The UK’S Financial Services Authority (FSA)
has decided to micromanage banks by specifying new rules for bonuses.
Specifically, the FSA has decided that
banks that pay their star traders bonuses that are multiples of their salary or
guarantee bonuses more than a year out will be considered to have “risky pay
structures” and will be forced to hold more capital -- essentially diluting
their profit.
Never mind that sales traders usually get
paid a pretty average wage, but make a serious money if they’re any good. And ignore the fact that door-to-door
salesmen get paid many multiples of their salary in bonuses (confusingly called
commissions). Clearly, there’s another
risky pay structure in need of regulation.
But my favorite provision in the new rules
applies to how bonuses can be calculated.
To avoid being classified as having a
“risky pay structure”, banks have to tie incentive bonuses to a group rather
than an individual team.
Here’s how it works:
Say the equity team is staffed by superstars and rake
in millions of commissions for the bank, while the fixed income team is staffed
with ex-government goons who somehow make a loss. The new bonus structure ensures that the huge
bonuses the equity team earned will be shared fairly throughout the group,
after accounting for losses from the fixed income morons.
And let’s assume the derivatives team and commodity
team -- the other two teams in the group -- just broke even. Suddenly the equity team is getting less than
a quarter of the bonuses they would have gotten under the old risky system when
each team got what it earned.
But at least the pay
structure will be less risky, because traders will be less inclined to take
risks if they only get a quarter of the incentives… right?
Hmm… well, let’s say a trader had a great
idea for making some short term gains, but knows that he’ll only get a quarter
of the profits, but is only sharing a quarter of the risk. The two logical changes to his behavior will
be to either quadruple the size of the bet, or take a riskier bet to increase
the risk/reward profile. After all, his
team’s share is only 25%.
What’s funny (if you look at it that way)
about these new rules is that the unintended consequences will be the exact
opposite of what they’re supposed to achieve.
But not everyone’s happy about the
move. Banks seem to think that the new
rules “would have adverse implications for the UK as a financial centre.” Gee whiz.
You really think that star salesmen being forced to share their
commissions with morons is a negative?
Where’s your sense of social responsibility?
One group that knows all about banking, the
General Municipal Boilermakers (GMB), a union that pushed for the new changes,
criticized them as being “about as watertight as a string bag.” This, they claimed, is “individual greed
versus social responsibility.”
No kidding.
Individual greed is precisely what I work for. But at least the GMB works towards social
responsibility, as stated on their webpage:
GMB is a campaigning trade
union focused on protecting GMB members in their workplaces and
growing the number of GMB members in order to strengthen the Union's power.
Ok, they’re just power-grubbing chimps, but
at least the government is on their side and is dead set on doing away with the
risky pay structures. According to
Treasury Minister Paul Myners,
The short-term bonus culture in the global banking
industry must end. The government is
pursuing all options to ensure banks can no longer get away with the risky pay
and bonus policies that contributed to the financial crisis.
Ah, so it was risky bonus policies that
were behind the financial crisis. And
here I was thinking that it was institutions that didn’t pay incentive bonuses
-- such as Fannie Mae, Freddie Mac, the Federal Reserve, and the government -- that
were the root cause of the crisis. Damn,
how wrong can you be?
But at least the government -- which had
no more to do with the crisis than the ballooning national debt -- is now on
the ball and fixing the problem!
