Money Talks

Two weeks ago the British Chancellor of the Exchequer announced a tax on the bonus money to be paid by British banks. There were several provisions around the implementation of the tax, but no question as to the two main reactions to the announcement: cheering from the ranks of folks who believe that the investment bankers out there are profiting at the expense of the rest of us, and utter aghast from the investment bankers and traders who were shocked, shocked, that their income (they think of it as earned income, not a bonus) was the target of the British taxing authorities.

Ever since the Credit Crisis hit us last year, and the U.S. government spent billions of dollars in an effort to “rescue” the financial economy, there has been an outcry from the rest of the country – as in, those who don’t work on Wall Street. Hank Paulson, the Treasury Secretary last September, gave all the major money center banks in the country money to keep them afloat. At least that’s what we were told. But as Lloyd Blankfein of Goldman Sachs has said in subsequent interviews, he thought they were well capitalized at the time, but they were forced to take the money anyway.

And once all those banks were being subsidized by the government, and starting to make money again, criticism began of all the money the bankers had made in the course of the crisis, off the fees they earned from underwriting mortgages and creating all those CDOs and CDSs from the mortgaged-backed securities. And they made a bundle. But now that the American taxpayers were supporting the big banks, there came rumblings of wanting to “make the bankers pay” for their transgressions, for their role in creating the crisis. Even President Obama got in the act recently and dissed “fat cat bankers on Wall Street” in a 60 Minutes interview, the night before he called them all to Washington to encourage them to free up credit for businesses.

But has there been anything done in the U.S. to change banker behavior other than the hyperbole (like Obama’s) that’s been thrown about? One has to admire, even if you don’t like the heavy-handed approach, Chancellor Darling’s plan to raise money for the depleted British Treasury. And perhaps it is no surprise that the French thought it was a good idea too, and took the same approach with the banks in France. If there’s anything we learned from this crisis, and from all other crises I would argue, is that money is the only incentive. And if you want to change behaviors, you have to change the way you compensate people.

I happen to work for a British Bank (one that did not take money from the US Government). There was great consternation at the bank when the British tax announcement broke two weeks ago. The concern was that the best people would flee the bank – not because the employees would have to pay the tax (the bank employer has to pay the 50% tax on any bonus amount over £24,000), but because those highly compensated traders and investment bankers might leave to make more money elsewhere, if the bank decided not to pay those big bonuses.

But I happen to work for an enlightened bank too. The management got it. Last week, the bank’s president announced that salaries for most workers would be increased, and that the ratio of salary to bonus would change – more salary, less bonus. Clearly the incentive worked. The U.S. can do the same thing. A slightly flawed attempt at this is Ken Feinberg, the so-called “Compensation Czar.” But he was given instructions to negotiate only with those banks that were wards of the government. So the other banks high-tailed it into paying back the money they had borrowed from the government, so they could pay those big bonuses.

And so they will this season. But it doesn’t have to be that way. If our legislators weren’t so deeply into the pockets of the financial world, they could do something similar to the British and the French. And do something that might change the compensation behavior of investment banks on Wall Street. Money talks.

For a related discussion, see “The Risk of Relying on Reputational Capital: A Case Study of the 2007 Failure of New Century Financial”