Monday, November 02, 2009

Novel suggestion on bank bonuses

Even that paragon of the free market, the Economist, has joined the chorus against bank bonuses. I suppose you could call that progress in thinking after the sub-prime crisis.

Banks argue that they have repaid government capital, they need to retail talent, that management pay is for shareholders to approve and that the government, the media and the public should stay out of it.

The Economist makes the point that the top ten investment banks at the start of 2008 made an average return on equity of just 8% between 1999 and 2008. Four made cumulative losses. Staff got four times as much as shareholders did in profits. So, bonuses are at the expense of shareholders.

Moreover, banks are handing out large bonuses to employees while arguing that higher capital requirements would be too onerous for them! In a free market, you could still argue that these are matters between management and shareholders and that the government and the public should stay out of it. But this is not a free market situation: the banks have been bailed out by tax payers and- more, importantly- still enjoy subsidies:
It is not just that they were saved from destruction. They got public capital (much of it now repaid), short-selling bans on their shares and rescues of counterparties, such as American International Group, which the public otherwise had no interest in saving. Today they enjoy laxer accounting, loose collateral rules at central banks, explicit debt guarantees and asset-purchasing schemes. And, critically, they can borrow cheaply because they are deemed too big to fail. All of them—from comparatively healthy Goldman to the nationalised weaklings—are being subsidised by the rest of us. As a way to keep cash flowing to the wider economy and help banks rebuild their capital, this subsidy made sense; nobody intended it to go to employees.
<>If we accept that outsized bonuses, courtesy of public subsidies, are just not on, how do we deal with them? The popular solution is to rein in bonuses. The Economist thinks this won't work and it will lead to micro-management by government. It proposes an alternative:
Assume that America’s top five investment banks would pay two percentage points more on unsecured borrowings without an implicit guarantee. On that basis the subsidy is $36 billion a year (compared with pay this year of perhaps $120 billion). Providing banks have built up adequate capital, they could face a funding “premium” in much the same way that they already pay premiums for deposit insurance......The premium would last at least until the state guarantees are withdrawn. The longer-term debate may yet move from wishy-washy living wills to breaking up banks (as the governor of the Bank of England suggested on October 20th—see article).

7 comments:

Siddharth said...

Do please check this article in Business Week. http://www.businessweek.com/bwdaily/dnflash/content/nov2009/db2009113_669822.htm

Would like to know your views.

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