When pushed, those who attempt to justify exorbitant pay in the corporate world often use comparisons between great sports players and their own “star” performers… But the comparison is disingenuous, if not duplicitous. When we watch Ronaldo score a spectacular goal, we know the only way we can do the same is in our dreams.
Now I don’t claim that everyone in an investment bank who gets a bonus is in any way special. But the big numbers do tend to go to people who have made a lot of money. And making a lot of money is not easy, given how much competition there is. Most people could only structure a convertible, or price a CDO, or build the book for an IPO in their dreams too. In fact you might argue that being a really talented banker is even more unusual than being a footballer (even one as bad a sportsman as Ronaldo) in that we can easily imagine what it might be like to be able to kick a ball well, whereas most people can’t even imagine what it is like to be an MD at Goldman.
The way to reduce distasteful bonuses isn’t to bad mouth hard working bankers, however little contribution to society they make. It is to stop banks making so much money. That is boring. It does not involve creating an artificial pariah class – rather it involves lots of detailed regulation and market structure reform. But it would do a lot more good in the long run than victimising some people who happen to have been talented (and lucky) enough to actually succeed at banking.
The vexed topic of bonuses is provoking lots of people: see for instance here for a news story about windfall taxes, or here for Alistair Darling’s latest.
A lot of ink has been split and a lot of pixels lit on this topic. So just two thoughts from me.
First, if banks did not make so much money, bonuses would not be an issue. Banking is after all one of the few genuinely socialist industries: the workers really do share in the benefits of production. So if there were fewer benefits, there would be rather less money to pay them, and all would be if not well, then at least less controversial. Perhaps we should be asking how it is that a few institutions are able to make so much so reliably. Perhaps it is because the large banks together constitute a functional monopoly in many areas of finance?
Second, I find it hard to begrudge a share of the profits to the most talented risk takers. Someone who can run a large trading book and make solid realised profits (not just mark to market ones) is valuable, at least as the financial system is currently set up. But what is bizarre, at least to me, is the trickledown effect. In some firms the back office people get six figure bonuses: the secretaries, five figures. It isn’t just the people who make the money who get large bonuses, it is more or less everyone who has worked for an investment bank for more than a couple of years. And remember a £30K bonus might be laughably low to a trader, but it is still more UK median earnings. There are a lot of people in financial services who get this level of bonus, so actually quite a bit of the total bonus pot is soaked up by people who do perfectly ordinary jobs in a bank rather than another type of company. If you are from the left, should you celebrate that sharing of rewards or decry the bonus culture? If you are from the right, how do you feel about the lack of any credible lever for shareholders to stop this money – money that would otherwise go to them – being paid out?
I almost fell off my chair laughing when I read this. Which is not a very sober response to a very sensible proposal: Credit Suisse is going to use $5 Billion of Illiquid Assets to pay Bonuses. As Bloomberg reports:
The bank will use leveraged loans and commercial mortgage- backed debt, … to fund executive compensation packages.
Assets in the facility will remain on Credit Suisse’s balance sheet and will be held in the company’s fund management division, the people familiar with the plan said. The new structure will mean that any mark-to-market losses or gains on the assets will be offset by identical gains, or losses, on the bank’s liability to employees.
Employees will receive semi-annual coupon payments on their investment in the Partner Asset Facility at the London Interbank Offered Rate plus 2.50 percentage points. The ultimate value of the facility will be determined over the next eight years as the loans and securities mature or default, the people said.
This is a really really good idea in fact. If bankers know that this can happen, they will be strongly incentivised not to originate illiquid assets. But you can just imagine the looks on the faces around the CS trading floors…
Suppose you are a trader in an investment bank. Suppose the world is fair, so you get paid for every pound you make over your budget. In options terms, that means you have a call on the P/L struck at the budget. How do you increase the value of a call? One way is to make a lot of money: raise the forward. But another is to raise volatility of the underlying: make the P/L more volatile. Taking bigger risks is good for this. Now, was this the kind of behaviour we wanted to encourage when we designed the bonus programme?
It gets better. Suppose you manage traders. You get paid for every pound your group of traders makes over budget. So you have a call on a basket of P/Ls. How do you increase the value of a call on a basket? Well, the two methods above work, but so does increasing correlation – get everyone who works for you to take the same risks. Hmmm. Not quite what we wanted there either…
