Keep Bureaucrats’ Hands Off Bankers’ Bonuses

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By Mark Gilbert

The Manchester United soccer club recently agreed to pay Colombian striker Radamel Falcao a salary that equates to about $61,000 a day. That’s a lot of money to run around a field kicking a bag of wind. But, provided their tax affairs are in order, what athletes earn, or movie actors or rock stars or chief executive officers, is none of the government’s business. And the same applies to bankers, with one important caveat.

The European Union wants to limit bonuses to no more than twice what a banker earns in fixed annual pay, in rules scheduled to begin next year. The U.K., with an economy more dependent on financial services than those of its EU neighbors, is fighting the cap at the European Court of Justice this week.

The motivation for scrutinizing pay in the banking industry is sensible. Traders shouldn’t make short-term profits from long-term liabilities, and private gains shouldn’t become public losses. If the world of finance is operating with the implicit blanket guarantee of a taxpayer bailout when things go bust, then the taxpayer’s regulatory representatives have a right to study pay arrangements.

Capping bonuses, though, is the wrong remedy, leading to what U.K. Chancellor of the Exchequer George Osborne has called “damaging consequences and perverse incentives.”

For one thing, banks game the system to make base pay a bigger share of total compensation. That in turn means traders have less skin in the game, with the unintended and undesirable consequence that rash risk-taking may increase rather than diminish. I’d almost rather a mendacious banker was able to pocket an enormous amount, then return much of it if things go awry in later years, as proof to others that any ill-gotten gains will be recovered.

Better mechanisms exist to align risk and reward in the post-financial crisis environment. Deferred bonus plans, along with clawback mechanisms permitting regulators to demand repayment if subsequent years suggest malfeasance or negligence, should prevent risky short-term speculation from sowing future losses while rewarding today’s recklessness. Delivering bonuses in the form of whatever securities generated the profits in the first place align the interests of financiers and their customers. All are preferable to monetary or ratio limits.

Unless the world decides to outlaw the buying and selling of securities for profit, traders should be able to share in the gains they make. Consider the case of Chris Rokos, currently suing his former employer Brevan Howard in the Jersey courts. Rokos earned a stratospheric $900 million or so during his time at the hedge fund, the court papers show; calculations by Bloomberg News, though, suggest he generated profits of more than $4 billion for the firm. Why shouldn’t a star trader at a bank able to replicate Rokos’s trading success also be able to emulate his income?

If Manchester United judges that Falcao will help it win more trophies, sell more replica shirts or attract more eyeballs to its televised games, it’s free to pay him whatever it chooses. If shoehorning Robert Downey Jr. into a robot outfit is what the director decides a film needs, Downey is free to charge whatever he can get away with for his services. And if taxpayers are still underwriting the finance industry’s adventures in casino-land, the true solution is to remove the banking safety net, not introduce pay barriers.

 

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