Saturday, 23 January 2010

In defence of bankers' bonuses

"Bankers are greedy bastards ... they're paid obscene sums of money ... all they're interested in is getting rich quick."

No argument there then. At least not where investment bankers are concerned.

As some of the world's major banks announce astounding staff bonuses—on the back of record profits achieved through the benign conditions set up by alarmed governments—it's unsurprising that taxpayers want financial retribution. And alarmed governments are minded to respond.

But let's look at bankers' bonuses from the other side.

Suppose you are fortunate enough to have substantial capital to invest in the stock, bond or commodity markets. Or perhaps you are the treasurer of a large corporation seeking a profitable return on corporate funds. Or maybe you are a hedge fund manager needing access to market trading.

What you need is the services of a reliable investment bank.

Such banks over the last ten years became dominated by derivatives speculators: Guys who were pulling in container loads of synthetic profits without needing or caring to know whether real markets were up or down.

But those guys are now largely dead and buried, metaphorically speaking, along with all those non-performing derivative vehicles left on their, or other banks, books.

The guys that are left at such banks now are traditional investment banking traders—buying and selling stocks, bonds and commodities at a profit, if they follow the market right.

But, as an investor, how can you know such traders will really look after your money? How can you trust their judgement? How can you be confident that the precious funds you place into their management really mean as much to them as they clearly do to you?

The answer is simple. Traders are paid bonuses to make profits. Successful management of client accounts brings profits to the firm and bonuses are the bribe that ensure traders manage client accounts well.

But do they really need to be bribed to look after our money wisely? Can't they just accept a salary for doing their job like most everyone else?

Well, who would you trust with your money? Someone who is paid a fixed salary whether they're effective or useless? Someone who arrives at 9:30, leaves at 5:00, takes three hour lunches and wastes half their desk time playing poker online?

Or would you rather trust someone who focuses every working minute analysing the markets, trying to secure client profits, because profits mean big bonuses and that's what keeps them pinned to their desk?

It's a no-brainer really. Funny that most of us can't see it this way.

It must be because most investment bankers are greedy, are paid obscene amounts of money and just want to get desperately rich quick!

Tuesday, 5 January 2010

Avoiding crashes — a word from the wise

       I am instinctively sceptical of big government—whether it be authoritarian national government, or regional or global governance. Big government rarely, if ever, properly understands the problems it claims to address—witness the global financial crash.

However, the opposite alternative—allowing economic activity to proceed without monitoring or check—also has its downside: witness the global financial crash.

So what is the solution?

I'm not sure I have one. But the answer must lie closer to the factors of economic production than the factotums of authoritarian government. It's only at the sharp end of economic activity that true knowledge lies and practical observation takes place.

However, how do we encourage those involved in economic generation to regularly report on their businesses. And how can we trust what they say?

Government has many select committees that invite senior representatives to comment on their, often troubled, industries. But what imminent pre-crash truths could have been learned from the CEOs of Lehman Brothers or RBS? Certainly very little indeed, since they were totally ignorant of the dangers they were in, or were in denial, or would have simply remained economic with the truth to protect their positions.

Other bodies in UK, such as the BofE, FSA, ONS, etc., seek to obtain real-time data on economic activity to inform policy-makers. But as we see from the financial crash, such data can be insufficient, unreliable or misunderstood—or the facts simply get ignored.

I've been reading a narrative* about the financial crash in the US, seen from the inside viewpoint of a financial trader at Lehman Brothers. This particular guy worked in the distressed bond department, where the skills required were to anticipate corporate financial disasters and take timely action for the benefit of the bank's clients and the bank itself.

This department began to notice worrying signs about the US financial economy back in 2005. They were concerned about the growth of unregulated credit default swaps (CDSs), which became disembodied bets against corporate collapses, and the vast expansion of the housing mortgage market, led by brokers not deposit takers, which generated collateralised debt obligations (CDOs), packaged and quickly sold by banks like their own with the active assistance of the major US credit rating agencies.

While the specialist derivatives traders, egged on by the management board, raked in profits hand over fist, without apparent risk or applied banking skills, the guys in the traditional trading departments who dealt daily in value and risk watched this phenomena with growing concern but were unable to be heard against the tide of profitability and the belief that the holy grail of a self-generating financial nirvana had finally been found.

Suffice to say, the guys on the lower deck were right, the profit-crazed management supporting the derivatives traders were wrong.

But how do governments, regulators, and the public who are put at risk, obtain the right information from the right people to be able to make wiser judgements than in the recent past?

It may sound like another aspect of intrusive big government, reaching in to the rivers and streams of the land, but perhaps some communication forum needs to be found that regularly enquires into the temperature of industry and particularly finance. The unique feature of this forum would be that its participants would be middle managers rather than the leaders of industry. In other words, those who deal directly with the trades, the clients and the finances that make the cogs of our economy work. Difficult to achieve, particularly where whistle-blowing is involved, but possibly worthwhile for the result.

Given the experiences we've recently been through, there is a self-interest in coal-face managers revealing trends and potential risk. At Lehman Brothers, the 'distressed traders' group took its own action—taking massive short positions against the activities of its own bank. Sadly, this could never match the colossal debts that finally stuck on Lehman's books. Nor did it affect the $14 trillion dollars of toxic debt that Lehmans and other Wall Street banks had already spread throughout the US and then the globe.

If only these wise, traditional, but actively engaged managers had had a way to speak to someone with ears to hear—it might all have been so different.

* The book is: A Colossal Failure of Common Sense by Larry McDonald