Opinion

Hugo Dixon

Banks should learn to say “Just Go”

Hugo Dixon
Sep 24, 2012 08:44 UTC

Shortly after last year’s bonus round I was having lunch with the boss of an investment firm. He told me how he heard a handful of staff had been grumbling about what, by most people’s standards, were still extraordinary pay packages. He called them into his office and told them that, since they were unhappy, they should “Just Go”.

Most of them packed their things and left the firm. But the next day one came back and said he had been misunderstood. My interlocutor said he hadn’t misunderstood him at all. The employee clearly felt he was worth more than he was paid. He should take his luck and go elsewhere as he clearly didn’t have his heart in his current job. He should “Just Go”. And he duly did.

These words “Just Go” stuck in my mind because financial services bosses use them far too rarely. My lunch companion was perhaps an exception because his family is a big shareholder in his firm. Most other bosses are stewards for shareholders – and normally not terribly good stewards at that.

Of course, banking and investment bosses do have some equity in their firms but typically they don’t act like owners. They want to get paid a huge amount themselves. They also want to be surrounded by a phalanx of fawning minions who tell them they are masters of the universe. That boosts their egos. The best way of achieving that is to pay their minions millions, even if it costs the shareholders.

During the bubble years, pay in the financial services industry went through the roof. It wasn’t just for the stars either. Fairly ordinary middle-ranking bankers raked it in. Even after the bubble burst, pay has taken a long time to come down. The 2007 bonus round was a record. Although pay was reined in after Lehman Brothers went bust in 2008, it rebounded the following year.

More recently, especially in Europe, bankers have hit relatively hard times. Compensation is being cut and banks such as Deutsche Bank have said they will do more. But returns to shareholders are still miserable. What’s more, as the economic situation in much of the world remains challenging, the general public is resentful towards an industry that played a role in creating the current mess and which has had to be bailed out repeatedly with public funds.

Quite apart from infusions of capital into specific institutions, the whole market has been buoyed by massive injections of cheap money by central banks across the world – whether it is round after round of quantitative easing in America, Japan and the UK or the European Central Bank’s ingenious support operations.

The endless stream of scandals – money laundering, mis-selling of financial services, rogue trading and attempted manipulation of interests rates – has further sullied an industry comprising institutions such as Barclays, Deutsche Bank, HSBC, JPMorgan, RBS and UBS.

On a more technical note, high pay reduces the earnings that banks can squirrel away to build up their capital buffers as a protection against future crises. Although regulators are pushing for higher capital ratios, this can be achieved either by increasing the amount of equity in a bank or by cutting its lending. If banks put too much emphasis on the latter route, the economy will be put under further pressure.

The coming bonus round represents a golden opportunity to reset compensation to a much lower new base. What is needed is not merely to cut pay in line with reduced revenue, but something more radical – a significant drop in the proportion of the revenue pot devoted to staff. Although the final figures won’t be set for several months, now is the time to start planning.

What’s more, this is not something that should be left entirely to managers. Given that there is an intense shareholder and public interest in curbing pay in financial services, investors and regulators should get involved. They should call in bank chairmen and tell them they expect them to take advantage of the current, uniquely favourable, climate.

Managers will undoubtedly say that they are already cracking down on compensation and that it is best not to move too rapidly otherwise key staff will jump ship. But if shareholders and regulators give the same broad message to all banks – even if it is not their role to give specific instructions – there will be less risk of such poaching. With pretty much the whole industry downsizing in response to weak market conditions, there isn’t going to be that much appetite among rivals to hire.

It is perhaps too much to hope bank bosses to think about the public interest. But they are mostly smart individuals who can see how the winds of change are blowing. They understand that it could be in their personal interest to get ahead of the curve. Some of those who didn’t seem able to adapt to the new Zeitgeist – such as former Barclays boss Bob Diamond – have been defenestrated.

Bankers will always be tempted to play their own version of the game of Monopoly one more time and see if they can pass Go and collect another $200 (add several noughts). And, even in the current climate, there will be many who complain if their pay is cut. But the message to them should be the same as that given by my lunch companion: “Just Go!”

COMMENT

Reward is a driver in entrepreneurial success. Do we deny Carnegie, Pullman, Bill Gates, Donald Trump, Richard Branson their finacial reward? As BidnisMan identifies where the employee has no personal relationship with the investor the sense of responsibility diminishes whilst the motivation to generate commission without enhancing real wealth generation increases. Can smaller banks support the multi-national corporations? Those same corporations, that by switching production (or profit centres) between countries may have more immediate financial influence than the respective governments. Should the accountancy profession accept some of the accountability? or is national legislation that needs immediate review. One thing is certain. Ask the one in two Spanish or Greek schoolleaver who have no job if they benefited from the global behaviour of the financial sector. Can we see global social stability increasing? Is it possible to increase mutal respect both in our contributions as ecconomic units and to our social culture?

Posted by jfw | Report as abusive

Can EU defend supranational interests?

Hugo Dixon
Sep 17, 2012 09:56 UTC

European integration tends to advance first with squabbling then with fudge. Every country has its national interest to defend. Some politicians appreciate the need to create a strong bloc that can compete effectively with the United States, China and other powers. But that imperative typically plays second fiddle to more parochial concerns with the result that time is lost and suboptimal solutions are chosen.

Amidst the europhoria unleashed by the European Central Bank’s bond-buying plan, it is easy to miss the immense challenges posed by two complex dossiers that have just landed on leaders’ desks: the proposed EADS/BAE merger; and a planned single banking supervisor.

Look first at the plan to create a defence and aerospace giant to rival America’s Boeing. This has been under discussion since at least 1997 when the UK’s Tony Blair, France’s Jacques Chirac and Germany’s Helmut Kohl called on the industry to unify in the face of U.S. competition. London, Paris and Berlin are the key players in this game because they have the major assets.

Since 1997, progress has been patchy. Airbus, previously an awkward Franco-German-British consortium, was gradually turned into a proper company wholly owned by EADS – and EADS itself was created by the merger of France’s Aerospatiale and Germany’s Dasa. But Paris and Berlin insisted on a dysfunctional governance structure designed to balance their respective power rather than promote an effective organisation and EADS’ early years were bedevilled by scandal. What’s more, BAE opted to stay out of European integration, instead merging with Britain’s Marconi and going on a U.S. acquisition spree.

The cost of developing new products, such as fighter aeroplanes, is huge: Europe’s last major initiative in this area, the Eurofighter, was developed through another suboptimal consortium. If Europe can’t get its act together, BAE may eventually find itself swept into the arms of a large U.S. group and governments may ultimately be forced to buy American. Being dependent on even such a close ally should not be their first choice. So there is a strategic benefit in creating a streamlined European defence and aerospace group.

The best solution would be to merge EADS and BAE, and run the new group on commercial lines. The politicians would abandon their right to decide who would manage it or where its factories and research centres would be located. The most important interests of France, Germany and Britain could be protected by ring-fencing their secrets and giving each government a veto over any takeover of the group.

To be fair, the planned merger – which leaked last week – takes a big step in this direction. A complex shareholder pact, which balances French and German interests in EADS, would be scrapped. The private shareholders involved in that pact – France’s Lagardere and Germany’s Daimler – are also expected to sell out eventually.

The snag is that Paris would keep a stake of around 9 percent, potentially letting it pull the strings from behind the scenes. Both London and Berlin seem worried about that. Germany may also be queasy about a plan, so far unannounced, to locate the merged company’s defence HQ in the UK and its civilian aerospace HQ in France.

Even if these circles can be squared, Washington may cause trouble. BAE has been able to acquire a substantial U.S. defence business because of the special military relationship between London and Washington. If the U.S. administration concludes that the new group is effectively controlled by Paris, with which relations are cooler, it may put so many controls on its U.S. business that it becomes commercially unattractive.

It would be better if France sold out of the combined group and depoliticised it entirely. But that doesn’t seem on the cards.

Now look at the euro zone’s plans for a banking supervisor, for which the European Commission unveiled a blueprint last week. Again, the idea is sensible, albeit not a silver bullet. A centralised supervisor based on the ECB might be able to clean up the banking cesspit in places like Greece, Spain and Ireland. This could pave the way for struggling lenders to be recapitalised with euro zone money rather than national money. And that, in turn, could play a role in diminishing the euro crisis.

There are, though, at least two major problems. First, Berlin doesn’t want its local savings banks supervised by the ECB. This is largely a matter of protecting vested interests, as the Sparkassen are closely linked to local politicians. But it is precisely such incestuous relationships that caused mayhem with Spain’s savings banks, the cajas. It would set a bad precedent if Germany could cut a special deal for itself merely because it is the biggest boy in the euro class.

Second, how will the interests of the 10 countries that are part of the European Union but don’t use the single currency be protected as the euro zone moves ahead with banking integration? This is of particular concern for the UK, Europe’s financial capital. Under the European Commission’s plans, the 17 members of the euro would caucus together to decide on matters like technical rules for banking which cover the entire EU. London could therefore find itself perpetually outvoted.

There may be ways of squaring these circles. But, as with defence integration, politicians will need to keep their eye on the big picture even as they defend their legitimate national interests. That hasn’t always been their forte.

COMMENT

One would need officials elected from the whole of Europe having a big input to policy, or at lest trans-national political parties. But the surest way to get such parties is by have some powerful elected offices each one elected by the majority of the whole Europe.

Posted by Samrch | Report as abusive

Spain and Italy mustn’t blow ECB plan

Hugo Dixon
Sep 10, 2012 08:23 UTC

The European Central Bank’s bond-buying scheme has bought Spain and Italy time to stabilise their finances. But if they drag their heels, the market will sniff them out. It will then be almost impossible to come up with another scheme to rescue the euro zone’s two large problem children and, with them, the single currency.

Mario Draghi’s promise in late July to do “whatever it takes” to preserve the euro has already had a dramatic impact on Madrid’s and Rome’s borrowing costs. Ten-year bond yields, which peaked at 7.6 percent and 6.6 percent respectively a few days before the ECB president made his first comments, had collapsed to 5.7 percent and 5.1 percent on Sept. 7.

Most of the decline came before Draghi spelt out last Thursday the details of how the plan will work. What makes the scheme powerful is that the ECB has not set any cap to the amount of sovereign bonds it will buy in the market. The central bank’s financial firepower is theoretically unlimited, whereas the euro zone governments’ own bailout funds do not have enough money to rescue both Spain and Italy.

But the new type of intervention, christened “Outright Monetary Transactions”, has three important limitations.

First, the ECB will only buy a country’s bonds if its government agrees to a bailout programme with the euro zone, and sticks to “strict and effective” conditions detailed in such a deal. Second, the central bank will focus its purchases on bonds with a maturity of one to three years. Finally, Draghi has not specified how much he wants to drive down Madrid’s and Rome’s borrowing costs.

This fine print makes sense. But it also means that there is no free lunch. While the ECB seems unlikely to dream up new economic reforms for Spain and Italy, it will probably want their governments to put more precise time frames around what they are already supposed to be doing. The involvement of the International Monetary Fund, which has a somewhat unfounded reputation as a bogeyman, will also be sought. No wonder neither Spain’s Mariano Rajoy nor Italy’s Mario Monti is rushing to take advantage of the scheme.

Meanwhile, the ECB’s focus on short-term bonds means that Madrid and Rome would have to find some other way of issuing long-term debt – which accounts for 66 percent and 62 percent of outstanding debt respectively. If they lost access to the markets, the zone’s bailout funds would have to ride to the rescue. But they still wouldn’t have enough money for both countries.

What’s more, Spain’s and Italy’s borrowing costs are still too high for comfort. The ECB’s main justification for bond-buying is that investors are unfairly punishing them because of fears that the euro will break up. But it also recognises that the spread between their bond yields and Germany’s 1.5 percent 10-year borrowing costs is only partly due to such “convertibility risk”. It is also because of bad economic policies.

While there aren’t any scientific measures of convertibility risk, it seems like the bulk of it has disappeared since Draghi’s comments in late July. A reasonable guesstimate is that the risk of euro breakup might still be inflating Spanish yields by 1 percentage point and Italian ones by perhaps 0.75 percentage points. If the ECB used those numbers to guide its bond-buying programme, 10-year borrowing costs would drop to 4.7 percent and 4.4 percent respectively. To fall further, the countries would need to take more action themselves.

Although investors are currently relatively bullish about Spain and Italy, they are notoriously fickle. Rajoy and Monti should remember how the good mood, engineered at the start of the year by the ECB’s 1 trillion euros of cheap long-term loans to the zone’s banks, vanished with the spring. What’s more, both are facing tougher political challenges than they did at the start of the year when they were enjoying their honeymoons as new prime ministers. Each of their economies has declined this year and will continue to do so next year – shrinking roughly 5 percent over the two-year period, according to Citigroup.

For all these reasons, it is vital that Rajoy and Monti don’t dawdle. Assuming the German constitutional court this week backs the creation of the European Stability Mechanism, the zone’s permanent bailout fund, the Spanish prime minister should apply immediately for a programme.

Italy, a rich country, should still be able to avoid a bailout. But to do so it needs to cut its public debt, ideally with a vigorous privatisation programme and the creation of a wealth tax. With elections due next April and no guarantee that an effective government can be formed thereafter, there is only a tiny window for action. Monti’s technocratic government needs to jump through it.

The ECB has put its credibility on the line with its new bond-buying plan. Germany’s central bank, the Bundesbank, has attacked it on the grounds that it has come close to breaking treaty provisions banning the ECB from bailing out governments. For now, Draghi can withstand the criticism, as long as Angela Merkel keeps backing him. But if Rajoy and Monti don’t move fast, the ECB’s magic will wear off. And if its medicine then fails, it will be hard to conjure up the political will for an even more powerful concoction.

COMMENT

Hey, Hugo, 3 years is not so short. Buying three year sovereign bonds of countries the Ratings Agencies are sending into junk territory amounts to major gambling with a hostage public’s funds. As regards Spain, the government wants EU money, but they don’t want to do anything for it. Spaniards know which way the wind blows and they have been steadily withdrawing their cash from the banks. Those with professional skills at the high end of the employment market are leaving Spain. After all, the job market is so bad, close to one-third are unemployed. Imagine the pressure on working conditions for those who are employed! Clever Swiss job boards like http://www.qual.ch even target top Spanish (and Italian) professionals and executives for work in Switzerland. Both Spain and Italy are experiencing capital flight — money capital and human capital.

Posted by Robert-Q | Report as abusive