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By Andrew Newton on 03 Sep, 2009 - 02:33 UTC

Mixed news on the battle brewing over bankers' bonuses.

 

European finance ministers (with the UK taking a back seat) are coming out strong on curbing banking bonuses.

 

This I get. Dealing with the excessive (arguably unbounded) risk taking that super-high bonuses encourages, and the crises such excessive risk-taking produce, finding a way of reining in the expectation of high bonuses for excessive risk-taking seems like the only way to ensure the recurrence of such a damaging crisis is avoided.

 

On the other hand there is something very disturbing about the recently announced French approach: curtailing the bonus upside but also punishing traders for any substantial hit suffered by the bank.

 

This seems to me merely to raise the stakes - a contributor to the adrenalin fueled environment that leads to excessive risk-taking in the first place.

 

The French, of course, are feeling somewhat bruised by the whole Kerviel affair in January 2008 when national financial champion Societe Generale was hit with  a 4.9 billion euros ($7 billion) loss due to what the bank maintains was unauthorised trading by Mr Kerviel. The preferred narrative in France is that the bank's systems and controls (including remuneration culture and policies) were not at fault; this was a simple case of a rogue trader. So punishing the trader when the bet goes the wrong way helps reinforce that narrative.

 

But surely it is better to address the up front incentive for unbridled risk-taking rather than pull your punches in favor of creating stiff personal consequences for the failure of the bet? Rogue traders already know that if the bet goes wrong they stand to lose their jobs and their lifestyles, but "rogue" traders (ie those produced by the prevalent bonus culture) show again and again that they never imagine they will fail, that the bet will go against them.

 

It is the size of the potential upside that motivates their actions and that is where serious politicians and regulators should focus their attention.

Was the chairman of the UK's financial watchdog just trying to impress concervatives when he expressed support for a tax on foreign exchange deals?

 

Development charities are delighted. And why wouldn't they be? The global economic crisis rooted in excessive risk-taking (rooted in remuneration policies that rewarded it) is estimated to have caused some 100 million down to the level of extreme hunger.

 

Personally I wonder whether a Truth and Reconciliation Commission could help bring some measure of justice by bringing together victims of the crisis perpetrators.

 

But a Tobin tax on currency transactions could help remedy the material impacts of the crisis rather than simply the emotional and cultural. It is argued that the tax brought in could be used to finance economic development for those who have suffered at the hands of the finance industry.

 

Lord Turner went on to comment that the UK's financial sector has "grown beyond a socially reasonable size". Hardly seems like posturing towards a future Conservative government to me; more like a note of sense from someone who is not only close to the action as a regulator now, but has himself been a business leader.

Does the ongoing anger over bank bonuses suggest the need for something akin to a Truth and Reconciliation Commission on the causes of the crisis?


You might think I have been spending just a little bit too much time outdoors over the summer; “Truth and Reconciliation” is the way nations like South Africa consign to history the egregious, state-supported human rights violations that have been committed against a large section of their people.


But bear with me for a moment and reflect on the breadth and degree of damage that the culture of greed managed to inflict by causing the worst financial crisis since the Great Depression: an increase in the number of people around the world in chronic hunger and poverty by over 100 million, to 1.02 billion; between 200,000 and 400,000 more babies could die each year between now and 2015 if the crisis persists; an increase in global unemployment by between 29 million and 59 million people; one in eight US mortgage borrowers is behind on mortgage payments or facing foreclosure at the end of the second quarter 2009; pensioners relying on developed country stock market returns for their retirement incomes have seen their savings fall by 45%.


Let’s not forget the stories behind the numbers. My friend Mike’s mother has been working for General Motors her whole life and was due to retire this year. Now she has no pension and will likely be working for the rest of her life. For more stories, take a stroll through the New York Times’ Living With Less – The Human Side of the Global Recession.


No wonder people remain angry.


The political will to rein in Wall Street and the City of London’s high stakes culture is lacking, and the financial sector is doing everything within its power to undermine what will remains.


A report by Essential Information and the Consumer Education Foundation found that $5 billion in political contributions over the past decade gained Wall Street freedom from regulation. According to OpenSecrets.org: “Despite the mortgage and banking crises of 2008, the financial sector still managed to donate $468.8 million to federal campaigns and candidates during the 2008 election cycle, an 80 percent increase during the two previous years.”


The Center for Responsive Politics notes that the finance, insurance and real estate sector spent $109.4 million on lobbying in the US during this year's second quarter alone, during which time the industry has been lobbying against the movement for tighter regulation provoked by the financial crisis.


How can we move forward?


We have a precedent for resolving situations where the will of government has been put at the service of powerful minority interests, to the detriment of the majority.


In 1995, after decades of the systematic abuse of economic, social and political rights known as apartheid, the South African government set up a Truth and Reconciliation Commission to give ordinary people an opportunity to air their grievances against a system that institutionalized racial segregation and discrimination in all aspects of life.


According to the then Minister of Justice Dullah Omar, "... a commission is a necessary exercise to enable South Africans to come to terms with their past on a morally accepted basis and to advance the cause of reconciliation."


The TRC was a forum in which anyone who felt that he or she was a victim of the system could be heard. Those on both sides who had done wrong could also give testimony and request amnesty.
Dead babies will never learn to speak, and how do you give voice to the 100 million starving? But that does not negate the need for public, open and free discussion of the causes of the crisis, to confront those responsible with those they have impacted, to raise the question of prosecution and possible amnesty rather than assume as now a cosy settlement between corporations and regulators.


How else do governments and financial institutions expect the results of egregious risk taking at great cost to communities and individuals to be put behind us?


How else can we say that we are serious in our desire to stop this happening again?

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Steven Davidoff at the New York Times reckons the focus on bonuses paid to Merrill staff is not the issue.

 

Steve is less willing than some to blame the lawyers in the BoA merger.

 

The elephant in the room, he argues, is the possible non-disclosure of the extent of Merrill Lynch's losses - $15.3 billion at last count.

 

If these were not disclosed then the bonus disclosure would become altogether more substantial. Steve thinks the SEC is avoiding dealing with that possibility because of the question of whether the Bush administration directed Bank of America to keep Merrill's losses quiet.

While bankers and politicians seem anxious to get back to business as usual, the current difficulty being faced by Bank of America suggests that “normality” is not going to return any time soon, if indeed it is permitted to do so at all.


The Securities and Exchange Commission is trying to conclude an investigation into Bank of America’s payment of $3.6 billion in bonuses to executives of the sinking ship that was Merrill Lynch upon the former’s purchase of the latter. The SEC and Bank of America have agreed a $33 million settlement – an amount that some might call (and have called) derisory.


The SEC replies that it is unfair to penalize shareholders overmuch for the actions of executives. But hang on, I thought shareholders were supposed to be owners holding risk equity? That is what is supposed to provide shareholders with the incentive to keep an eye on how executives run their business, rather than simply smile while the money comes in. If shareholders don’t end up picking up the tab for reckless risk-taking then you create a moral hazard; shareholders will be better off turning a blind eye than supervising.


Enter Judge Jed S. Rakoff, a United States District Court judge in Manhattan. Whereas most such settlements are simply waved through, he has the temerity to question whether this settlement is really in anyone’s interest. Apparently he would like to take this opportunity to exert what little influence he has to deter further behaviour of this kind.


No doubt he has his own reasons for thinking the time has come to take a stand. Judge Rakoff presided over the SEC’s case against WorldCom – as in “corporate fraud on the scale of Enron and WorldCom” – and took the step of appointing a former SEC commissioner as a Corporate Monitor to oversee the reform of WorldCom’s corporate governance. He will recall that there was much talk after Enron and WorldCom of the importance of not letting big business return to its former ways, particularly the financial and professional advisers who enabled those corporations.


They did, however, and on his watch. And he knows that his courtroom is practically the only venue where pure greed can be stopped in its tracks.
 

At the end of this year bailout recipient Goldman Sachs may award its highest level of bonuses ever.

 

This seems more than a touch surreal.

 

Goldmans' revenues are experiencing a surge benefiting from business driven by the crisis the firm helped bring about.

 

Firstly, the crisis wiped out some of their main competitors, so they can charge much more for their services.

 

Second, the crisis created a need for governments and corporations to raise substantial amounts of new money (eg, in the government's case, to bail out banks like Goldman Sachs). Goldman Sachs is a prime broker of government debt and one of the principal market intermediaries in all asset classes and is therefore benefiting from a cut on these transactions.

 

So, bonuses are back. Goldman's points out that now bonuses are held back for one year before payment, but the risky behavior they reward generally take a few years longer to translate into problems.

 

Better sit tight, or tackle your legislator to support effective regulation.

 

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Sigh.  According to Reuters, the bonus culture at many financial firms--those left standing--is so entrenched that top bonuses may increase by 20 or 30% this year.  For those at the very, very top, at any rate.  Everyone else will likely see smaller, or no, bonuses. 

 

So, it looks as if the richest may just keep retrenching, making the palace walls higher, the moat deeper, all the while defenestrating more and more of the new peasantry. 

 

Maybe, when they hit the billionaire mark, some of them will do a Bill Gates because it will make them happier.

 

Or maybe camels will fly through the eyes of needles first.

Serious consideration is being given to ways to curb pay policies that encourage financial stability-threatening behavior by employees.

 

The rules may come through the Federal Reserve or the Securities and Exchange Commission.

 

Separately, House Financial Services Committee Chairman Barney Frank (D., Mass.) is working on his own proposals.

 

The industry lobby group the Financial Services Roundtable is resisting any such move, so earning its name by ensuring we come back full circle into the same mess.

The Sunday Times of London chronicles the expression of investor anger over pay-for-failure during this year's corporate annual meeting season.

 

The days of shareholders passively sitting back and disengaging from corporate oversight might well be over. At least until the next boom.

Around the world, "Corporate Social Responsibility" legislation comes in multiple forms. California's targets certain spending by TARP recipients.

 

According to the California Chronicle report:

 

"The Corporate Responsibility Act of 2009 will prohibit state regulated banks and credit unions that receive federal or state emergency economic assistance, from using the money for executive bonuses, corporate aircraft, travel accommodations or the hosting of corporate conferences, parties and events. Additionally, it will prohibit use of taxpayer bailout money for lobbying activities. A financial institution that violates the act will be subject to civil penalties of at least $100,000 per violation, and will be prohibited from receiving any future emergency economic assistance."

Goldman's CEO Lloyd C. Blankfein said in a speech on Tuesday that compensation across the industry should discourage excessive risk-taking.

 

In the speech, given at the Council of Institutional Investors' annual spring conference, Blankfein outlined a set of guidelines by way of proposal to the financial sector.

 

Key proposals included assessing performance over time and allowing for a "clawback effect".

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