I was in New Delhi last week, speaking at a conference organised by ICRIER and the think tanks, Brussels-based Bruegel and French-based CEPII. The conference was on ‘International Cooperation in Times of Global Crisis: Views from G-20 countries’. Montek Singh Ahluwalia kicked us off having just arrived from G-20 sherpa meetings in Washington.
Montek kept his cards close to his chest choosing not to talk about Pittsburgh. He spoke instead about the evolution of G20 and the mechanics of leaders meetings. He was also rightly sceptical about the current band wagon in France, Germany, the US and the UK of focusing on controlling bankers’ pay. Having once been a banker I have tried to avoid this debate as it is engulfed in understandable moral outrage rather than rational debate and having been a banker, I might get confused of being conflicted. That said, here are some thoughts on the hot subject of international policymakers.
My objection to government involvement in pay is not the typical banker’s objection that it can not be done. These things are invariably more feasible than bankers would like you to think. (Isn’t it interesting how bankers in industrialised economies have to be rescued by their governments from an Armageddon of their own making, but they still dismiss out of hand the competence of these same governments.) Banks’ best client is government. Government banking business, be it, debt issuance, privatisation, payments, restructuring advice etc is lucrative. If government insisted on only doing business with banks that have signed up to a code on remuneration and its spirit—so no sub-contracting work to related parties—it may impact bankers pay. But just because it is feasible doesn’t mean you should do it.
There are three reasons why I think there are better things to do to make the financial system safer than messing around with pay. First, if government starts ascribing value to bankers, why stop there? Will they not have to ascribe value to others with government contracts? Remember we are talking about private sector pay here not how they pay their own employees. Government control of pay in the private sector would be a form of government control of the economy. I thought we had tried that path and found it more limiting and more impoverishing than first imagined.
Second, setting bankers pay is a lot harder than you might imagine. I used to be on the global management committee of one of JP Morgan’s main divisions, and later the same at State Street, helping to pay out hundreds of millions of dollars and I can safely say almost never ever got it right. In hindsight you always felt you paid your good people too little, which is why they waved good bye one day and you never saw them again, and you paid the people who turned out to be not so good, too well, so they stuck around interminably. We tried all kinds of innovation to incentivise good behaviour: ten year, restricted, stock options; special bonuses to encourage sharing of clients and information; no promotions for people with poor ethical standards however good they were at making money for the bank. But it was hard to get it right. Would government do better? I doubt it.
Third, government’s want to get involved because of the justifiable moral outrage at bankers pay levels. But pay levels are not the source of the systemic risk problem; it is the incentive to make more money is, which is a rather fundamental aspect of the capitalist system. Jerome Kerviel, who allegedly, single handedly, lost Soc Gen, the French investment bank, $7bn, was, allegedly, trying to boost his modest $50,000 bonus to say $100,000 and, perhaps more important, he was trying to make his colleagues respect him more.
My own approach would be to incentivise good remuneration practices and limit the overall size of the bonus pool. The size of the bonus pool should be influenced by contra-cyclical capital charges where less money is available to bonuses as a boom progresses and more money set aside for the rescue from the inevitable crash. Secondly, if the regulator believes a bank has remuneration practices that support excessive risk taking, it can ask a bank to set aside further capital as a systemic risk charge. Third, long-term stock options should not be cancelled when someone leaves a bank. Given that traders are regularly poached by other banks and once they leave the poacher compensates them for any cancelled stock options, these long-term options have no effect on long-term behaviour. But if they could not be cancelled, you knew that your interests were always aligned to the long term, irrespective of whether you stuck around and so your hiring and business development would change. Then I would focus on the stuff that really matters, such as offsetting the tendencies of markets to underestimate risks in a boom and overestimate them in a crash. That is the fundamental cause of crashes.
The author is chairman of Intelligence Capital Limited, emeritus professor of Gresham College and member of the UN Commission of Experts on International Financial Reform