[Reader-list] [Urbanstudy] "regulators should intervene in banker's pay" by Martin Wolf

[Anirudh]

The answer?

http://www.theatlasphere.com/columns/elder-mortgage-crisis.php
http://www.forbes.com/opinions/2007/12/03/predatory-business-act-oped-cx_yb_1204predatory.html

On Jan 18, 2008 9:11 AM, lalitha kamath <elkamath at yahoo.com> wrote:

> FYI
>
> Regulators should intervene in bankers' pay
>
> By Martin Wolf
>
> Published: January 15 2008 17:35 | Last updated: January 16 2008 05:16
>
> You really don't like bankers, do you?" The question, asked by a former
> banker I met last week, set me back. "Not at all," I replied. "Some of
> my best friends are bankers." While true, it was not the whole truth. I
> may like many bankers, but I rather dislike banks. I recognise their
> necessity, but fear their irresponsibility. Worse, they are
> irresponsible partly because they know they are necessary.
>
> My attitude to the banking industry is not a prejudice. It is a
> "postjudice". My first experience with out-of-control banking was when I
> watched the irresponsible lending that led to the devastating
> developing-country debt crises of the 1980s.
>
> The world has witnessed well over 100 significant banking crises over
> the past three decades. The authorities have even had to rescue
> important parts of the US financial system – on most counts, the world's
> most sophisticated – four times during the same period: from the
> developing country debt and "savings and loan" crises of the 1980s to
> the commercial property crisis of the early 1990s and now the subprime
> and securitised-credit crisis of 2007-08.
>
> No industry has a comparable talent for privatising gains and
> socialising losses. Participants in no other industry get as
> self-righteously angry when public officials – particularly, central
> bankers – fail to come at once to their rescue when they get into
> (well-deserved) trouble.
>
> Yet they are right to expect rescue. They know that as long as they make
> the same mistakes together – as "sound bankers" do – the official sector
> must ride to the rescue. Bankers are able to take the economy and so the
> voting public hostage. Governments have no choice but to respond.
>
> Nor is it all that difficult to understand the incentives at work. I
> gave the broad answer in my column, " Why banking is an accident waiting
> to happen" (FT, November 27 2007).
>
> It is the nature of limited liability businesses to create conflicts of
> interest – between management and shareholders, between management and
> other employees, between the business and customers and between the
> business and regulators. Yet the conflicts of interest created by large
> financial institutions are far harder to manage than in any other
> industry.
>
> That is so for three fundamental reasons: first, these are virtually the
> only businesses able to devastate entire economies; second, in no other
> industry is uncertainty so pervasive; and, finally, in no other industry
> is it as hard for outsiders to judge the quality of decision-making, at
> least in the short run. This industry is, in consequence, exceptional in
> the extent of both regulation and subsidisation. Yet this combination
> can hardly be deemed a success. The present crisis in the world's most
> sophisticated financial system demonstrates that.
>
> I now fear that the combination of the fragility of the financial system
> with the huge rewards it generates for insiders will destroy something
> even more important – the political legitimacy of the market economy
> itself – across the globe. So it is time to start thinking radical
> thoughts about how to fix the problems.
>
> Up to now the main official effort has been to combine support with
> regulation: capital ratios, risk-management systems and so forth. I
> myself argued for higher capital requirements. Yet there are obvious
> difficulties with all these efforts: it is child's play for brilliant
> and motivated insiders to game such regulation for their benefit.
>
> So what are the alternatives? Many market liberals would prefer to leave
> the financial sector to the rigours of the free market. Alas, the
> evidence of history is clear: we, the public, are unable to live with
> the consequences.
>
> An alternative suggestion is "narrow banking" combined with an
> unregulated (and unprotected) financial system. Narrow banks would
> invest in government securities, run the payment system and offer safe
> deposits to the public. The drawback of this ostensibly attractive idea
> is obvious: what is unregulated is likely to turn out to be dangerous,
> whereupon governments would be dragged back into the mess.
>
> No, the only way to deal with this challenge is to address the
> incentives head on and, as Raghuram Rajan, former chief economist of the
> International Monetary Fund, argued in a brilliant article last week ("
> Bankers' pay is deeply flawed", FT, January 9 2008), the central
> conflict is between the employees (above all, management) and everybody
> else. By paying huge bonuses on the basis of short-term performance in a
> system in which negative bonuses are impossible, banks create gigantic
> incentives to disguise risk-taking as value-creation.
>
> We would be better off with Jupiter's 12-year "year", since it takes
> about that long to know how profitable strategies have been. The point
> is that a year is an astronomical, not an economic, phenomenon (as it
> once was, when harvests were decisive). So we must ensure that a
> substantial part of pay is better aligned to the realities of the
> business: that is, is made in restricted stock redeemable over a run of
> years (ideally, as many as 10).
>
> Yet individual institutions cannot change their systems of remuneration
> on their own, without losing talented staff to the competition. So
> regulators may have to step in. The idea of such official intervention
> is horrible, but the alternative of endlessly repeated crises is even
> worse.
>
> The big points here are, first, we cannot pretend that the way the
> financial system behaves is not a matter of public interest – just look
> at what is happening in the US and UK today; and, second, if the problem
> is to be fixed, incentives for decision-makers have to be better aligned
> with the outcomes.
>
> The further question is how far that regulatory net should stretch. I
> believe it should cover all systemically important financial
> institutions. Drawing the line will not be simple, but that is a problem
> with all regulation. It is not insoluble. The question the authorities
> need to ask themselves is simple: if a specific institution fell into
> substantial difficulty would they have to intervene?
>
> If the conflict of interest that dominates all others is between
> employees and everybody else, then it must be fixed. All bonuses and a
> portion of salary for top managers should be paid in restricted stock,
> redeemable in instalments over, say, 10 years or, if regulators are
> feeling generous, five. I understand that the bankers will not like
> this. Yet one thing is surely now quite clear: just as war is too
> important to be left to generals, banking is too important to be left to
> bankers, however much one may like them.
>
> martin.wolf at ft.com
>
> Copyright The Financial Times Limited 2008
>
> cross-posted from DEBATE
>
>
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