Skewed market to blame for big banker bonuses
Sydney Morning Herald
Saturday January 9, 2010
Sharemarkets are back to 15-month highs but most investors face a much longer wait for their assets to recover. For those people working in financial markets, however, that lucrative perk of the industry, the oversized performance bonus, remains intact.Although the huge pay packets dished out to investment bankers dwindled in 2008, last year saw a return in six- and seven-figure bonuses, which can double or triple the pay of the (mainly) young, well-dressed men working around Martin Place.And despite attempts to curb the excess, bankers are staunchly defending their perceived right to absurdly high pay. In the latest attempt to keep the money flowing, Goldman Sachs this week threatened to abandon offices in London unless the British Government dumps a 50 per cent tax on bonuses above 25,000 ($43,000), following a similar threat by JPMorgan.The three biggest Wall Street banks paid their staff a record $US30 billion ($33 billion) in bonuses last year, equal to $US250,000 for every staff member.All up, it's clear the bonus culture of the financial markets is little changed. So how do bankers manage to pay themselves such obscene amounts, despite bringing the system to its knees?A new play inspired by the crisis has a simple but insightful way of explaining the extraordinary pay dished out in high finance. In The Power of Yes by David Hare, which is now running in London, a character known only as "Financial Journalist" sums it up this way:"From 2000 onwards the bank employment market ceased to be a genuine market. That's when bankers decided that because they were working in an ice-cream factory, they could help themselves to as much ice-cream as they liked. They came to believe that they made the money, not the company."Much of this account is spot-on - it certainly captures the greed. And it captures the sense of entitlement expressed by Goldman's global boss, Lloyd Blankfein, who last year said that bankers simply performed "God's work." It also helps to explain how a bonus culture takes hold (what's a few hundred thousand dollars if a banker makes tens of millions a year for the company?)But while greed certainly plays its part, blaming excessive pay on selfishness alone leaves a few questions unanswered.Namely, why did banking become such a hugely-paid job only in the fairly recent past? Lending money has been around for centuries, but it's only in the last few decades that it overtook medicine or law as the quickest way to a six- or seven-figure salary. How can investment banks afford to pay their staff such huge sums in the first place? And why doesn't competition for these well-paying jobs drive down wages to more reasonable levels?The wave of financial sector deregulation since the 1980s plays a big part in answering all these questions.Before capital was allowed to flow much more freely around the world, there was nothing sexy about working in a bank. But thanks to an easing in capital restrictions and technology that allowed trading around the clock all over the world, a vast number of new markets appeared.Spying big potential profits, banks pounced on these new opportunities. People with dollar signs in their eyes were also drawn to the increasingly exotic arms of finance. By the noughties, the glamour jobs were in complex fields that remain baffling to most of us: investment banking, hedge funds, private equity firms or structured finance (slicing up debt and reselling it).A 2009 paper from Paul Woolley's Research Initiative on Capital Market Dysfunctionalities, in France, charts the rise of financial market pay during waves of innovation. Sure enough, after the waves of deregulation in the 1920s and 1980s, the paper says that managers in finance extracted significantly higher pay packets than people working in other industries. But why?Bankers were able to do this because all these new exotic activities were types of innovation, which gave the financial sector super-normal profits. As the people who were running the show, staff in the financial houses were able to demand pay at a premium to people doing a similar job in other industries. In economic jargon, they extracted "rent" for their services.The problem is that the super profits and higher pay led to overconfidence and excessive risk-taking - and we've all seen the consequences that can have. These economists conclude that pay packets should revert to normal in innovating industries after "boom" turns to "bust".However, this hasn't necessarily happened this time around because much of the financial industry continues to prosper. Investment banks have been surprisingly resilient in the past year, squeezing out profits where they can - such as bulking up their bond trading desks to cater to the huge amounts of government debt.But none of this explains why investment banks choose to pay their staff such enormous rewards when they could get away with paying less.Many people working in the field like to claim that investment banker pay simply reflects the money they bring into the company, which, they say, is a function of skill. Textbook economics helps perpetuate this myth by basically assuming people deserve what they earn.But University of Technology Sydney economics professor Ron Bird says much of the mystique around working in the markets is a furphy. "These people feel they are worth what they are paid, but for every one of them there are several others who could do the job just as well," he says. "You wonder why the price is not bid down."Why indeed? One likely reason their pay is stubbornly high is that the market for the most lucrative part - the bonus - is not open to the same degree of competition as regular salary. Incumbency is a huge advantage. When bonus season rolls around, bankers are only really competing with others in the company for a slice of a pre-allocated pool. Even if there are people outside the company who would do the same job for less, they rarely get a look in.After the financial carnage of the last two years, common sense tells us wild performance bonuses to bankers should become a thing of the past. But experience shows bankers are clinging to excessive pay with all their might. Like trying to take ice-cream from a child on a hot summer's day, bonus culture is tough to dislodge.Ross Gittins is on leave.
© 2010 Sydney Morning Herald
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