Monday, 10 August 2009

The Price For Failure

Fortunately, I am not one to watch TV in the morning as a rule, but while on a family visit to Wales this weekend I did watch the intriguing 'The Big Questions' hosted by Nicki Campbell. The question of bonuses was inevitably a discussion point.

I have blogged on the culture that has arisen of incentivisation for failure in the past. We see it most obviously in certain sports like Football where at the playing level the weekly wages are a great deal more than I earn in a year yet they are paid whether the footballer plays good or bad. The argument goes that no one would watch if John Terry were not even on the Chelsea playing staff let alone whether he is picked for a game or plays good or bad. So it is his inherent value, not necessarily his ability we pay for. I can understand that in the case of certain stars like Cristiano Ronaldo but you still have to believe that the astronomic sums are eye-wateringly excessive. But if it is what the public are prepared to pay, well who can argue - that's entertainment, after all.

More to the point, if you look at the spectacular lack of success by the likes of Steve McLaren, Sven Goran Eriksson and Philipe Scolari yet the immense amounts of money they walk away with for short periods of failure in their roles then you have to wonder where is the incentive to succeed in sport management? These people have proved that the best formula is to have a short tenure in which you fail dismally - in fact the shorter the better - then walk away with the whole contract value only to find another set of mugs who will do exactly the same. Why succeed over 5 years when you can get nearly or the same money for failing in just one or two? It suddenly makes you think what motivates people like Sir Alex Ferguson or Arsene Wenger over a Scolari who said only weeks into the job that if he failed there was always another job to be had?

I would say that incentivising failure breeds a band of prima donna management who think they are worth the money but who in fact are are only motivated by the money. So if it is offered, they take it.

But it is when the same logic is applied to banks that the argument suffers. The same cannot be said of these so-called star performers that have now been publicly defended. These people, in the eyes of executives like Stephen Hester, CEO of RBS, are needed by the economy and so should be commanding huge bonuses. It is rather strange that the man installed at RBS to oversee its recovery after record losses in British Corporate history should say this.

The 'Big Question' argument in favour of bonuses came form the Chairman of the UK Shareholders Association who said if we cannot afford people like Stephen Hester then RBS would not recover and so we should pay him and his team of super-traders the highly geared bonuses to succeed. In normal situations, I would agree with the argument - I have personally made a living out of helping distressed companies to recover so I understand the point. But in this case, the argument is misguided. RBS was in all senses of the term a 'failed bank'. It had traded itself into a bankrupt position and it was defunct as a bank. The Government chose to rescue it by providing capital, loans and guarantees which ended in the UK taxpayer owning 70+% of the bank. Stephen Hester could not have succeeded without the incredible amount of money thrown at the bank to prop it up - money which under normal circumstances, no company ever gets if it is that broken.

From that position, Hester was only ever going to get better - to pay him a bonus for that is like paying me to recover a car when all I do is drive it after it has been repaired.

And what did Hester do to gain his bonus? He did not fire one single person who caused the massive losses, not one trader. Instead he turned on the backbone of the company that deals with the real banking world and fired over 9,000 backroom staff, tellers, customer service providers not one of whom was responsible for a single penny of the £21bn loss last year. Not one of whom approved a single stupid debt purchase or dodgy loan - he fired the people who were not rated as stars but who were there to service real customers and the purpose of a bank in the public eyes. And he asks to be paid a bonus for that?

So why the hell should Stephen Hester get a bonus for doing nothing for the good of the bank and its customers? His massive £10m bonus will be no more or less than a year's roll up of the salaries he saved. Some would argue that he made sure the bank has made £16m this year in profit. Big deal. After that much bail out money, even a ten year old could have made a profit. This is reward for failure.

Then you look at the argument by senior bank executives for paying extremely high bonuses to their 'star traders'. This is not even a year after each of them trooped in front of the Treasury Committee for collectively causing the biggest financial meltdown since the Great Depression. £1.3 trillion later of taxpayer's monies and pledges, the banks have been allowed to rebuild from the mire they created and there was at least a hope that they had learnt some lessons and rebuilt their businesses based around some more sensible principles. But no, they have chosen exactly the same path as before with exactly the same people.

Instead of incentivising people for long term, steady success, the bonuses are highly geared to short term, instant success regardless of whether that profit can be sustained over a period. regardless, again, of the worth of the deals and whether the underlying principles make good sense like asset values and due diligence. The banking world has gone on exactly as it was - no reformation, no new regulation, no new people - exactly as before.

As if we simply wiped the slate clean for a compulsive gambler and recharged his bank account with fresh millions to lose, we have sent the banks back to the gambling tables that broke us last time and told them to go do it all again.

It is that stupid and that is exactly why we should not allow these senseless bonuses in the current form. We are firstly rewarding the failure of last time around and secondly priming the system to fail spectacularly again. And here is the bad news - if, when it inevitably fails again, we are asked to bail it out, then are we prepared to do so? Will we have a choice? Can we afford it?

There can only be one way of ensuring banks and their super stars stop and think and that is if the price of failure is equal or worse than the price of success to them personally. Not one of these clever people feels one hint of remorse because they are not motivated by social things beyond how much champagne flows at the bar in the evening, but money. So, the only way of making them think properly is to make ensure the penalty for failure in gambles are equally spectacular as the the reward for success or worse.

But there is a better way - don't let them gamble in the first place. We must reform banks and the system so that highly leveraged, unresearched and risky gambles on multiple debt trading is regulated properly and that bank executives are forced to do due diligence and forced to be totally accountable for their actions. It does mean a slowdown in the economy - that's the reality, you cannot grow on thin air. The banking system was a house of cards, just waiting for a puff of wind. We have rebuilt it in exactly the same way, with our money.

Why we are having the debate about bank bonuses less than a year after this spectacular disaster only shows how greedy and stupid we all are. The people in the lofty towers who threw tenners out of the windows at the G20 protestors are so far out of touch with reality that they are a danger to us all. We have to stop this now before we are in so far that we cannot get out.

Britain lies at the edge of an abyss.

How do we get Alex Ferguson and Wenger type management and thinking at the top level in banks? They have always operated on boom and bust cycles and it is always low level staff they pick on each time the bust arrives. Their modus operandi has never changed and they show some of the worst types of management in British industry, in my opinion. There is no place for the sensible, strategic thinking planner who makes superb success built upon lasting principles which make sense. Manchester United and Arsenal have shown that long term success in football can be built on solid management principles and not boom and bust.

We need the same approach in banking. Like football, if they can sustain the success, they can certainly have the bonuses. But, as Taleb would assert, all banks do is make huge profits then give all the money back later in equally huge losses - the only difference being the huge bonuses paid, in the final analysis, for no gain. The only things that banks make real profits on is lending to people like us. Yet the staff who serve us are the ones culled every time to bust comes.

Yep, that's what we have sustained.

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