By Tim Price
“The reality… is that banks … support a thick layer of second tier executives, as well as legions of pen-pushing, meeting-loving, middle-and back-office workers who are paid multiples of their worth and contribution, especially compared with other industries.”
- Financial Times‟ Lex column, January 19th, 2012.
* * *
“Stephen [Hester, CEO of RBS] is being urged by a number of people to accept the bonus and I think he will”… This person [an unnamed senior banker] added that if [Hester] turned down his bonus, it would “demoralise” staff members and would send a signal that they now effectively “worked for an arm of the civil service or a utility, rather than for a bank.”
- Unnamed banker, playing the world’s smallest violin on behalf of Stephen Hester.
* * *
Erik Schatzker (Bloomberg News): “$1.6 billion in compensation [at Goldman Sachs] is still a lot of money.”
Nassim Taleb: “Anything above zero is too much money.”
Erik Schatzker: “Why zero ?”
Nassim Taleb: “Because it is a utility. Anything you bail out, should not be earning more than a civil servant of corresponding rank. Period.”
- Nassim Taleb on Bloomberg News, Oct 18th, 2011.
* * *
Contender for leading meme of our time is the idea,
fast becoming conventional wisdom, that capitalism is somehow experiencing a
crisis. UK Prime Minister David Cameron (or his speechwriter) suggested last
week that it is now the time to use the “crisis of capitalism to improve
markets, not undermine them.” If we draw a
straight line back in time from the current financial crisis to the dawn of the same crisis, few would dispute that it was, and is, banks carrying the smoking gun. It was banks that made questionable loans to flaky borrowers – sovereign as well as individual – and it is banks that required extraordinary levels of involuntary taxpayer support to keep them “in business”, that is to say, keep their senior executives in the manner to which they have become accustomed. Unfortunately, in saving the banks from themselves, sovereign governments have now largely destroyed their own balance sheets.
straight line back in time from the current financial crisis to the dawn of the same crisis, few would dispute that it was, and is, banks carrying the smoking gun. It was banks that made questionable loans to flaky borrowers – sovereign as well as individual – and it is banks that required extraordinary levels of involuntary taxpayer support to keep them “in business”, that is to say, keep their senior executives in the manner to which they have become accustomed. Unfortunately, in saving the banks from themselves, sovereign governments have now largely destroyed their own balance sheets.
There is not, and never was, a free or fair market for
banks. A free market would have allowed insolvent banks to fail. A free
market, for that matter, would have no need of a central bank dictating
monetary policy: the genius of the market is that it is perfectly capable of
pricing money and interest rates in the same way it makes a price, every day,
without fail, for the value of Tesco plc, crude oil or wheat. If the Prime
Minister were capable of framing the problem correctly, he would have said that
it was now the time to use the “crisis of statism to introduce markets”.
Instead, career politicians in the coalition, with no practical experience of
any world other than the political, have been busily urging the rest of Britain
to become “a John Lewis economy” [John Lewis is a large UK retailer] of
motivated employee shareholders. As Martin Vander Weyer asked archly in “The
Spectator”, “Have you wondered why there’s only one John Lewis Partnership, Mr.
Clegg ?” But then criticising the Lib Dems (official financial policy: join the
euro zone) for economic confusion is like criticising David Blunkett for being
blind. [Blunkett is a blind Labour politician, fired twice from Tony Blair's
cabinet for his controversial personal life.]
Having said that, the “sex-tips-from-virgins‟
unsolicited economic advice from Mr. Clegg did inadvertently stumble upon a broader
truth about the financial crisis: in large part, it does come down to
ownership. Example. The two largest Swiss banks, UBS and Credit Suisse, have
not exactly covered themselves with glory during the financial crisis. They’ve
covered themselves with something, but it doesn’t smell like glory. Credit
Suisse stock between the start of 2007 and the end of 2011 has delivered a
total return to shareholders of some minus 70%. UBS stock over the same period
has done even worse: a total return of minus 82.6% (and that includes dividends).
By their very nature it’s difficult to comment about how genuinely private
Swiss banks have performed during the crisis, but since they’re not beholden to
a widely diversified (read: essentially powerless) shareholder base, they can
concentrate on customer service rather than on filling their boots and
extracting value from shareholders. And as hedge fund manager Kyle Bass has
pointed out, having unlimited liability as a partner in such a bank gives those
employees a particular interest in ensuring that they don’t entertain reckless
malinvestments. For this reason alone, private banking groups have a higher
likelihood of outliving their publicly listed competitors.
The phrase “market failure‟ also crops up in David
Swenson’s guide for individual investors,Unconventional Success. The
title is an allusion to Keynes’ famous observation that fund managers, courtesy
of endemic groupthink, tend to prefer (and to deliver) conventional failure
over unconventional success. Swensen himself is famous for steering the Yale
endowment through many years of impressive investment returns. He uses “market
failure‟ in the context of a managed fund industry that involves the
interaction between sophisticated, profit-seeking
providers of financial services and naive, return-seeking consumers of investment
products. The drive for profits by Wall Street and the mutual fund industry
overwhelms the concept of fiduciary responsibility, leading to an all too
predictable outcome: except in an inconsequential number of cases where
individuals succeed through unusual skill or unreliable luck, the powerful
financial services industry exploits vulnerable individual investors.
To Swensen,
The ownership structure of a fund management company
plays a role in determining the likelihood of investor success. Mutual fund
investors face the greatest challenge with investment management companies that
provide returns to public shareholders or that funnel profits to a corporate
parent – situations that place the conflict between profit generation and
fiduciary responsibility in high relief. When a funds management subsidiary
reports to a multiline financial services company, the scope for abuse of
investor capital broadens dramatically. In contrast, private for-profit
investment management organizations enjoy the option of playing the role of a
benevolent capitalist, mitigating the drive for profits with concern for
investor returns.
The financial crisis of 2007-? has taken the
role of giant vampiric money-squids masquerading as investment banks to new
levels of surrealism quite beyond the realm of satire. Not content with ripping
the faces off clients, banks – not limited in the scope of their operations to
pure investment banking – have now shown themselves quite adept at ripping the
faces off taxpayers too. If deficit exists, it is not in free market terms,
because as we have seen, no such free market exists. The deficit is a political
and regulatory one.
In The
Puritan Gift, the Hopper brothers identify the proximate cause for the
crisis as
an excess of borrowing by government, businesses and
individuals … Increasingly, reckless lending and borrowing – two sides of the
same coin – have characterized most aspects of American society for the last
thirty years …
This abuse of credit across the whole of society
coincided with, and could not have occurred without, deterioration in corporate
culture occurring in the last third of the twentieth century. In the Golden Age
of Management (1920 – 1970), executives had learned the craft of
management “on the job” from more senior colleagues. As they progressed up
the ladder of promotion, they would also absorb “domain knowledge” about the
activity for which they were responsible – to borrow a term favoured by Jeff
Immelt, chairman and chief executive of General Electric. Starting in the late
1960s, however, a new concept appeared on the corporate scene: that
management was a profession like medicine, dentistry or the law, which
people were “licensed’ to practise at the highest level if they had
studied the subject in an academic setting. Business school graduates and
accountants set the pattern of behaviour; others would follow in their
footsteps. In 2001 a “professional” manager entered the Oval Office of the
White House to take charge of the nation.
Whether considering the managers of listed businesses
or the managers of discretionary funds, investors should be well served by
identifying those conforming to a moral as opposed to a purely self-interested
approach. Decent moral behaviour is to a degree subjective, but as Justice
Potter Stewart famously said of pornography, we know it when we see it.
Reforming banking sector pay will only be the start of an overdue cleansing of
the Augean stables. When banks compete properly for business and run the risk
of genuine failure in so doing, the market will be on its way to being fixed.
As things now stand, banks in collusion with central
banks are distorting the term structure of debt markets (and through
inflationism, all other asset markets too) and giving investors a delusional
sense of safety with regard to sovereign bonds. Both financial signals and
financial signalling are all wrong. When monetary policy rates and supposedly
market-led interest rates are as low as they currently are (5 year US
Treasuries yield less than 1% and 5 year Gilts barely that), it is not a sign
of confidence, Messrs. Cameron and Osborne, but a reflection of absolute terror
on the part of the crippled banks that have been buying them in preference to
any form of more constructive lending.
Again, this is not a crisis of capitalism, but of
state-controlled capital.
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