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Yesterday, four former bosses of UK’s RBS and HBOS (former HBOS chief executive Andy Hornby, former HBOS chairman Lord Stevenson, former RBS CEO Sir Fred Goodwin and former RBS chairman Sir Tom McKillop) faced the Treasury Select Committee for a questioning session about their role in the financial meltdown and the disasters that came to befall their banks.

The key snippets of this session, which has been dubbed “the show trial” for all the public apologies it started off with, can be found here.

Read the rest of this entry »

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Much has been said over the past few months about the responsibility of regulators in the current global financial crisis. I’ve written about it myself back in September suggesting that they are yet to acknowledge their role and their own failings.

Three months on, it still seems that the regulators are either in denial, or suffering from a debilitating shock of their own past incompetence, as we are still not seeing much positive change from them. Even with the current obvious trend for greater regulation promoted on the government level, there is no clear evidence of regulators stepping up their game.

What do I mean by that, I hear you say? Well, there are two aspects to this. The first one is about acknowledging regulators’ failure to prevent the financial crisis – and in this, I am going to specifically focus on auditors in this post. The second aspect is about regulators changing their attitudes immediately, not at some point in the future. That would be the subject of another post.   Read the rest of this entry »

The role of stratospheric banking bonuses in encouraging the culture of greed and excessive short-term risk-taking by bankers has now been fairly widely publicised in the context of the financial meltdown of 2008. Is this the full story, however? Should bonuses be reduced, controlled, set differently, or abolished altogether?

Conflicting interests: The biggest problem that massive remuneration packages cause is the misalignment between the interests of bank executives, who want to maximise their year-end cash reward by any means open to them, and the companies’ shareholders, who are interested in long-term growth and stability of their investments. There is thus a different appetite for risk between these groups: bankers are risk-takers as incentivised by their pay structure; shareholders are much more risk-averse.

Banks’ top management will say all the right things about the duty they have to responsibly manage their shareholders’ investments. The truth remains, that if one’s banking bonus is many times the basic salary, in the heat of daily deal-making and profit-chasing it seems all too easy to forget this duty to the ultimate investor. It seems that presently, there is no 100% effective mechanism ensuring bankers are fulfilling their responsibilities to look after this money.

Ultimately, if a banker messes up and loses their firm a lot of money, they tend to be able to find another job elsewhere. And they might not feel strong pangs of conscience – as the money they gambled never felt like it was their own, duty to the shareholder forgotten, and their own assets retained. However if shares become worthless, shareholders feel the pain immediately as it was their own money.

Fancy words: Whilst banks’ management will all say (in AGMs, on their mission statements, in the press, etc) that they aim to maximise shareholder value, effectively they often allow more junior staff to do this with risky strategies that take a short term view despite being long term in their execution. This can backfire like it did with sub-prime mortgage investments in America: bankers who packaged these very dubious loans and sold them on as over-rated investment bundles only wanted to earn a bigger bonus in that particular year.  

Internal compliance and risk control departments – here to give comfort to senior management that all is well – cannot have kept tabs on such activities effectively, otherwise banks would not have gotten into trouble.

Thus we have a lack of accountability of the real deal-makers, plus a disconnect between senior management’s eloquent words of responsibility to shareholders and the reality. The few high-profile court cases where senior people were brought in before legislative bodies to answer for the negligent financial misdeeds of their firms are presently the exception, not the norm. And the real deal-makers are never being brought in to answer.

Banking bonuses in recent years: Let’s look at some recent numbers.

UK: In 2006, 4000 people earned more than £1m each in bonuses in the City of London.

In 2007, with the global credit crunch already in full swing, City million-pound bonuses seem to have been given to over 4200 people. In total, the City paid out about £14 billion in bonuses for 2007 to 1 million City employees – an increase of 30% on 2006 (2006 bonuses: $10.9bn. Source – Office for National Statistics (ONS) ).

Overall, bonus payments in the UK financial sector have more than trebled since 2003, when about £5bn was paid out (Source: ONS).

US: Wall Street bonuses were approximately $24 billion in New York City for 2006. In 2007, despite the credit crunch, mounting billion-dollar losses and write-downs on Wall Street, bonuses were $38 billion.

So, we can see that bonuses have been on the rise up until 2008, the year when the proverbial really hit the fan. Bankers have been heard justifying the increase in 2007 bonuses citing large profits of early 2007, before the credit crunch really hit. Yet again, it just shows bankers taking a short-term view of their activities.

Are bonuses to blame for the current crisis?  To some extent, yes, although there is a danger of over-focussing on bonuses themselves as THE only culprit.

We have seen how the promise of bonuses can encourage short term irresponsible risk-taking. But some trading strategies can yield large profits in a short space of time and not destabilise the bank.

What is really missing is the ability of management to assess the riskiness of activities of its deal-makers, and adjust their bonuses accordingly – not just look at the bottom line profit number earned in the current year.

For instance, if the effect of banker’s transaction can be felt over several years, rewards for its success should be deferred and spread over a number of years years and not paid immediately. So if a deal goes sour in the longer run, the individual will not get rewarded for it at all.

To encourage longer-term view of banking, more bonuses should be paid in shares or options rather than cash. Such share or option schemes can be sellable only several years down the line, encouraging the individual to stay with the firm, work hard and wait for their incentive schemes to come into force.

And I think that there needs to be more accountability by more layers of bankers – not just top CEOs and an odd rogue trader. Regulations should be watertight so that irresponsible behaviour is easier to spot and stop, and if need be taken to court.

Will bonuses be reduced? In the short term, definitely. 2008 bonuses are expected to fall 60% in the City.

However big bonuses are probably here to stay to some extent. This is partially because bankers make big investments to get top jobs (an MBA can set you back £100,000) – and give up their personal lives for their careers.

But crucially, I feel that the external regulators and internal risk controllers must step up their game and play a strong role in defining the guidelines and recommendations on how banking rewards should be set. The objective is to incentivise responsible risk-taking behaviour that takes a long term view.

If this line is taken and successfully implemented, then surely rewarding some exceptionally hard working bankers will not be such a big deal – as long as we know they are taking good care of our finances?

Then I would suggest the answer becomes – bonuses should to some extent be controlled through following new regulatory guidelines and should be set using different methods and types of incentive, but not abolished or reduced on a whim.  

… but the culprit goes unpunished today: What hurts most is that even as the global credit crunch is unravelling this year, bankers who caused it and earned their massive bonuses in recent years are currently in the Bahamas sunning themselves not knowing how to best spend their money.

Apparently there is a real shortage of luxury accomodation in exotic tropical destinations.

And that really shows that we are letting the real culprits get away with it today.

 

Copyright 2008 by CuriouslyInspired

Today I feel like I am reaching my own personal point of saturation with bad news relating to the Big Financial Meltdown.

Not that I am about to panic, no way. It’s just that there is so much of it, and it is coming through so fast, that I feel that the initial “edge” has been taken off it. It does not seem quite so appalling anymore. I am coming to terms with it.

I am familiar with this feeling. A long time ago the country I have strong ties with started opening up its archives and started sharing details of its horrible past with its citizens. And we gorged ourselves on the gory details of mass murders, betrayals, poverty and the limitless lust for power of our leaders until we could take no more bad news. We felt low and worthless as a people, and every trouble that was coming to us was just and fair because we deserved no better. People competed in painting their own nation in the blackest colours possible – this became a sick national obsession for a while. Then the information we learnt about our past became part of the everyday life and either faded away, or caused a backlash in aggressive patriotic feeling which is still rife.

So, the Credit Crunch. The Big Meltdown. It’s easy to get obsessive with it. It’s easy to look for someone to take the blame and then kick them. I’ll offer this thought for your consideration: we are all responsible to some extent. Sure enough, many of our governments fanned the fires of irresponsible lending with abandon. Bankers greedily chased quick profits and drove their own employers’ firms into the ground in the process – and I would love to see them in court and their assets confiscated. And regulators failed miserably to spot the rot. Sure, the trust in “government bodies” has gone and might not return for a long time, if ever.

But we all gorged ourselves on consumer credit, plunged our money into investments that were bound to go up-up-up and never-ever stop, buy ever bigger houses etc. We all lost our heads. And no-one really thought that it looked too good to be true and would end. Perhaps we should have. We might all have been, to some extent, part of the problem.

We are where we are and life carries on. So however the meltdown crisis impacts us personally, and I am sure it can be bad and it might get worse, we need to accept it, get on with it and make do as best we can. I’ve read some wonderful thoughts in other blogs putting the current calamity in perspective by considering how people survived the Great Depression. Something similar might yet come – but people lived to tell the tale. We will as well.

And one day future students will be tasked to write an essay “The 2008 Global Financial Meltdown. Discuss the relative merit of available solutions in 2000 words“.

 

Copyright 2008 by CuriouslyInspired

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