Rein in the banks and end fat-cat bonuses

PUBLISHED : Thursday, 21 January, 2010, 12:00am
UPDATED : Thursday, 21 January, 2010, 12:00am

Bankers and financiers in the West have long been accustomed to being treated like masters of the universe. It must, therefore, be disconcerting to be cast in the role of public villains in the two years since the onset of the financial crisis. The Financial Crisis Inquiry Commission in the US lined up Wall Street's top bankers for public testimony last week. It was probably the closest thing for the bankers to being put in the dock.

It does not help matters that it is reporting season again and the public has just learned that the top five US banks will be paying record bonuses and compensation to the tune of US$50 billion. US President Barack Obama has rightly described the new round of bonuses as obscene and introduced plans to claw back bailout money over 10 years from financial institutions that have received federal support during the crisis. It is clear the return of many Western banks to profitability was not the result of bankers' skills but the unprecedented support and debt guarantees offered by their governments. Taxpayers are, therefore, subsidising their bonuses.

The furore in the US follows something similar in Britain. Banks in the City of London have collectively thumbed their noses at the authorities; most said they would cover the new punitive 50 per cent tax on bonuses for their staff. In other words, shareholders will be made to pay the tax while bankers go on their merry way after being bailed out by British taxpayers. To rub salt into fresh wounds, British bankers and their lobbyists warn financial institutions will simply move elsewhere given the new punishing tax and regulatory environment. Regulatory arbitrage - by which you exploit differences in supervisory regimes and operate in countries or jurisdictions with lax monitoring - has long been only hinted at; now it is an open threat. That is why governments must work together to align effective tax and regulatory regimes in major financial centres around the world.

There needs to be an end to the Anglo-American bumper bonus culture. It is not only distasteful and morally reprehensible; it is socially corrosive, because it undermines the social contract under capitalism. A fundamental capitalist principle is that while you get to enjoy the fruits of your labour, enterprise and ingenuity, you must suffer for the mistakes you make. But the bonus culture has turned that upside down. Its tie to performance has always been tenuous, if not a charade. The bonuses stayed high on Wall Street and in London even when Western financial systems were on the brink of collapse. It is questionable whether, even during the preceding bullish decade, the phenomenal rise in the return on equity of big banks was due to skill or performance. A recent Bank of England study finds a complete - complete! - correlation between British banks' higher leverage and rising return on equity in the past decade. Any profits most of these banks made have since proved illusory.

So, high leverage before the crisis, government support after it - bankers in New York and London make it look like they are just there to game the system. They can afford to do so because banks and other financial institutions are at the heart of the Western capitalist system, which in turn underpins the global economy. They have bet, correctly, that they can make fatal mistakes and taxpayers will still have to bail them out collectively as an industry - and in many cases, individually. That is why they need to be reined in and controlled in a worldwide effort co-ordinated by governments and regulators. We need to save capitalism from itself.