In his pre-Budget report today, Alistair Darling announced proposals to double tax bankers’ bonuses – a 50% super tax paid by banks on any bonuses paid to employees over £25,000 on top of the normal income tax payable by bankers on their bonuses for the year to 31 December 2009. Is he right to levy a punitive tax on bankers’ bonuses in this way? And, even if this is a one-off levy, what message does it send to the outside world about the UK’s readiness to portray itself as a global financial centre?
Bankers’ bonuses
The British Bankers’ Association has taken a tough line against the government’s willingness to bash bankers for electoral gain. They argue that if you pay peanuts, you get monkeys, so big bonuses are justified in order to attract and retain the talent we need to bring our banks back to profitability.
Yet bonus systems for banks seem to work in a different way than for the rest of us. Bonuses are meant to reward good performance. Most bonus systems require two conditions before a large payout is made to an individual. The first is that the individual’s performance must exceed expectations and the second is that the company’s profits justify a payment.
Many would argue that neither condition has been met in the case of many bankers: for example, some of the executives in line for large payouts were the same ones that were in charge at the height of the banking crisis last year; moreover, if the ‘bonus period’ were measured over the last two years, rather than the generally accepted bonus period of one year, many banks that claim to be profitable in 2009 would in fact be reporting record losses over the last two years.
Profit manipulation by banks is a real risk for shareholders of banks. After all, many bank executives told their shareholders that they had made record profits in 2005 and 2006, only to hit them with some of the biggest losses (and bankruptcies) in corporate history just a year or two later in 2008. The problem with banking is that it you never know how much profit you’ve made each year. It’s always a guess. And that’s because banks are different to any other industry.
If you read Ford’s accounts, things are pretty simple. They bought this much steel, this much plastic, put it together with a bit of electronics and wheeled out this many cars. Make a few adjustments and hey presto, this is your profit – or loss in their case. The key thing is, in the majority of industries, most of that profit is actually generated by selling your product and banking the cash. Profits will, of course, be manipulated by accounting provisions and be affected by year end stock levels. But the maximum stock a car company, say, might hold could be a month’s worth of cars, maybe two months.
At a bank the maximum stock – by way of loans – could be ten, perhaps twenty years. But whilst banking profits can only be realised in the long term, bonuses are paid out in the short term. If things turn sour from one year to the next and you’ve paid out too much in bonuses – tough shit.
Banks calculate a big element of their profits not by what they’ve sold, but by pricing what they haven’t sold. In the jargon, it’s called mark to market. These profits are sent up or down at the click of a computer mouse. They’re not based on real sales – like they are at Ford, or Apple or McDonalds. They’re based on guessing the value of their assets. The higher the valuation of those assets, the higher the bonus pool for the banks’ key executives.
If you think it’s easy to mark to market, have a word with Ben Bernanke. The Fed Chairman said on Tuesday 17 November 2009, “It’s inherently extraordinarily difficult to know whether an asset price is in line with its fundamental value.” If the world’s most powerful central banker finds it difficult to value banking assets – which directly impact bank profits – why would you trust a bank’s employees (whose bonuses depend on the outcome) to do it?
Some would say that if you live by the sword die, you should die by the sword. The sword of bankers is capitalism. The first rule of capitalism is that you should protect capital; yet all banks failed to do that. The second rule of capitalism is that it is survival of the fittest; yet bankers expect taxpayers to bail them out when they lead their businesses to the brink of bankruptcy. The third rule of capitalism is that the providers of capital should reap the biggest rewards. Yet the biggest provider of capital to UK banks over the last year has been the UK government – on behalf of the UK taxpayer. We have provided direct capital injections into banks like RBS and HBOS and indirect support to banks like HSBC and Barclays, who would have lower profits had taxpayer’s money not come to their assistance. Yet, as the largest provider of capital, the UK government seems to have little control over how that capital is allocated. No doubt that is partly because the capital was handed over to the banks at a time of crisis, when the Treasury was more concerned about averting financial meltdown than negotiating a good deal for the taxpayer. Yet now, after averting the banks from bankruptcy, the banks seem to be in a state of ‘employee capture’. Employees are grabbing capital provided by their shareholders to enrich themselves rather than using it for the intended purpose – to recapitalise the banks. The profits generated from the owners of capital are not going back to them, but being diverted to labour. That’s not supposed to be how capitalism works.
And that’s because capitalism in the banking sector has been distorted by moral hazard - the concept that bankers will continue to take excessive risks with other people's money as long as they know that the government will be there to bail them out.
The concept of moral hazard is against the instinct of all free market economists. In capitalism, if you take big risks and fail, you go bankrupt. That’s the end of it. In the banking sector however, several banks took large risks, secure in the knowledge that – because they were too big to fail – we would never let them go bankrupt. In September 2008, the former US Treasury Secretary Hank Paulson called Lehman Brothers’ bluff on this and let them go under, but he got heavily criticised for it afterwards, with some commentators blaming him for the subsequent carnage in the wider economy as banks refused to lend to each other. Since then the global banking sector has received support from taxpayers amounting to 5% of global output, according to The Economist. Banking profitability is directly linked to the taxpayer support they received. And the rewards for that capital support, in a capitalist society, should go to the providers of capital – us – yet governments appear to be unable to stop those rewards from falling into the wrong hands.
Even George Soros, the legendary hedge fund manager, told the Financial Times a few weeks ago, that “Those earnings [referring to bankers’ bonuses] are not the achievement of risk-takers. These are gifts, hidden gifts, from the government.”
The UK as a global financial centre
Whilst the question foremost in the minds of UK taxpayers is why their money is being used to pay bankers’ bonuses when it should be used to rebuild the capital base of our banking system, the bigger question is this. What do we want the UK banking industry to look like in five years’ time? And how do we shape regulatory policy to achieve that vision?
Today financial service revenues account for around 10% of UK output. By global standards that is relatively high. Proponents of a large financial services sector argue that the UK should protect its overgrown banking sector and continue to focus on what it does best. Opponents argue that the costs of insuring our banking sector are simply too high and the industry itself is not paying a high enough premium to taxpayers for the insurance that taxpayers provide. There is nothing wrong with having an oversized banking sector, provided we understand what that means – it means we, as taxpayers, are taking on more risk.
What this banking crisis has illustrated beyond any doubt is that risks taken by the UK’s investment bankers are synonymous with risks taken by the UK taxpayer, because when things go sour, it is the taxpayer that picks up the bill. In extreme cases, the bill racked up by a poorly regulated banking sector can bankrupt an entire nation, as was the case in Iceland. Other countries are showing signs of heading that way too. A couple of weeks ago, the government of Dubai indicated that it would not honour the debt commitments of companies it wholly owns. Greece has this week seen its sovereign debt downgraded to BBB+. The UK itself has received several warnings from rating agency analysts that its sovereign debt may be downgraded if adequate plans to reduce public borrowing are not forthcoming by the time of the election to be held by June 2010 at the latest.
The bigger the UK investment banking sector, the bigger the risks to the UK taxpayer, because the game of investment banking is a game of risk taking. And it is not bankers that take the ultimate risk, it is the country. So, as custodian of UK plc on behalf of us taxpayers, it is the UK government, as chief risk taker, that needs to decide whether it is in the UK’s national interest to have such a large financial services sector.
And if the government concludes that the risk levels are too high, given the size of the UK economy as a whole, it has a duty to manage that risk by downsizing the UK banking sector.
Wednesday 9 December 2009
Bankers as the baddies ... Never!
[First published on CrimeTime, 10 July 2009]
In 2002, after many years in the City, I left corporate banking to set up independently. In my spare time I wrote “City of Thieves” – the story of one man’s fight to protect his honour in a world where honour holds no value.
When you’ve worked in any industry for long enough, you reach a point when you ask yourself a simple question: “Do I do what is right, or do I do what makes money?” All industries have an unethical side to them – the tobacco industry denied that their product caused cancer; the supermarket industry destroyed the quaint look of our high streets; and the motor car industry poisoned our planet. But ethics within the banking industry are fundamental to its very existence: banks don’t sell cigarettes, food or cars – they sell trust. You go to a bank, you hand over your money and you trust that the bank will return your money whenever you ask for it. When an industry is based on trust, there is always scope for abuse.
Over the last two decades, as Western governments gradually relaxed regulatory controls over the banking sector, bankers began to systematically abuse that trust. They used their customers’ money to make high risk bets. When the profits came rolling in, they paid themselves huge bonuses; but when the bets turned sour they walked away leaving the taxpayer to foot the losses.
The City, by virtue of what it is, attracts very clever people. But is also attracts greedy, evil, dysfunctional people – people that some psychiatrists might say harbour serious character flaws. In order to understand the mess the City is in today, you need to get inside the minds of some of the leading players who messed it up – minds that can be filled with a toxic mixture of greed, arrogance and self-importance. Some of the egos in the City are so far off the ground you’d need a lasso to drag them down to earth.
The culture of greed, arrogance and deceit that investment banks had fostered for years is now facing intense public scrutiny. There were many contributors to the banking crisis we all now face, but unethical working practices within the investment banking sector played a pretty big part. And despite politicians’ best efforts many of these practices still remain rife in the City today.
‘City of Thieves’ is the story of an analyst who dared to challenge such working practices. It’s a murder thriller written from the perspective of an outsider entering the unforgiving world of investment banking. Whilst the book is pure fiction, the issues it raises – particularly the rules, the ethics and the culture within the City – are very real.
All throughout my career I saw the good guys in the City fall like flies. Those who put their principles first were laughed at and shown the door. They weren’t part of the club. Greed was good. Ethics were for wimps - they were what losers clung to when the battle was long over. Well, today nobody is laughing at the good guys. There aren’t enough of them.
The problem with human nature is that we never really see things clearly until they smack us in the face. Back in 2003, once I had finished my manuscript, I sent it out to several agents. Not a single one was interested. Dismissively, they told me that “a story of the greedy world of banking would never sell.” Five years later the credit crunch came along and I had more literary offers than I could handle. The other problem with human nature is that we never learn from our mistakes.
In 2002, after many years in the City, I left corporate banking to set up independently. In my spare time I wrote “City of Thieves” – the story of one man’s fight to protect his honour in a world where honour holds no value.
When you’ve worked in any industry for long enough, you reach a point when you ask yourself a simple question: “Do I do what is right, or do I do what makes money?” All industries have an unethical side to them – the tobacco industry denied that their product caused cancer; the supermarket industry destroyed the quaint look of our high streets; and the motor car industry poisoned our planet. But ethics within the banking industry are fundamental to its very existence: banks don’t sell cigarettes, food or cars – they sell trust. You go to a bank, you hand over your money and you trust that the bank will return your money whenever you ask for it. When an industry is based on trust, there is always scope for abuse.
Over the last two decades, as Western governments gradually relaxed regulatory controls over the banking sector, bankers began to systematically abuse that trust. They used their customers’ money to make high risk bets. When the profits came rolling in, they paid themselves huge bonuses; but when the bets turned sour they walked away leaving the taxpayer to foot the losses.
The City, by virtue of what it is, attracts very clever people. But is also attracts greedy, evil, dysfunctional people – people that some psychiatrists might say harbour serious character flaws. In order to understand the mess the City is in today, you need to get inside the minds of some of the leading players who messed it up – minds that can be filled with a toxic mixture of greed, arrogance and self-importance. Some of the egos in the City are so far off the ground you’d need a lasso to drag them down to earth.
The culture of greed, arrogance and deceit that investment banks had fostered for years is now facing intense public scrutiny. There were many contributors to the banking crisis we all now face, but unethical working practices within the investment banking sector played a pretty big part. And despite politicians’ best efforts many of these practices still remain rife in the City today.
‘City of Thieves’ is the story of an analyst who dared to challenge such working practices. It’s a murder thriller written from the perspective of an outsider entering the unforgiving world of investment banking. Whilst the book is pure fiction, the issues it raises – particularly the rules, the ethics and the culture within the City – are very real.
All throughout my career I saw the good guys in the City fall like flies. Those who put their principles first were laughed at and shown the door. They weren’t part of the club. Greed was good. Ethics were for wimps - they were what losers clung to when the battle was long over. Well, today nobody is laughing at the good guys. There aren’t enough of them.
The problem with human nature is that we never really see things clearly until they smack us in the face. Back in 2003, once I had finished my manuscript, I sent it out to several agents. Not a single one was interested. Dismissively, they told me that “a story of the greedy world of banking would never sell.” Five years later the credit crunch came along and I had more literary offers than I could handle. The other problem with human nature is that we never learn from our mistakes.
Friday 4 December 2009
"City of Thieves", Prologue
'City of Thieves' by Cyrus Moore
Published by Sphere, 2 July 2009
Prologue
16 November 2007
‘What does your gut tell you?’
‘My gut tells me I’m right. The problem is I don’t have Larry’s support.’
‘Larry doesn’t know what he’s talking about.’
‘Maybe. But he’s my boss.’
Charlie took a sip of wine and placed his glass down firmly on the table. ‘Hold your ground and Larry will respect you. You won’t last a minute without his respect.’
‘I’m just scared that if I go out on a limb with this one, then I’m fucked.’
‘You’re fucked anyway, kiddo. Look, anyone who tries to predict the future is going to screw up at some point. But right or wrong is not what’s important in this business. If you want to be a winner in this game, you need to follow my three little rules.’
A waitress glided over to take their order. Charlie dismissed her with a wave of his hand. ‘Rule number one: stand up for what you believe in – your reputation is all you’ve got,’ he declared. ‘Rule number two: don’t follow the crowd – if you can’t think of anything original to say, keep your mouth shut. And rule number three …’ He looked furtively right and left, leaned forward and eyed Niccolo with steely precision. ‘… never trust anyone in this business. They’re all a bunch of dirty, lying motherfuckers.’
Published by Sphere, 2 July 2009
Prologue
16 November 2007
‘What does your gut tell you?’
‘My gut tells me I’m right. The problem is I don’t have Larry’s support.’
‘Larry doesn’t know what he’s talking about.’
‘Maybe. But he’s my boss.’
Charlie took a sip of wine and placed his glass down firmly on the table. ‘Hold your ground and Larry will respect you. You won’t last a minute without his respect.’
‘I’m just scared that if I go out on a limb with this one, then I’m fucked.’
‘You’re fucked anyway, kiddo. Look, anyone who tries to predict the future is going to screw up at some point. But right or wrong is not what’s important in this business. If you want to be a winner in this game, you need to follow my three little rules.’
A waitress glided over to take their order. Charlie dismissed her with a wave of his hand. ‘Rule number one: stand up for what you believe in – your reputation is all you’ve got,’ he declared. ‘Rule number two: don’t follow the crowd – if you can’t think of anything original to say, keep your mouth shut. And rule number three …’ He looked furtively right and left, leaned forward and eyed Niccolo with steely precision. ‘… never trust anyone in this business. They’re all a bunch of dirty, lying motherfuckers.’
Thursday 3 December 2009
What made me write "City of Thieves"
In 2002, I left the investment banking sector.
I didn't fit in: my ego wasn't big enough; my swagger wasn't arrogant enough; and my car wasn't flash enough. More importantly, I didn't WANT to fit in with this crowd.
Even back in 2002, the atmosphere in the City was claustrophobic to anyone with the faintest hint of a personal code of ethics. There were so many things wrong with the City, it was difficult to know where to start - it was greedy, it was corrupt and it was riddled with conflicts of interest. I felt so strongly about it, that I took a year off that year and wrote a book on the subject.
“City of Thieves” is a page-turning murder thriller set in London’s thriving investment banking sector in the days leading up to the credit crunch. Whilst the story is fictional, the issues it raises are very real.
When I first sent the manuscript out to literary agents - in 2003 - I got a long list of rejections. The standard response was, "Great story ... but a novel about greed and corruption in the investment banking sector? Sorry, pal, it'll never sell." So the manuscript gathered dust on my bookshelf for the next five years. Then the credit crunch thing happened, and I suddenly had more offers than I could handle.
Little Brown published the book on 2 July 2009 and it is now available in the UK, Europe and most of Asia. The first edition has already sold out and Chinese, French and Dutch translations will be coming out in May 2010.
Since the release of "City of Thieves" I have been amazed at the diversity of the book's fan base. Lawyers love it because bankers are the bad guys. Bankers love it because it reminds them of some of the characters they work with. Undergraduates looking for a job in the banking sector tell me it's really opened their eyes about their future career - I remember one young graduate who recently told me, "City of Thieves taught me what text books on banking never could - what it FEELS like to work in the City."
I haven't had a chance to get back to every single one of you, so if you've read the book and liked it, I just wanted to say, "Thanks."
I didn't fit in: my ego wasn't big enough; my swagger wasn't arrogant enough; and my car wasn't flash enough. More importantly, I didn't WANT to fit in with this crowd.
Even back in 2002, the atmosphere in the City was claustrophobic to anyone with the faintest hint of a personal code of ethics. There were so many things wrong with the City, it was difficult to know where to start - it was greedy, it was corrupt and it was riddled with conflicts of interest. I felt so strongly about it, that I took a year off that year and wrote a book on the subject.
“City of Thieves” is a page-turning murder thriller set in London’s thriving investment banking sector in the days leading up to the credit crunch. Whilst the story is fictional, the issues it raises are very real.
When I first sent the manuscript out to literary agents - in 2003 - I got a long list of rejections. The standard response was, "Great story ... but a novel about greed and corruption in the investment banking sector? Sorry, pal, it'll never sell." So the manuscript gathered dust on my bookshelf for the next five years. Then the credit crunch thing happened, and I suddenly had more offers than I could handle.
Little Brown published the book on 2 July 2009 and it is now available in the UK, Europe and most of Asia. The first edition has already sold out and Chinese, French and Dutch translations will be coming out in May 2010.
Since the release of "City of Thieves" I have been amazed at the diversity of the book's fan base. Lawyers love it because bankers are the bad guys. Bankers love it because it reminds them of some of the characters they work with. Undergraduates looking for a job in the banking sector tell me it's really opened their eyes about their future career - I remember one young graduate who recently told me, "City of Thieves taught me what text books on banking never could - what it FEELS like to work in the City."
I haven't had a chance to get back to every single one of you, so if you've read the book and liked it, I just wanted to say, "Thanks."
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