pin-striped Scargills” as he has dubbed them – and their bonuses inflame rather than inform debate.”  In their broader summary, they say:

An unsavoury mix of populism and seemingly easy fixes. The more serious proposals for splitting up big banks and imposing a levy on profits are flawed but deserve consideration, if done on a global basis. There is nothing liberal or sensible about a draconian clampdown on bonuses.

But the trouble with Vince is that he is very good at two things: the biting memorable soundbite (Scargills, elephants in the room*, Bean-Stalin, etc), and more nuanced, detailed analysis.  At both of these he beats the competition.  The latter was in display when Michael White interviewed him for the podcast.  I transcribe:

“We’re not against the City – there are a lot of very good companies in the City, which make money, provide employment and enrich the UK …The problems related to one specific segment of the City which were the banks – and not all the banks, some banks HSBC, Standard Chartered were not involved in this it was a handful of banks, mortgage lenders and other irresponsible lenders that were at the heart of this catastrophe … I spend a lot of time in the City, I get quite a respectful audience because I think an awful lot of people in the banking system realise they fouled up, seriously, caused enormous damage not just to their own institutions but to others.”

It’s 10 minutes in, and suggests there is a more nuanced view behind the bluster.  But the bonus policies, as they stand, would hit the responsible HSBC man setting up a valuable new network in the Far East as well as the daft and mendacious CDO punters.  I think, like some other policies**, these would be honed and toned down in office.

There are huge issues in injustice in the world of banking.  Bankers make too much money.  The Brilliant Andrew Smithers*** has a letter explaining how in much more forensic detail: it is because banks are oligopolistic, not because of the bonus system. This is worth reflecting on at length:

If a subsidy is received by a fully competitive industry, the result will not be a higher return on equity in the industry, but an otherwise unjustified increase in its size. If a subsidy is received by an industry that engages in rent extraction through oligopoly, then its profitability is enhanced by the subsidy, which enables the boosted level of profits to be earned on a reduced level of equity. The case against large financial institutions is first that they are rent-gouging oligopolies and second that these activities are subsidised by taxpayers.

If you make ‘too much money’ because of hidden subsidies and monopolistic market structure, it will find its way to powerful staff.  Work on those things, then you can worry less about bonuses and their ilk.

*Apparently a zoo refused to let them use one

**My major beef remains this Unfairness thing with regards to tax and benefits (as the Chris Giles link also argues).   Look at Slide 11. Repeat: Labour did Significant Redistribution.  And going on about the bottom decile leaves them open to the charge from the Left that their flagship 10k threshold policy is not an answer to this specific ‘unfairness’

*** Finally emerging from the shadow of Mr Burns


27 thoughts on “Do the LibDems hate banking too much?

  1. Short answer: No.

    I love that faux moderate quote from the FT: “inflame rather than inform debate”. Ha! I mean, let’s be reasonable here chaps–there’s no need to get all emotional. Bankers work very hard and some of them are even halfway decent. They worked very hard for all of the money that we gave them.

    Aww, diddums. Don’t make the bankers cry!

    If you just stop rationalising this for a few seconds, then what is more surprising, and IMO more worrying, is the fact that there is not really that much banker hate. They caused a massive collapse, sucked the global economy into a near depression, ate huge amounts of public wealth, and now they’re probably going to cause a secondary contraction as governments “pay” for the bailouts by deflating their economies–possibly leading us into a Japan style lost decade. And yet, what has actually changed? Where is the political will to reform the non-productive socially malignant financial sector? I think if we had a bit more populism and a bit more entirely justifiable ire, we might get some movemenmt.

    1. hmmmm

      In the time available I am not going to be the banker defender. But:

      – states collected many of their rents in terms of tax in the good years. It paid for lots of good stuff. There was complicity
      – not all the collapse is bank related. Look up Spain. Credit gets out of control in lots of ways
      – high previous growth is also partly bank related. Have to take a careful counterfactual here. Imagine perfect restrained bank behaviour, what would the economy have been like. Maybe not so high before
      – they have not eaten much pub wealth since. Bailout costing not much at present.

      But I agree with much – see Credit where it’s due.

      We can avoid Japan if we adopt the right policies. Chin up!

      1. Well, naturally I’ve already read it and know that we’re probably largely in agreement. Just a random outburst not directed at anyone in particular. I guess that’s one of the problems of trying to inflame the debate, eh!

        To your comments:

        The financial sector and growth: I would say that there is a danger of circular reasoning here. I don’t disagree that the financial sector made a lot of money over the last decade. Some of this money showed up on the naitonal income accounts. Some of this money contributed to govt tax revenues. Is this a (partial) defence of the financial sector? It doesn’t seem like a stroong one. I love the following passage from Michael Lewis’ Vanity Fair article on Iceland:

        “Yet another hedge-fund manager explained Icelandic banking to me this way: You have a dog, and I have a cat. We agree that they are each worth a billion dollars. You sell me the dog for a billion, and I sell you the cat for a billion. Now we are no longer pet owners, but Icelandic banks, with a billion dollars in new assets.”

        Spain: I was under the impression that Spain had a housing bubble and is now suffering under the combined weight of the GFC and the EMU. Why can’t we hate bankers for a significant share of this as well?

        Bailouts: I would include as costs of the bailout, money not spent on stimulus and any cuts to net spending resulting from deficit hysteria. IIRC, UK spent 20% of GDP on bank bailouts. 20%!

        The counterfactual: Contra your counterfactual, I notice that in the era preceding the dawn of silly banking, we had pretty decent growth. Actually, didn’t we have *better* growth?

  2. Hi Giles

    I think we are now singing from more or less the same hymn sheet in terms of basic principles.

    First, remuneration systems should be a matter solely for managements and shareholders in all firms that cannot expect a state rescue if they collapse. Personally, I find the economic justifications for a bonus-based working culture as opposed to one based on a decent salary unconvincing, but I agree that Government should keep its nose out. And this includes hedge funds.

    Second, reducing the hidden subsidies and oligopolistic rents of the banks, should be the priority of every responsible politician when it comes to financial reform. I agree that the obscenely large bonuses seen in many large financial organisations are a symptom of this fundamental underlying problem.

    Yet we are in a world where politically-powerful banks are trenchantly resisting those sort of reforms (witness the recent efforts of Bob Diamond of Barclays and Jamie Dimon of JP Morgan) and where the will of politicians to impose them is doubtful.

    We also live in a world in which the bonus systems of the large banks are manifestly broken, no matter what you think of the principle of variable remuneration (see this enlightening report from the New York Attorney General, Andrew Cuomo which shows that the nine US TARP recipients paid out $9bn in bonuses in the same year that they lost $55bn – http://www.ag.ny.gov/media_center/2009/july/pdfs/Bonus%20Report%20Final%207.30.09.pdf)

    I would argue that, in this context, it is entirely reasonable for the Lib Dems to seek to curb the bonus culture.

    For one thing the British public are the primary shareholders in two of our giant banks – RBS and Lloyds. As we agree, the owners of a company have a right to determine its remuneration policies.

    The question of whether a government should have a right to interfere in the remuneration policies of large banks which did not accept state equity, like HSBC and Barclays, is more difficult. They are in the private sector so they should, in theory, decide their own pay. But restricting bonuses in RBS and Lloyds, but not the other two, would make little sense and would create labour market distortions.

    My view is that policymakers should be guided by the “too big to fail” principle. If a bank comes into this category, a government is entitled to impose restrictions. HSBC and Barclays might not have taken public money, but the lower cost of their funding amounts to a significant public subsidy.

    I stress that this is not ideal – I would much rather a large chunk of the banking sector had not been rescued and that all banks were small enough for governments to safely ignore their remuneration practices. But we are where we are.

    Incidentally, what Clegg proposed was a £2,500 limit on cash bonuses. The banks would be able to reward their best staff with as much as they liked in shares, so long as these couldn’t be sold for five years. Is this really such an extreme policy? It strikes me as rather mild all things considered.

    1. Thanks for the excellent reply. I still reckon that they could curb the way bankers are paid, and if everything else were left as is, the system would still have done what it did. You know the examples: Cayne, Fuld etc all had perfectly aligned incentives, they still acted like muppets. And (pace Krugman, referred to in your recent blog), a shoal of smaller banks could still screw up. Indeed, financial history is still replete with such examples – that is what makes them systemic crises rather than just The Crisis of the Bank called _____.

      I am fairly satisfied that the LD’s have the right mixture of outrage and expertise to really contribute to this one.

      I wonder what would have happened had those TARP recipients NOT paid those bonuses?

  3. Of course the title of your post is whether Lib Dems hate bankING too much rather than bankERS.

    Given that old Liberal banker Josiah Stamp’s somewhat famous (in certain circles at least) quote:

    “Banking was conceived in iniquity and was born in sin. The Bankers own the earth. Take it away from them, but leave them the power to create deposits, and with the flick of the pen they will create enough deposits to buy it back again.

    “However, take it away from them, and all the great fortunes like mine will disappear and they ought to disappear, for this would be a happier and better world to live in. But, if you wish to remain the slaves of Bankers and pay the cost of your own slavery, let them continue to create deposits.”

    I’d say no. More than that, whilst not attacking those who happen to make their living out of the system, because it is the system that exists, for good or ill, I would say it is not possible to hate the bankING system too much given that it is part and parcel of a state privileged and protected counterfeiting ooperation that incessantly devalues our wealth, and which can be said to be at the root of such enormous inequity in society.

    It needs radical systemic reform. It is no longer, if it ever was, fit for purpose. And it has been exposed. If those who worked within the system and were so handsomely rewarded were to be advocating radical change I would certainly respect them a lot more.

    1. “I would say it is not possible to hate the bankING system too much given that it is part and parcel of a state privileged and protected counterfeiting ooperation that incessantly devalues our wealth, and which can be said to be at the root of such enormous inequity in society.”

      Fantastic writing: but could you explain how (a) it has reduced wealth in the conventional measure of the term and (b) what you mean by counterfeiting?

      1. a) by inflation and b) by fiat money amplified by fractional reserve based credit creation. Okay – “fraud” might be a more technically correct word than “counterfeiting”

  4. I’ve never been entirely clear why people claim that fractional reserve accounting ‘creates’ money. It’s rather like the covered short-selling of shares, and despite years of creative vituperation no-one has yet accused short-sellers of ‘creating’ shares. It increases the velocity of money, but it’s still the same money, because (some percentage of) every asset entry has a corresponding liability entry.

    1. Well, just look at this time round, it *has* created money in effect. I accept that what it actually creates is “purchasing power” rather than “real” money, though that “purchasing power” all the same is counted in the broad money definition. And this credit crunch has proved, in a sense, that it is not “real” money because when it all went pear shaped they had to scramble for the comparatively little “real” money to cover their doubtful assets.

      But the effect *has* been to create “real” money because faced with a precarious situation what has the state done? It’s “printed” more “real” money than ever existed previously. The point is such a system will *always* be precarious, will *always* tend to lead to new real money which it will eventually of course use to create vastly more purchasing power, and all this in turn will *always* tend to increase the size and quantity of malinvestment which then need to be liquidated in a proper “bust”.

      And fraudulent of course because it goes on without being open – try telling average Joe that there’s only £1,000 of money for every person in the country and he’ll rightly tell you that that must be nonsense. “A method so simple it repels the mind” – J K Glabraith.

      1. Over a couple of hundrd years of this precariousness, we have somehow managed to increase GDP by some factor in the double digits. A funny sort of precariousness …

        I agree that Fractional Reserve Banking seems outrageous, but it isn’t fraud. It’s a funny sort of miracle in my view. Mind boggling, one of the greatest inventions ever, a scandal, all these things. But I doubt very much we’d be as well offf without broad money

      2. It is essential that we distinguish between gold standard FRB (where gold reserves back lending) and fiat currency FRB (where reserves/base money are only clearing balances). You cannot move forward on the basis of a critique of a financial system that no longer exists.

  5. Posted by vimothy on April 15, 2010 at 5:41 pm
    It is essential that we distinguish between gold standard FRB (where gold reserves back lending) and fiat currency FRB (where reserves/base money are only clearing balances). You cannot move forward on the basis of a critique of a financial system that no longer exists.

    But in essence it is merely another step along the same continuum – fiat FRB took over when GS FRB became impossible to sustain because of constant inflation. And since all is bed-based and needs financing, it is inevitable that it transfers wealth from those who don’t hold financial assets to those who do. And in effect…

    Posted by vimothy on April 15, 2010 at 5:45 pm
    And BTW, unlike the US the UK actually has no reserve requirement.

    …is just another step on that same continuum. One doesn’t really know what shorthand to give it now – “Infinite Inflating Banking” perhaps 🙂

    Giles, of course us Austrians don’t put much store in GDP in any case, but I would also argue that inflationary money is, along with taxation, a significant factor in the sort of “disposable” (not *quite* the right word but nearly) world we are in – producers have to produce more and more crap (as someone suggested to me, Dr Seuss’s “thneeds”) to “grow” outpacing the inflation. Less inflationary money – whether specie or simply free banking type corporate competing money – would be more eco-friendly!

  6. Vince Cable and the Lib Dems do go down the route of populist bashing the bankers. It is all part of the British media obsession with pantomime villains. The British banking system did not nearly collapse in 2008 because bonuses were too high. The system nearly collapsed because every bank was undercapitalised due to a decline in the value of their assets. Now you could say that if they had retained more revenue in the previous years by paying lower bonuses then they would not have been undercapitalised. However, you could say the same if they had distributed lower dividend payments to shareholders.

    If capital was the problem then obviously higher capital ratios is the best solution to preventing a repeat. Moreover, higher capital ratios are expensive for banks and will lead to lower profits. Lower profits for the banking sector will lead to lower bonuses. There is no need for politicians to stipulate bonuses if you put in place ratios that make banking less profitable.

    The Paul Krugman argument against the obsession with TBTF is correct. What matters in contagion is not the size of the institution but how interconnected the institution. We are kidding ourselves to believe that any deposit taking institution would be allowed to fail. It is simply not credible. Therefore, effective regulation and high enough capital ratios to make failure not an option is the way policy should proceed.

    What amazes me in the policy debates is how little criticism the BoE receives for the near collapse. From the dithering over Northern Rock, to the initial refusal to accept the banks non-gilt assets as collateral. Mervyn King and his refusal to accept that he was a governor of um a central bank did more to cause the decline in assets than any of the pantomime villains in the banks. Although recapitalisation would still have been necessary there would not have been the turmoil if the central bank had operated like a central bank should.

    This Tim Congdon paper covers the same point in significantly more detail.

  7. Is that the same Tim Congdon who was on the news channels almost in tears when the government nationalised Northern Rock? That did amuse me.

    Being old fashioned and seeing wealth as coming from workers, arguably bankers remuneration bears no relation to the work done – they’re in a priviledged position. If you want to get some popularity but don’t want to move towards a more democratic economy, then you can see why you’d focus on the agents rater than the system.

    Those financial institutions that haven’t totally fucked up have been those aimed not at profit-maximisation but at profit-making, owned not by external investors but by their members. It is cooperative and mutual enterprise which offers hope for a fair and sustainable economy.

    1. Yes, Congdon has some surprisingly rum views on whether banks should ever have capital at all. I hear he had quite a lot of NRK himself.

      But I agree with Richard that it is bizarre how the Bank is due to get so much more power given how poor its performance was at the outset. I am often blinded by the high quality of their publications and speeches, and forget that executive judgement not analytical ability is what matters in a crisis.

  8. Some guys from the Business School here put out an excellent report on banking reform recently, “An alternative report on UK banking reform”: http://www.cresc.ac.uk/publications/documents/AlternativereportonbankingV2.pdf

    Apologies for the long quotes in this comment, but I think that they make some germane observations that are worth posting here in full. Firstly, that, “In the aftermath of the financial crisis, many want more radical banking reforms than those proposed by the UK government and the Conservative opposition.” However, the government has “not moved beyond its timid proposals in the July 2009 White Paper Reforming Financial Markets which is inadequate.”

    This is because of the,

    influence of the ‘distributive coalition’ in and around the City of London, which has co-opted the political leadership of both major parties. The alignment of finance and politics works because the crisis has reinforced government reliance on finance insiders to form policy and frame choices.

    Current and ex-investment bankers and fund managers took key positions in the process of crisis management and resolution after 2007. At the same time, HM Treasury and the Mayor of London commissioned reports from the same City finance groups about the importance of maintaining the competiveness of London as an international financial centre.

    The resulting Bischoff and Wigley reports represented a new kind of politics where finance reports on finance by telling stories about finance. Bischoff group members collectively had 662 years of work experience and 75% of those years were spent in City occupations or servicing City needs. Wigley called expert witnesses but 90% of its witnesses came from finance or consultancy with revenue links to finance…

    The distributive coalition around the City of London frames political choices through the insider reports. Bischoff and Wigley construct a narrative about the ‘social value of finance’ in terms of tax contributions, job creation and the diffusion of prosperity. This inhibits reform because the policy implication is that nothing should be done that inhibits competitiveness.

    However, contra the not exactly disinterested opinions of finance insiders,

    It is important to challenge the distributive coalition’s narrative about the social value of finance, which makes exaggerated claims and uses evidence selectively:

    i. The tax revenues from the finance sector in recent years are offset by the immediate cost of bank bail-out. In five years up to 2006/7, the finance sector paid and collected £203 billion in taxes, but the upfront costs of the UK bail-out are £289 billion, rising potentially to £1,183 billion.
    ii. In terms of job creation, the finance sector directly employs no more than 1 million workers (mainly in retail) and numbers employed do not increase in the boom years. If we add jobs in consultancy, accounting and law sustained by finance, the number of those directly and indirectly employed by finance still accounts for no more than 6.5% of the UK workforce.
    iii. The business model of wholesale banking and the geographical clustering of wholesale activity, together ensure that the finance sector concentrates rather than diffuses employment opportunities and prosperity across the UK. Retail banks control the costs of high street jobs, while wholesale pulls a small number of well-paid financial actors towards its centre.

    In its present form, finance is a pro-cyclical activity with limited job creating capacity and a proven ability to disrupt the economy at great cost to the taxpayer.

    1. Quick observations: costs ‘potentially’? I think there is a reasonable chance of making money from the bailout guarantees. Costs is being misused there.

      I agree there aer problems with banking – obviously! – but we need to get the figures straight. There have not been @upfront costs’ that are the same as a tax transfer. Equity investments are not costs ….

      1. Not a transfer, no, I agree–a payment for which UK govt received paper assets in the form of liabilities of companies that, in a fairer world where governments did not feel obliged to save financial institutions from the fruits of their own poor decisions, would have gone bankrupt. Given the reflation of the financial sector on the back of QE and the bailouts, govt may eventually sell these assets for a profit.

        Govt is also guaranteeing loans and providing liquidity support, so that £298bn figure is obviously only one way to look at it. We could include more govt support in that figure. (NAO were reporting not so long ago that Treasury will pay about £100mn to City advisors working on bailout, e.g.). However, even if you think that govt may make a profit, this is still obviously a cost in the standard definition of the term. Govt paid some money, and got some paper claims in return. In the future, it may convert these paper claims back into money. In the future.

        Personally, I side with the chartalists on govt financing and do not worry about the govt running out of money or needing to make a profit. That said, and I think that this is even more important than the undeserved windfall that the financial sector received from the public coffers, the opportunity cost of the bailout was obviously econoomic stimulus for the real economy. We got pretty much nothing. Furthermore, the govt is now threatening to reduce net spending (as in, rather than direct net spending to the real economy, it went to the banks–now the banks are back to normal, net spending is going to be reduced. Reduced)! So the true cost of the bank bailout is substantial. That’s right now cost. The future is unknown.

        Furthermore, the cost of the financial sector does not only include periodic bailouts in general and this one in particular, but also the loss of output due to the contraction caused by finance.

  9. My answer: probably not. I may be repeating things that have already been said, but here’s why:

    1. This is coming up to a general election, where bankers (in fact almost all the Establishment) are seen as unpopular. Populism is popular. Doesn’t mean that they would be as tough as they are saying.

    2. These are Orange bookers we’re talking about.

    3. As I understand it, these restrictions are only a temporary measure until the banks can be broken up. Which would help solve the “oligopoly” problem mentioned above. And these restrictions do make some sense. Consider that there:

    *was bailout of a number of banks.
    *has been QE, and perhaps more in future.
    *is a formerly implicit, now explicit, taxpayer guarantee on all the financial sector, causing moral hazard.

    Considering all that, can it really be said that these massive bonuses are the result of the free market (competitive or uncompetitive) in action?

    And if not, can these proposals really then be seen as illiberal?

    1. Oi! I’m an Orange Booker.

      I obviously hold strongly to 3. And believe that equity instead of cash bonuses do a lot more to get the company better capitalised. I suppose I would like this phrased in more technical and less judgmental language – this is not the clunking Robin Hood Campaign but Vince. Yours, Politically Naive Wilkes

      1. Not saying there’s anything wrong with being an Orange Booker, I’m just saying when you look into these proposals, you should take into account where they normally find themselves economically. They won’t have made this decision lightly.

      2. The Liberal Democrats have surely always accepted markets? Have I missed something?

        The years you refer to are BEFORE the crash – and before St. Vince became famous as Mr Get-Tough-with-Bankers. Not only is Vince an economist, he’s a politician – and they are in the business of winning votes…

  10. Channel Four’s Faisal Islam raised the following question on the hung parliament situation

    “Are the Libs, “rightwing” free-trading economic liberals, or progressive social liberals? They may well have to make a choice rather soon.”

    Actually, I’m getting less sure that this will be a problem. Given St Vince’s ability to balance the two tendencies. It might be more of a problem for party activists, though…

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