Thursday, December 10, 2009

Both sides are wrong in the debate over bank bonuses

Greedy bankers lining up at the bonus trough when the rest of the country is still in recession and the government is drowning in red ink was bound to cause outrage. Noone is listening to the City’s dwindling band of defenders protesting about bonus taxes and the damage they will do to what remains a prime export earner and revenue generator. But the arguments about bonuses are more finely balanced than the government would have us believe and besides they are, as they were intended to, deflecting attention from the real problem which is government economic policy, both past and present.

The case against the bankers

At first glance the case for taxing bonuses seems overwhelming: the bankers caused a recession which has blown a huge hole in government finances so why shouldn’t they help repair the damage particularly as the bonuses they have “earned” were only possible because of government bail-outs and guarantees. Look harder though and you will see that the first part of this argument is almost wholly untrue – the banks are not primarily responsible for our current economic difficulties and the appalling state of the public finances is almost wholly the fault of the government.

Before getting onto the blame game, let’s look at the second part of the argument which is more persuasive because it is true that the banking system would probably have collapsed in its entirety but for state support and taxpayers deserve some return for the bail-outs done in their name. However, if the banking sector is to pay up, it would be fair and rational to (1) tax the banks themselves rather than their employees and (2) tax the banks that benefited from state support most.

They don't want justice, they want blood

There are two problems with this approach in the eyes of the anti-bank lobby. Firstly it is the state-controlled banks like RBS that received the bulk of the support and their paying more tax is self-defeating and pointless. Secondly this group’s real intention is to punish “greedy”, “reckless” bankers themselves and thus only an attack on “rewards for failure” bonuses will do. The problem with this argument is that of all the tens of thousands of people employed in banking and due to be paid a bonus there are unlikely to be more than a handful who fit this description. Most of them work for hedge funds, insurers, investment banks that did not fail and had little if anything to do with the crisis. The handful of banks like RBS and HBOS that failed spectacularly did so because their senior management made some very poor decisions and most of those responsible have been sacked. Most employees were not greedy or reckless and if their employers want to pay a share of their profits to them rather than to its shareholders, they should be free to do so.

The government has to hit the right targets for the right reasons

The government should use its influence with the banks it owns or has stakes in to make sure bonuses, if paid at all, are fully justifiable. Perhaps a tax or levy on the banking sector generally could be justified as recompense for the funding support that the sector received when the credit markets froze. If there is a general feeling that the rich should pay higher taxes then raise tax rates for all high earners. Why should a bank clerk on £50,000 a year pay a higher tax rate than Jonathon Ross who earns 10 times that every month? There is little justification for a general attack on City bonuses but yet there is a lot of public anger to be assuaged. Why? Where does the sense of outrage spring from and is it justified?

Is the City a curse or a blessing?

The City line is that the financial sector is a great asset to the UK economy and that nothing should be done to kill the goose that lays the golden egg. Since the bail-outs the public has firmly rejected that line and in my opinion are right to be sceptical of the idea that what’s good for the City is good for Britain. The public outrage about bankers’ bonuses really boils down to a sense that the financial sector’s profits and the payments they make their staff are not deserved in the sense that they are not being earned in exchange for anything really useful or beneficial to the rest of society. In large part the public is right to be suspicious.

The economy needs an effective financial sector to allocate resources efficiently, support investment and manage savings and transactions, but it does not need the swollen, dominating force that the City has grown into today. To the extent that the City has grown to accommodate the financial activities of other countries and capture international business, that is a positive for the economy but a large proportion of the growth in the significance of finance to the UK is the result of government action, specifically the loose monetary policies of the Bank of England.

Who's to blame?

Now we arrive at the heart of the matter: the blame game, which the government seems to be winning because it is not widely held to be responsible for the recession. The public anger about bonuses shows they accept the bankers’ appointed role as the villains of the recession. The “they got us into this mess” line of argument has it that up until last year everything was fine with the economy thanks to prudent management by the government and Bank of England. Then those reckless bankers came along and caused a credit crunch which in turn caused a fall in house prices, businesses to be starved of loans and unemployment to soar. This conveniently absolves the government of blame but is also absolute nonsense.

Yes more boom and bust

In reality the UK, US and other countries’ low interest rate policies stoked a boom earlier in the decade and the recession was the inevitable bust that followed. You do not need to be an economist to see that the pre-recession economy was pumped up by low interest rates and easy credit, just think back to how crazy house prices became, doubling and then tripling and more. “No more boom and bust” was a hollow joke and everyone in government should have know that the housing and credit boom, which saw total household debts go up 300% to £1,500 billion, could not last. Yes, banks played their part by pushing credit cards, mortgages and loans and the City got way too clever with its financial wizardry but behind it all was a deliberate policy of holding down interest rates too low and for too long, because the government could not resist the feelgood and tax revenue benefits of the housing and consumer booms.

The buck stops with government

If the City got too big and outgrew its useful purpose this is because government policy encouraged it do so. Highly paid bankers are easy targets, and certain bank bosses have been rightly pilloried, but blaming City workers for Britain’s economic woes, especially the black hole in the public finances, is like blaming cancer on cigarette factory workers. Had UK government been genuinely prudent with public spending during the boom and raised interest rates much earlier to dampen down that boom, the UK would have still suffered in a recession which has played out across the world but not nearly to the same degree.

Up to their old tricks

Current government and Bank of England policy is not much different today: practically zero percent interest rates, quantitative easing and the rest are designed to flood the financial sector with money in the hope that some of the easy credit will flow through to the rest of the economy via the housing market and then the consumer. Of course banks are making profits (and paying bonuses) in this environment of free money but, as during the boom years, it is a direct result of government policy.

Look beyond the scapegoats

I said at the beginning of this post that the bonus question was a distraction from the real issue: failed and failing policy. The government has used low interest rate policies to keep the economy going for years and is trying similar tricks to lead us out of recession. This is the real reason for the shape of our economy today. Is it any wonder that we have an economy dominated by finance, property and retailing at the expense of industry, engineering and technology? Should we be surprised that science graduates flock to work in banks? Are we to wonder why we import so much while our exports shrivel? Is it a mystery why the UK is seemingly addicted to debt, the consumer is king and saving is a mug’s game? No, because we get the economy the government’s easy money policies deserve, so if you want to get angry about something look beyond the scapegoats and think about those that are doing the scapegoating.

Other economy posts and articles by this author:

Spanish property price outlook

US economic decline is looking terminal

Outlook for Spanish business in 2010


  1. Thanks for that Advoco. Good reasoned argument as I would expect from you. I am glad I am entering estate agency just as bankers are the great unwashed!

  2. Mostly I agree but I still think you are being kind to the bankers


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