Fresh blow to the City based on a false analysis of the crisis

Allister Heath
EVERY company in the world knows that incentive schemes have to be properly worked out and supervised. A sales person – be it in a car dealership, an estate agent, a shop or a bank – who earns a commission – an older, less loaded, word for a bonus – will have an incentive, without checks and balances, to cheat potential customers. But the answer is to make sure that they cannot do that, introduce procedures and guidelines, measure customer satisfaction, introduce customer cooling off periods, defer payouts and so on.

As every businessperson knows, one can incentivise staff to perform, and align their interests with that of their organisation, without causing chaos. Of course, performance related pay isn’t always necessary but well thought out schemes make sense.

I have no doubt that investment bank pay was often badly structured, in many but not all organisations, prior to 2008. It was hardly as uniformly problematic as many critics believe – Lehman Brothers staff owned substantial stakes in their firm, for example. Too many of the payouts were excessively short-termist – but many were not.

There has been a complete revolution in the structure of pay since then, including a greater deferral of payouts, and the ability to cancel (or “claw-back”) unpaid bonuses if they turned out to be based on unsound transactions – will have rectified this.
There is no evidence to suggest that flawed compensation practices were the key – or even a major – driver of the crisis. They wouldn’t even make any honest top ten list of its causes, which include factors such as flawed inflation targets that omitted asset prices, low central bank interest rates, depressed yields on long term loans caused by global imbalances and savings gluts, government policies to promote sub-prime lending, banks’ insufficient capital and liquidity, absurd Basel rules that incentivised securitisation, incorrect mathematical models, useless credit rating agencies and a massive over-optimism and collective madness which led to huge but genuine errors of judgement.

Too much money was lent far too cheaply to far too many dud, usually property-based projects; thousands of institutions ended up exposed. The EU’s bonus cap would not have changed any of this. Sure, bonuses enable companies to execute bad decisions more efficiently – but sub-prime lending would have happened anyway, albeit perhaps a little bit more slowly, had bonuses been 200 per cent rather than 400 per cent of base pay.

At the time governments, regulators, central bankers, academics, credit rates, accountants, bank CEOs and bank employees all thought sub-prime was fine, CDOs were fine and very low levels of capital were fine. Bonuses merely facilitated errors that would have happened anyway. Of course, they also encouraged some criminal actions and fraud – but that was either a failure of policing and supervision, or one of contract design.

Sadly, the EU is using a fake narrative of the crisis to continue its power grab. It wants to cripple the City, and couldn’t care less if global firms move staff out of London, if it becomes impossible for the likes of Standard Chartered to remain based here and subject to these rules on all of their global operations, or if Barclays becomes uncompetitive in its crucial New York market.

Brussels’ attempt at wage controls is an outdated, scandalous, absurd and self-defeating edict which will destroy jobs and reduce tax receipts. Those City grandees that continue to defend our increasingly indefensible relationship with the European Union have a lot of explaining to do.
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