Why the bonus culture must be defended
The B-word sums up everything most people have come to hate about the financial industry. The Bonus Culture is convenient shorthand for what has gone wrong in the markets. When people try to find out just how the great catastrophe of the past two years could have happened, they focus on huge risks being taken for huge bonuses. When Congress wants to punish Wall Street, it threatens to take the bonuses away from the people who work there. When the British government wants to show it is getting tough with the City it gets Sir David Walker to produce a report saying that bonuses should be dribbled out over years instead of being paid all at once. When commentators want to say how banks should be run they warn of a huge gap between the interests of the shareholders and the managers as if financial companies were unique in having absentee owners (in fact they are far less absentee than in most industries because so much compensation is paid in shares that large chunks of these firms are owned by their employees.)
So poisonous has the word become that even the BBC, about as far removed from the City as you can get, has felt the need to ban all bonuses.
In polite society, no one seems willing to say straight out that they do not like other people earning so much more than they do, but that is obviously part of the underlying resentment that is there even at times when the banks have not had to be bailed out at enormous cost to the taxpayer. People will not say “bond traders should not be able to earn $10m”. Instead we get a stream of rationalisations about why the compensation system in finance, the “bonus culture”, is at the heart of the problem.
Let us look at the issues one by one.
First, why are bonuses the centre of attention rather than total pay, to such an extent that some banks who knew that they might be restricted in bonus payments simply doubled the basic salary of their key staff?
Outside finance, bonuses are a very small component of total earnings because people need to be sure of their income flow. The extra money is nice, but in most jobs even the most successful get bonuses only in the tens of per cent. Finance is different, partly because even when it was run more sensibly than it has been in recent years the revenue fluctuates a lot. Firms need the flexibility that comes from holding their fixed salary costs down to a level where they can meet them even if things go bad. But that means that when things go well, there is enormous upside, with bonuses in the many hundred percents. Most people at big investment banks do not think of a bonus at all. They just get told at the end of the year what their total pay will be and the salary they have received each month is effectively an advance on it.
None of that alters the fact that the total amount paid is in many cases quite mind-boggling to people outside. But if the people doing the business do not get the money, who should?
Take Goldman Sachs, which is probably the most successful investment bank over the past years. (To declare an interest I worked there for many years.) In the second quarter it had revenues of $13.76bn. If it was a newspaper, enormous amounts of that revenue would have gone to buying newsprint, paying distributors and so on. But in Goldman’s case, the equivalent costs only came to around $2bn. So there is more than $10bn to be divided between the shareholders and the staff. Goldman says the shareholders will get $3.44bn of that and the rest ($6.65bn) is earmarked for the staff. Anyone at an investment bank will know that that money can melt like snow before the end of the year if things go wrong. But the share of 49 per cent of the gross is roughly what banks usually pay.
Many people say that the workers are getting much too good a deal in this. But nobody ever seems to explain what the shareholders have done that is so wonderful that they should get a lot more of it. There is a long tradition that recognises that the people who do the work should get their share, starting with the King James Bible: “The labourer is worthy of his hire.” There was even once a political party in Britain which went to the extreme of saying that the purpose of its existence was “to secure for workers by hand and brain the full fruits of their labour”, though admittedly they had to abandon that as impractical. But no one has yet come up with a persuasive explanation of why there is a moral need to give shareholders a bigger share and employees a smaller share than current practice. There is no reason to think that shareholders have a longer-term outlook than employees. Most employees expect to stay at their firm for several years. Equity investors look at performance every day. Even if an investment bank paid a much higher proportion of revenue to its shareholders than it does now, once the change had happened it would need to produce continuing and rapid profit growth. Trading operations in big banks aim for big profits because that is what the shareholders want.
There are perfectly legitimate questions to ask about the role of the financial sector, especially given that it only exists in its current form because of huge government generosity. It goes against all fairness that failure should be rewarded on an enormous scale. The concentration of power in the market in a few big players does not just risk dangers if one of them fails; it raises concerns about the extent to which they can make excess returns at the expense of the rest of the economy.
These are big issues which governments in the US and UK have chosen to run away from. But those problems will not be addressed by playing around with superficial controls on what the banks pay their staff.