Jake's View
PUBLISHED : Tuesday, 09 April, 2013, 12:00am
UPDATED : Tuesday, 09 April, 2013, 4:25am

Why top bankers deserve to be paid huge salaries

Governments are leaving it to market smarts to invest deposits, and they don't come cheap

"Despite billions of pounds of liquidity support from taxpayers, many senior bankers seemed still to be arguing that they deserved their precrisis levels of pay"

Barclays internal report,
SCMP, April 4

 

I sympathise with the outrage in this Barclays memo. The very people who plunged the bank into trouble and who should have been sacked, or at least seen their pay cut, still think they deserve huge salaries.

I also happen to think that these people are right. It is perverse, but it is the logical, inevitable outcome of the way that governments around the world want to remove deposit risk from banking. To their employers, senior bankers are worth every cent of their high pay.

Let's start here by sketching a Norman Rockwell-style picture of the traditional bank of Anytown. Townbank has a simple balance sheet. On one side, it holds deposits from the public and shareholders' equity. On the other side, it puts this money to work as local loans and advances plus a portfolio of municipal and corporate bonds. It also holds a big stash of cash, just to be safe.

These assets are safe indeed. Fail to meet payments on your home or car, and you're in trouble. Townbank will have your home listed tomorrow and your car on the forecourt at Honest John's Motors. Corporate borrowers don't get much easier terms.

In Townbank's securities portfolio, there is also little risk of default on the municipal bonds. Townbank's chairman is one of the municipality's aldermen. He also sits on the boards of important local corporate clients. Townbank is safe.

And you, as a depositor, want it that way. In the traditional world, your deposits are at risk. If Townbank fails, you may get back only 50 cents on the dollar of your deposits or, perhaps, nothing at all.

Now let Townbank decide that it would like to boost profits by holding credit default swaps on foreign currency collateralised debt obligations.

You will certainly hear about it quickly. In Anytown's world, this sort of news travels fast, only barely faster than the speed with which you will take your bank deposits out. Townbank will soon get the message and go back to the old style of business.

This style of business doesn't need much brainpower. It's a farming business. The bank sows the deposits and reaps the harvest. It's really an administrator's job, and it pays an administrator's salary.

Now let's shift to the world of government deposit guarantees, today's world. If Townbank goes for the default swaps on the CDOs, you don't care. You will get your money back from the government if it all goes wrong, and in the meantime, Townbank may pay you a more competitive deposit rate.

Of course, Townbank's directors don't want it to go wrong, but they now live in a much more complicated environment than when they just did old-style banking. They must follow the trend or risk losing your deposits to a bank that does follow the trend.

It means they have to find people who know exactly how to write default swaps on CDOs and are also savvy enough to know when to pull the chain on these default swaps and take their cash. We are now talking big brainpower and market smarts. These don't come cheap.

And there you have the perversity of it all. Government deposit guarantees, which are intended to create a level playing field for all depositors, have exactly the opposite effect on the salaries paid in this field.

In fact, they also do not help the depositors much. You may get your money back when Townbank fails, but you pay for the rescue in your taxes. You are probably worse off.

The lesson of it is that governments cannot just take over one side of a bank balance sheet. If they guarantee deposits, then they must also take control of how those deposits are invested.

But they shrink from this prospect. They haven't a clue of how to do it. So they just leave the asset side of the balance sheet in the hands of the wolves. The inevitable result is regular trouble and outrageous salaries.

jake.vanderkamp@scmp.com

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