As the furor over the Merrill Lynch bonuses brings into focus what many see as the greatest evil of the banking industry, it's worth questioning exactly what it is that gets us so angry.
In the Merrill Lynch case, the problems are fairly obvious -- a payment that appeared illogical (why should a bank making a multi-billion dollar loss pay out almost 4 billion in bonuses?), immoral (why did the bonuses equal more than a third of the government bail out?), and corrupt (why did Bank of America let the bonuses go through, and why the hell are they only being fined $33 million for doing so?)
But should we judge financial-sector bonuses only on what be the worst-case scenario? Back in my native England, a country that dined out on the good years as much as anywhere else, news that Goldman Sach's London staff would earn an average bonus of three quarters of a million dollars this year provoked shock and outrage. "What recession?" ran the bitterly sarcastic headline of the Daily Mail, perhaps Britain's most populist newspaper. This despite the fact that Goldman had actually managed to turn around its finances and start posting huge profits.
Bonuses deserve careful consideration.
A bonus is simply a form of performance-related pay, a concept that has been around for centuries, at least back to the Greeks. The practice became a popular concept in the late 19th century, when the industrial revolution caused a new interest in management. The idea was that if you paid people for their performance, they would perform better out of self-interest - a fairly logical conclusion.
It was not really until the 20th Century that the huge lump sums we have come to equate with the financial sector became widespread. As profits from investment banks got bigger, the logic was completely rational -- give someone a share of the profits and they will create more profits.
These incentive structures have unusual ubiquity within the financial industry. "A unique feature of banking is that it extends performance pay to almost all of its employees," wrote Tom Kirchmaier of London School of Economics in a paper last year. "In fact, it is not uncommon that investment banks pay out up to 40% of their net revenue to their employees."
Whilst plenty of industries use performance-related pay, the financial industry leans towards this form of remuneration for a couple of reasons. First, the industry is relatively unique in that individuals can be directly responsible for deals that earn millions of dollars. It's relatively logical that if someone closes a deal worth $100 million, they might expect to gain a share of it.
Secondly, a bank's most valuable resource, and thus their most significant of costs, is its staff. Banking itself tends to differ relatively little from company to company, so bonuses become not so much a reward for performance, but a sum to prevent the earner from moving to another company.
The bonus arms race began in the 80s, and has shown little sign of abating since. In practice this has meant that bonuses have ceased to be performance related at all, and instead just a guaranteed sum.
Even where the bonuses are performance related, they can act in ways that are counterproductive. The chief problem seems to be that whilst profits from the company are shared, losses are generally not -- short of losing out on a promotion or getting fired. At a personal level, losses are finite for an employee, whilst profits to all intents and purposes appear infinite. Couple this with the fact that most bonuses tend to be given out at the end of a year -- thus allowing bankers to earn huge bonuses on financial products that later make huge losses -- and you have a system that seems to perpetuate risk and short-sightedness.
Whilst it's clear in theory that the system is harmful, what is difficult, however, is actually working out the extent to which these problems caused the recession -- academia, business, and government all seem unable to come to a complete conclusion. "It's very difficult for an academic to get access," says Vicky Wright, a senior consultant at Watson Wyatt who deals with executive remuneration packages. "And practitioners can find it hard to see the bigger picture."
What's clear is that the bonus culture was certainly not the only thing to blame. When the British Financial Services Authority looked into bonus culture earlier this year, they concluded, "A reasonable judgment is that while inappropriate remuneration structures played a role, they were considerably less important than other factors."
Regardless, governments in the UK and the USA are now looking into ways to regulate bonus culture. Favored options include withholding bonuses for five years or so, or enabling banks to take back bonuses if deals go sour. Every solution would pose it's logistical problems.
It's clear that the bonuses doled out in recent years were not a good thing. As Andrew Clare of Cass Business School in London, told me, "If the bonus culture did anything at all, it was negative." Most worrying perhaps is the way they revealed a huge gap between thinking Wall Street and the rest of the world. Bonuses, for better or worse, were expected, and frankly dubious dealings, such as those between Bank of America and Merrill Lynch, show something of the unshakable belief that the bonuses were deserved -- even if your company failed on a huge scale.
But while it's very easy to find fault with the bonus system, their role in the recession is at best contributory. What is worrying is that bonuses may be an easy target for anger -- an easy scapegoat for wider problems. Its easy for a politician to point to huge bonuses and complain, rather then fix the complicated regulatory problems that lay at the core of the financial crisis. It's true, the bonus system in banking has reached illogical heights, but it was only one problem of a system that was screwed, on many, many levels.
From my point of view the 80:20 rule is at work here, 80% of the transactions are being traded for the benefit of 20% of the players and their brokers. Under this scenario the top 20% are the big players, with high-frequency trading advantages, whom the top performing brokers focus on to maximize their bonuses. These top brokers help these big players manipulate the market to generate more fees. The average investor is just inventory for the big player to harvest. Corporations jump on board when they provide brokers with misleading financial information that the brokers then recommend to us.
(1) the fact that it is extremely difficult to attribute failure should keep you from sleeping at night, not make you feel better.
It means that unless people make a conscious effort to work through this, the next crisis is a certainty.
(2) there is no question that the crisis was in fact 'causally overdetermined': the rotten bonus culture alone suffices to necessitate it, other things being equal. Of course there are other flaws as well. But they don't serve as excuses.
The complexity and the excuses come from the fact that due to intransparency, you can tell too many stories. But the flaw is in the intransparency. Excuses based on the fact that banks refuse to disclose what's going on (which of course is often due to the fact that they themselves don't know) are worthless.
When corporations give ridiculous sums, whether in bonuses or regular pay, to robber barons, they are portrayed as fulfilling the American, capitalist dream.
I don't get it.
We are just appalled that WE TAXPAYERs are funding these bonuses when the corporations are LOOSING MONEY....WE TAXPAYERS ARE PAYING FOR THESE BONUSES and don't forget that for one minute.....
It's asking for HELP as though the company is on its last legs!
If you are on the verge of losing your home and you go ask your grandparents for some money, do you immediately go out and buy a boat???
It makes NO SENSE.
These companies that ran to the government couldn't fathom cutting back on expenses, overhead, and yes, PAY.
PS: you can ALWAYS hire youngbloods with energy and elders with experience who will work for FAR LESS than those in-between.
The whole thing makes me sick.
And making money on speculation and bulls**t, creating absolutely NOTHING, is at the core root of the economic crisis. Entitled m-f-ers!!!
Could that be because asset managers and hedge funds aren't playing with an implicit guarantee?
Hard to tell, isn't it? Almost impossible, in fact.
And as usual: THAT is precisely the problem. Who should carry the burden of proof here? The taxpayer? Aren't you laughing your a$$ off when even the NYC attorney can't get the most basic information without staging a revolt?
Some hypocrisy or what do you call it?
In addition a 90% tax rate should be slapped on all personal income over $500k (this would indirectly influence corporations to find other ways to compensate.... note that the increase in wealth concentration for the the top 0.01 % from 1% to 6% began as the tax rates on the top tax brackets dropped.)
Furthermore, all corporate charters should be limited to 65 years... by which time a corporation's resources must be sold off and funds returned to investors. Corporations are government constructs, the only ones with eternal lives! They started with 21 year lifespans... subject to review and renewal... but corporate money changed that. Every large corporation has a parasitic load; nature imposes term limits on all species to reduce their average load.
Top executives of public behemoths should be limited to 8 year terms.... after which they must leave the employ of that corporation.
Do you really think Google and Apple should fire their executives or are you just sitting around writing drivel.
And what's more: if you could it would mean that you have an enormous extra risk to consider when estimating the proper net present value of the firm. Namely the risk that your CEO gets hit by a bus.
Write some more drivel please, I'm having fun with your crap.
How can you measure the value-contribution of an individual that you have stipulated to be singular and unique in the previous step in your argument?
The very notion that there could be a market (or a market price) for this kind of 'value-driver' is a fiction. It's the epitome of the thing on which you cannot put a price-tag.
I don't even think it is farfetched to call this original lie the 'incest-taboo' of the business world.
To get TARP money when your bets go bad, a bank has to have no money.
So any money they accumulate, they pay out in bonuses.
All these folks belong in jail for fraud.
If the U.S. government wants the firms they have invested in to be profitable, they must award profitable divisions. That means targeted bonuses at the divisions of firms like Bank of America that are making profits, performance bonuses, so they can retain top talent and pay off their government debts.
Obviously the banks made terrible decisions about risk regarding derivatives contracts and we are dealing with the consequences. Burning what we've bought by crippling their ability to retain talent does not solve this problem. What does is wise, enhanced regulation which focuses on risk-taking and leverage. While this is more difficult than political populism on bonuses, it is a meaningful long-term solution.
During the 50's and 60's when tax rates went up to 91%, bonuses were not the primary way to retain good people or to reward performance. An unintended consequence of lowering the top tax rates was to promote a concentration of wealth in the upper 1% of wage earners while inflating the Federal deficits and forcing the average consumer into debts (lent to him by that upper 1%).
Watch Hong Kong and London become the world's financial centers and see our GDP dwindle.
In tehh 50's and 60's talent wasn't nealy as mobile as it is now.
The conventional wisdom of the money as a the primary motivator of reward for talent is inherently flawed, as it removes other factors ingrained in human nature. Maslow in his hierarchy of needs theory, opined that once man's basics needs are met, man looks to other sources to fulfill himself, thus once safety and security are met, other motivational factors take over.
Other behavioral theorists and psychologists have lamented the concept of rewarding avarice with high financial reward as pandering to antisocial narcissistic behavior which is bad for society AND business in the long run.
Those motivated by innovation and opening up new paradigms and who may have different ideas are often seen as the enemy.
BTW, I particularly liked your comment about the best wives and best prostitutes and what motivates them.
thank you.
And the first step is to be happy as a child can be for every single one of the 'talented' traders who leaves.
To think you can get back to financial health by pumping up risky business (and that's what profitable business is) is the original sin of finance.
It is the precise reason why banks (in normal times and even more so in stressed times) are reluctant to extend credit to weak or uncertain firms. The risky firms keep the upside, the bank is stuck with the losses. This is credit 101. It's no different when you extend credit to banks - or refuse to.
There are also people who are demonstrably better at geneating these fees than others. You want them and to get them, you are going to have to pay them.
WHY, in the name of HELL, are these people being paid bonuses, when the rest of the country has gone through layoffs, pay cuts, no pay raises (not even cost of living), and no bonuses for 2009?! These dirtbags are the ones that not only ran our economy into the ground with "questionable" (at best) practices, but then proceeded to belly up to the trough for some bailout money?!!!
There needs to be SERIOUS criminal charges levied against these companies, CEOs, and accountants. Where is the retribution for the American taxpayer? We need to start investigating with a hammer....