The UK government’s current embarrassment over banking bonuses illustrates three uncomfortable truths. First, the global response to the banking crisis of 2007-09 was flawed in many crucial respects. Second, the financial services industry is American-led and the rest of the world has little option but to salute the US flag. Third, British politicians either misunderstood the industry they were trying to reform or, if they did understand, chose to exaggerate their influence in order to appease a bloodthirsty electorate during the 2010 election campaign.
High bonus payments are a symptom of a problem, not its cause. The banking settlement was deficient because it did little to address the asymmetries in the universal banking business model. This model causes investment banks to jeopardise global financial stability in bad times whilst allowing bankers to cream off film star compensation in the good times. The global reforms have done a bit to improve financial stability but almost nothing to constrain the profitability that produces the bonuses. That profitability arises from a business model that gives banks in general and investment banks in particular the best possible view of global economies and markets. They are able to use this information advantage to load the dice and generate super-profits. This is where the bonuses come from and this is why the banking lobby worked so hard and so successfully to defend the model.
That lobbying was most successful in the US, where attempts to break up universal banking and constrain bonuses were portrayed as backdoor socialism and an affront to the country’s entrepreneurial spirit and capitalist culture.
Consequently US banks, unlike their European counterparts, retained the right to pay staff more or less freely. This is a powerful advantage in an industry where global reach can be achieved from a New York or west coast base and where a Manhattan calling card still has a certain cachet. British and European banks are right when they say that they will lose staff and in turn business unless they are permitted to pay to compete on level terms with the Americans.
This should have been obvious to the politicians of all three major British parties when in the 2010 general election campaign they milked the applause by promising to clean up the banking bonus scandal. The coalition government, however, is finding it hard to put the fine words into practice. So what went wrong? Did politicians fail to read the direction of banking reform in the US? Did they misunderstand the global nature of 21st-century banking? Or did they tell the electorate what it wanted to hear in a lie now, pay later Faustian pact?
Politicians on the stump should not be taken at face value but the principal lesson to be learnt from the bonus saga is the need for a properly co-ordinated global response to the question of banking profitability. If the chancellor and the business secretary wish to appease an electorate miffed at the sight of the bankers waltzing off with their millions, they could do worse than to take a leadership role in initiating such a response.
The writer is the author of several books on financial services including ‘The Greed Merchants: How the Investment Banks Played the Free Market Game’ and ‘Reckless: The Rise and Fall of the City’
