When Does A Bonus Drive The Right Behaviour?

The front page of the FT yesterday had an article which said that en masse 30 people from Societe Generale's Hedge Fund activities in France resigned and formed their own Hedge Fund.

The whole saga was triggered, allegedly, by the French President's stated desire to curb the bonus culture in financial institutions specifically by limiting the percentage of profits earned which can be set aside for bonuses. Defenders of current and future bonuses in the City, like Barbara Knight of the British Banker's Association (BBA), would argue this would be a growing trend if bonuses are curbed meaning that extraordinary 'talent' would migrate to other places or set up their own businesses in order to maintain their earnings.

I am not sure how much bonus was in question about these 30 individuals at Soc Gen but I think it is safe to assume that it is more money in a single year than most of us would earn in a lifetime. That sort of frames the context here. We are talking incredible amounts of money. This is only a snapshot of an industry that rewards a comparitively small number of their workers with more wealth each year than the average weekly lottery pay out in the UK. It would be easy to trivialise the work that they do - I would venture to say that their jobs are hard, require incredible levels of dedication, aggression, some skill (come on, give them some credit) and specialist knowledge and I am sure also that the work is highly pressurised. We have all seen the films and TV programs about these types of job, the peer pressure is immense, the relentess pursuit of profits is huge and the potential rewards are fabulous leading to a lifestyle few of us can comprehend.

Perhaps if we knew the kind of pressure these people worked under and the level of specialist 'skills' required to do their job, we would have some sympathy with the 'Soc Gen 30' who seem to be martyrs for the cause of freedom of the right to earn in the world of finance. Is their loss to Soc Gen going to change the balance too for the French institution? Will it affect France as an economy? These are important questions as we deal with the concept of bonus and its culture in order to understand how we deal with the issue in future.

We need also to ask ourselves, if the incredible bonuses which have been earnt, say, in the last 12 years had not been available, would the financial world have been any different than it is today? Would the Credit Crunch and the fallout which we have suffered ever have existed if such levels of bonuses be available?

It's an important and fundamental question on a very complex topic.

Many entrepreneurs' memoirs say their commercial acumen was evident at very early ages. People like Richard Branson started making money when he was a schoolboy. He is today the epitome of the successful man in Britain, perhaps only dwarfed by the bizarre pedestal on which Lord Sugar is placed as some kind of Enterprise Tsar who openly ridiculed his own Viglen products with Ratner-style comments and whose business practices have their own war stories, some of which I can attest to. Clearly, success is only measured by the money made in that context as surely Sir Philip Green could not have been knighted for paying himself, via his non-domiciled wife, a single one-off dividend of £1bn in a year when his company earned less than a fraction of that amount in profit. In fact, it is not only the fact that people are revered if they have a great deal of money, we do not care how they made their billions to be idolised by would-be entrepreneurs. Perhaps this is human nature.

There is also in innate desire within such people to keep earning more and more fabulous amounts of wealth even though they have more money already than they could ever spend in their lifetime. What makes Warren Buffett get up each day or Bill Gates? What makes Philip Green want to buy another company? It would be like me winning the lottery then going to the bank to raise a loan and then spending the loan on buying more tickets. Some of us know when to quit when we are ahead, the knack for these people is to keep on going and making much more. We all want a steady rise in our eranings but this is at a much higher level.

You do not have to look far to understand that bonuses are woven deep into our society. Hardly a job in Britain, particularly in the private sector, does not have an element of the total compensation available marked as 'bonus or commission' - the part of the annual remuneration which is termed 'at risk'. You can also look at the public sector and see a great deal of evidence of the same culture at work - only today there is an article about head teachers being paid sizeable bonuses and even 'golden handshakes' for starting jobs in a very similar vain, although the figures involved are orders of magnitude less, as the world of finance. In the world of teaching, there are zero profits to be made as in the same way as in the world of finance but there are Government targets to be hit and that's where bonuses were and are still designed to attain.

I am a sales animal at heart and a portion of my attainable earnings each year has been driven by attaining targets - in some cases it has doubled my annual salary. From the web 1.0 era I also had stock options which came to nothing but at one stage I could have speculated about possibly paying off my mortgage if not more if things had gone right. However, in all situations, if I did not reach minimum target levels or if the business collectively suffered then my bonus/commissions and stock options were completely at risk, if worth anything at all. In many schemes it was normal to have 'clawback' mechanisms that adjusted automatically my bonuses over a year-to-date performance so if one good month triggered a bonanza and then there was poor performance, over time I earned only the average amount. Such schemes are commonplace and can be very complicated, often have large caveats to reward specific behaviour and not unwanted ones and even be taken away at the discretion of the company for whatever reason they dreamt up. Some schemes in the IT business could see SAP or other big ticket software salespeople earn over £250,000 a year in total remuneration while in general people could have anywhere from 20 to 60% of their overall package geared on achieving certain targets. I am not talking about anything unusual which has not gone on in my business for a long while.

This is generally acknowledged to be a successful system - you pay for achieving but you don't pay for not achieving - some companies do get this wrong but that is in the minority. Also, in general, it has promoted the generation of profits based on product or service sales which have added value to the customers who bought them - and this is critical in our analysis. In the public sector, when profits are not at stake, then other performance measurements and targets are in place. Some of these are just silly as they are often handed out for no more than someone doing what is on their job description and that can lead to people believing that bonuses are some sort of guaranteed element of their earnings which in turn can lead to big issues when a recession arrives.

But the general principle is the same - in Britain today, bonus culture goes far, wide and deep in both the private and public sector.

So why are we so inflamed by the bonuses in the financial world? The Soc Gen 30 would argue that they are high performers in their field, they might argue that they have generated €billions in profits for their company, they might argue that they are the 'best in class' people in their field, they might even argue that they did not cause the credit crunch and associated losses and indeed, during that time, they continued to generate profits possibly. I am sure that this will be the basis of argument for the majority of traders in the financial world - it was someone else who lost the money or management's fault for not covering the risk. And we are talking $billions and billions of profit. In fact, the amount of money allocated to bonus pools is actually a small fraction of the kind of money these financial companies have earned - let us not forget that they have also distributed a great deal of wealth to their shareholders while handsomely rewarding other sorts of investors like bondholders. The base argument here is that such incredible profits cannot be generated without the vast bonuses available to be earned down at the traders' end and the management above. One does not go without the other. Before we argue otherwiese, you have to agree with the basic principle as it pervades in all business and even the public sector as I have argued above.

Bonus drives profit - that's the credo.

Well it is not always true. In the case of the financial world we have learned that it is not true. And let us be clear here - the incredible amounts of profits earned in the last 10 years by banks have all been written off with few exceptions. Most financial companies in the main stream of commerce have had to write off all, if not more, of the profits they have made over a period of around 10 years. If companies have not already done so, i.e. those who have not made such huge losses, then they probably will at some point in the future. The reality is that the financial system has regularly given back the proceeds of periods of huge growth as huge losses, and some more learned than me would argue that the only stable underlying profit banks make are from general lending, mortgages and insurance products. Almost all profits associated with investment banking or hedge funds are regularly wiped out.

But in those periods of huge profits, a comparitively small number of people make massive bonuses. It could be argued that our financial system today, our prosperity as a world even, cannot be as we observe it today without the world of finance driving such massive profit cycles to end in bust. In the last 10 to 15 years since deregulation of the financial system we have experienced an unprecedented period of 'sustained growth'. We have found, to our cost, this has been a false boom. Yet in that period, bank executives and traders have earned more in bonuses than they ever have. And as the trades got riskier, they earned more.

In fact, they are still doing so and more aggressively as now they have the safety net that if they do make huge mistakes that incur amazing losses there is an unlimited fund available to pay for their mistakes - they have the freedom to trade as hard as they like, risk more and get paid more without fear of losing. It's like playing the casino with fake money.

And these people are already fabulously wealthy. Many earn each year in bonuses the equivalent of an individual like me winning a single lottery jackpot which is a once in a life time experience and has a chance of one in 14 million of occurring. For these people, playing the lottery is a mug's game, they have a far more secure way of winning. It's called using other people's money and the financial system.

While I would expect, quite habitually, that if I did not acheive my goals that I would not get paid a bonus or, as in the case right now, I would not get paid at all, these people have no such level of accountability. The financial system has just been bailed out to the tune of $15trillion globally and the measure of accountability has been almsot zero with the odd exception and in reality the actual collapse, far from wiping out the stupid banks that caused, it has actually primed them again to believe they can make money out of the losses they incurred.

Think about that last statement as this is the essence of the argument. By wiping the slate clean for all these people and allowing them to keep their methods of working, they will make $billions on the fact that they made the losses. Lehman Bros derivative positions worth just fractions of of their original values are now potential gold mines in the eyes of financial people. Toxic debt will be worth billions in speculation that there are plenty of potential good bits in there. Bankers already speculated before the fall of the system that repackaged Government debt would be worth trillions.

Why? Because we underwrite the whole thing and these people simply do not get it. You cannot make money out of nothing - someone, somewhere pays for it. You can buy a derivative from Lehmans for 20 cents in the dollar without someone someone else paying for that loss. When Barclays bought the assets of Lehmans for less than $2bn, it has been now alleged that the structure of the deal allowed them to make $8bn immediately. We can sit here in awe that such daring and brilliance can occur or we can stand up and call a halt to this fantastic game that is being played with our money.

The point about bonuses is that it drives behaviour. In the public sector it makes people do only the the things that hit targets - if it is reducing waiting times in Accident & Emergency at hospitals then people will be registered minutes after they arrive and then wait hours to be seen by a medical person because the statistic records that they are not really waiting at all. If the target is 20 operations per day and ingrowing toenails operations take 30 minutes but heart surgery takes 5 hours, then only ingrowing toenails get done by surgeons skilled to save lives not nails.

You get what you pay for - you reap what you sew. You gear people to take incredibly high risks without fear of accountability or losing their bonuses by selling products of no real value then they will take ever more riskier options and they will dream up ever more creative ideas to create bonuses knowing full well that such profits that are earned have to be given back at some time as they are literally conjured out of nothing.

There is a price to pay. As numb taxpayers we can watch in awe as £1.5 trillion is added to the National Debt of which by 2014 the interest alone will be £60bn which is equivalent to the entire annual education budget. Do we scrap education or raise tax to cover it? You guessed it - and the whizz kids in the City will employ clever accountants so that neither the companies who incurred the debt or the traders who engineered it pay anything like their fair share of that £60bn.

It is that perverse. We sit here glibbly reading about the whole situation and we think that because we think we understand bonuses that the financial system should have them, it is just a matter of how much they are. But we don't get it as we are the only schmucks who pay for them - they are not, over the long term, paid back for the sustained losses made; these bonuses are paid for by the taxpayer to cover the losses that are really being made.

But banning or curtailing bonuses is not the answer as the Soc Gen 30 have shown. They simply will up sticks and go elsewhere. The economy does not lose out, France does not lose as they simply do the same eleswhere - maybe Soc Gen loses for a while. The point is that until we change the system at the fundamental level to properly define what these people can trade, then will we start to get to pay them for doing things which really help our economy rather than just helping themselves.

The time has passed when we could do this and so the new course has been set. The financial world is at the trough making vast profits out of the losses they made and maybe we can curb the bonuses but we cannot stop the damage they are causing.

It's like building your house with bricks of poor stone, it does not matter how much you pay for them, your house will fall over sooner or later.

Bonuses are not the problem. It's the industry that is the problem.

Hell's Teeth

The mighty FSA is showing its teeth and everyone is scared. Everyone, that is, except the high earning City types.

Once again, the FSA has backed off on its promises to get tougher on bonus schemes in the City and this, it claims, is in response to fears of an exodus of 'talent' from London. This is the talent that has directly caused the predicament which the taxpayer is lumbered that could see as much as £1.3trillion fly out of its pockets, so this in not just any talent. This is a talent that is exceptionally good at putting an enormous amount of money into its pockets, losing billions of pounds, getting us to foot the bill and then starting all over again. We have heard all the unconvincing arguments that all this 'talent' is good for the economy, even though they do not pay their full way in taxes, we just have to trust that the genius financiers are right and we, the mugs with the deepest of pockets, are the really stupid ones.

So the FSA has actually written into its regulatory rules that banks can even pay bonuses when they make losses. Amidst all the loudest and most plaintive of screams by the public in the face of bank bonuses and bail outs, it was the fact that obscene bonuses were being paid out when the banks lost incomprehensible amounts of money that most narked us - mainly as we paid for it.

And here we go again - only this time the FSA, the regulator, has written rules which allow such practice.

This once again opens the doors for others to pay the price of the bonuses when the banks make losses. Hopefully, the taxpayers will be the idiots of last resort in the next wave of losses but I dare say we will have another bash at it some time in the future, but it is more likely that it will be everyday, ancillary, administrative and customer-focused bank staff in the retail divisions who will pay with their jobs for such bonuses. Banking is, after all, nothing to do with the public any more.

Even better, the concept of bonuses being deferred over a period of time like 3 years to make sure the traders are not going for short term, high risk deals and losing the money soon after, has been thrown out of the window by making this part of the remuneration plans a mere 'objective' rather than a rule. On top of that, any part of the deferred bonus can be paid regardless of the banks' performance. So in our current scenario, even if, say RBS, had failed so badly as to have to be owned 70% by the taxpayer, any bonuses that have been deferred need to be paid. It is as non-sensical as you can get as such a scenario of losses would have been caused by the very trades the deferred bonuses are to be paid upon and should be the precise reason why you would want to defer them.

Utterly crazy.

Of course, the reason trooped out by the FSA is that it fears that Britain will be uncompetitive with the rest of the world if it were to limit or shackle the bonuses in this way. My memory often gets hazy but this history occurred close enough for me to remember that it was the fact that Britain avidly pursued, sheep like, the rest of the world's crazy financial schemes and deals that we suffered so hugely. Even if ministers could convince us that sub-prime caused the credit crunch, it was the fact that British banks had gorged itself on the deals that we had exposed our economy worse than any.

Today we learn that France and Germany have already emerged from the recession technically. Once again, our fearless PM's guff comes back to haunt him that our economy was more robust than others and so the recession would not hit us as hard and we would recover quicker. It simply wasn't true and it was the extent upon which our banks had over-traded in dubious products that made us more vulnerable than most.

Now we have the same regulatory authority, with the same people at the helm, whining that they cannot over-regulate because Britain would lose out. Once again, with investment bankers at the helm of advising Government and writing the regulatory rules, you will always get the same answer.

Once again, we have missed the opportunity to get to grips with the disease itself rather than treating its symptoms.

Business As Usual

Spital Square was always a busy place. It's where a small fleet of very smart private taxis wait for RBS staff to give them a ride to wherever they may be going - home presumably. You may think such little luxuries go by the wayside when their company has collapsed in value but not these good fellows.

Last night, the little fleet of smart cars were ferrying evening-dressed managers from RBS to a swanky City dinner so they could blow some expenses, I dare say, and congratulate themselves on another terrific year. It appears there is little scope for consideration of bail out monies or public scrutiny - the business of the City must go on, come what may. Perhaps it may have been Cava not Champers this year. I doubt it, must keep up appearances, eh?

Revulsion

As the banking system staggers after each explosion, it does not sound like the glamorous career it used to be with the potential of somewhat less bonuses in the future. A further advert on why such a career is pretty revolting was last night's TV documentary called 'Million Pound Traders' which was yet another show designed to satisfy our seemingly unending appetite for 'Reality TV'. This time a foreign investor gave some money to a group of would-be traders who proceeded to spend it in a series of trades designed to show how good they were in making profit. They were headed by the seemingly hard-nosed 'Anton' who said for the camera's benefit that 'It's time to press the brutality switch'. All sense of Employment Law naturally goes out the window in such environments as we saw in the excellent docu-drama last week called 'Sex, the City and Me' which acted out an amalgam of real stories set around a successful woman who became a mother and her career in a fictional trading house.

What it illustrated was that the City is so single-minded about greed as to make the people who do it at best seedy and at worst down-right revolting. Coupled with the lack of guilt displayed by people at the top like John Thain, Fred Goodwin, Dick Fuld and others it shows that it comes from the top down.

Once again, it really does not inspire confidence that Gordon Brown surrounds himself with the flannel-talking, obsequious Investment Bankers as his Advisers at this time.

Bail Out, Bail Out

'No, this is not a bail out', stressed Lord Mandelson yesterday as the newly enlightened Business Secretary outlined the basis for around £2.3bn of loans designed to save the car industry. I have blogged on this before and at stake are around 850,000 jobs associated, directly or indirectly, with the car industry as production has collapsed by 49%, sales by over 35% and acres of unsold cars litter our countryside.

He was right - according to the Tony Woodley of Union Unite, it falls short of what is required to save tens of thousands of jobs. Mandelson is hosting a summit for the industry today but there will be calls to extend the £1.3bn of loan guarantees and offer of £1bn of lending for car makers in order to safeguard their industry and attempt to stimulate demand. A whole raft of car makers have downgraded or stopped production and the immediate effect was felt by steelmakers, Corus, who announced 2,500 lay offs this week.

Once again, it seems the Government has come up with a half-baked, knee jerk solution which has been devised by unskilled Advisers and not listened to the views of the carmakers themselves.

What is the Point of The FSA?

"Highly paid bunch of layabouts," spat my source close to the FSA. "Cushy jobs for former mandarins or retired City types, combined with tons of Non-Executive Directorships - it's just a nice place to have an office, get rich and play online games all day."

Well my source had nothing to with the FSA but was making an irritated observation at the apparent lack of action by the FSA in the lead up to and since the banking collapse. No heads have rolled, no explanation as to why no one spotted that the whole system was at risk and no comment or insight as to how the future of banking will shape up. It really is time we got some people in the FSA who are actually going to do something in these key roles rather than former names who just collect the cheques and ignore the obvious.

If the FSA is to survive going forward, it needs to start dictating the rules Brown's 'New World Order' and get some sense of proportion into banking that removes the blind avarice that causes the problems we face today.

Dive, Dive, Dive

The Commercial Property market paid out record bonuses last year and whooped it up at the tail end of the property boom. Many claim they have set aside plenty of funds to ride out the downturn in their defence but I sure hope it's going to be enough.

I will lay a small wager that we will see plenty of job cuts in this sector before the year's out and not a penny of all those whacking bonuses will be repaid.

The share prices of the barometer companies in this industry have dived at an alarming rate. In the last 12 months shares in British Land have collapsed by 58%, Hammerson by 65%, Land Securities by 60% and Liberty International by 63%. The predicted fall in capital values from 2007 to 2010 will be 45% and it is now anticipated that rental values will collapse in 2009.

Bonus well-earned then.

Financial Stimulus to Defibrillation

The rather salaciously termed 'Financial Stimulus' package we know as 'bail out' is already in its second iteration. What started as silky stroking of the poorly patient, the Economy, had little effect. It now seems the patient has been rushed to A&E where a team of 'Advisers' are now administering rapid pulses of electricity to its chest. We had the second bail out and now we have the car industry bail out - pretty soon we shall be having more. That is, if the views of a body of influential MPs are to be believed.

A report from a Treasury Committee has expressed what most of the country felt that the bank recapitalisation program announced in October did diddly squat and because of the 'onerous' terms may actually be hampering them, the poor lambs. Credit, or lack of it, to consumers is seen as the biggest threat.

Erm, haven't we got around £1 trillion of it unsecured on our credit cards already?

While the report talks of the £12.4bn VAT giveaway having about as much effect as attacking a tiger with a bottled fart, it warns of a 'self-reinforcing deflationary cycle' occurring if we aren't careful. I dare say they have either looked in Gordon Brown's Terminology Booklet for Gobbledygook or this is a new type of carbon-friendly bike as yet not available at Halfords.

I still think it's cuckoo land expecting consumers to go and clock up more debt to get Britain out of this mess. We are going to have to take a lot on the chin before things get bright enough to start loaning again.

The Mortgage Scam

I need to be careful here. Why is it that it is extremely hard to get a tracker mortgage that is not some way above Bank Base Rate now?

My current one, taken out around 2 years ago is 0.49% above base rate. Most UK banks now have access to money from the Bank of England at base rates and are no longer worrying about having to borrow at the inter-bank lending rate which went sky high in the Credit Crunch as no-one wanted to lend to one another.

Well here's a thought. If all these banks can borrow at 1.5% and have their borrowing guaranteed under the generous schemes by the Government, then they can lend this out at the LIBOR rates to foreign banks who are struggling to get credit and also make an absolute mint on lending for mortgages. Trackers have absolutely no reason to be so high in particular as they are directly linked to base rates - if it goes up, so do they offering a consistent margin to the lenders. It should be the fixed rates which should be the premium products when you think about it as base rates must rise again some time in the future and so decreasing the margins.

I bet there are an awful lot of lenders rubbing their hands at the very, very easy money they are making, completely underwritten by the very people they are lending to - us! Nice one, Gordon - as usual make sure the banking boys get their bonuses next year at taxpayers' expense.

Lordy, Lordy

I couldn't let the day go by without taking a poke at the scandal in the House of Lords. Again, there is widespread surprise that some Lords are claiming massive expenses, as much as £400,000 per annum in some cases. That's nothing - now Lord Mandelson is on the scene, we should see some real growth here. Further, the Evening Standard reports that Ministers like Jack Straw have received donations from companies associated with Lord Taylor.

I am so glad that Brown and his cronies got turned over on MP Expenses transparency. It really is time that whole political expenses, donations and backhander gravy train got really looked into by real people who care about how the money is being spent rather than by Government-appointed stooges who themselves are on the train.

Exterminate!

Ah, I thought it said Davros, not Davos - apologies but the word springs to mind.

I am delighted such luminaries as the well-paid Bob Diamond, CEO of Barclays Capital which recently bought part of Lehmans Bros and then caringly laid off a load of their staff to part-pay for it which I am sure they were all suitably grateful for, will not be attending to the Davos Summit this year. I believe he has more pressing matters like the bank's earnings announcement after it was feared Barclays could fall into the clutches of the Middle Eastern investors who bailed it out in preference to the Government's largesse.

Things must be tough for bank executives to miss a freebie like this and hobnob with the likes of Jet Li, whose insight on world matters is legendary, I'm sure.

The World's Favourite Debt - Not!

Fresh-footed back from India having secured new routes there, BA CEO Willie Walsh might be choking at the headline in the Telegraph which warns that Standard & Poor could rate the airline's debt as junk. Willie must have been delighted that in a year which saw the Terminal 5 fiasco show his skills at its best that his company announced a £150m loss for the year. S&P have now put BA's rating as BBB which does not stand for 'Bad, Bad, Bad' but isn't far off. In a comment of blinding decisiveness, S&P analyst, Andreas Kindahl, said "There is a 50:50 chance the next move could be down."

Poor Willie - he did so want 65% of the merged new airline between BA and Iberian but at current market prices, Iberian is actually worth more than BA. If that's the case, maybe the Armada did not die in vain.

From Jet Li to No Jet

As Jet Li prepares to take his place at the Davos summit, spare a thought for the executives at Citigroup who have had to cancel their order for a private jet. As they were not prepared to cancel the order themselves, new US Treasury Secretary, Tim Giethner, stepped in and did it for them.

Let's get things into perspective, Tim, it was only $50m. Compared to the bonuses paid out by these fellows to themselves last year, this was just a snip.

Thain Update

Poor JT - the billions of dollars paid in bonuses to executives at Merrills just days before the merger with BoA and the recent announcement of a mere $15.3bn loss in the quarter are beginning to get blown out of proportion as he has now been called before the real beaks as part of a legal investigation into the matter.

Aw, how dare they harass the poor chap.

Maybe they should look more closely at Dick Fuld, the glassy-eyed ex-CEO of Lehman Bros who got hauled up before a Senate committee to explain how, after paying handsome bonuses to himself and his executives, that he managed to bust the company.

Poor Dick had to sell his house at a knock down price, you know. The $13m Florida mansion had to be sold for just $100 which shows the terrible extent of the property market.

The new owner of the 3.3 acre site on Jupiter Island, where Tiger Woods and Celine Dion live, is a certain Kathleen Fuld who by happy coincidence is his wife.

At least they won't be needing their $21m Manhattan apartment right now as Dick is out of work and having to defend his good name - and his $20m art collection.

Bad News For Kids

Everyone gets hit by the recession, even kids. The news is that Hornby will be raising the prices of its train sets and scaletrix products pretty soon despite the recent success at Christmas thanks to their brands like Corgi and Airfix but they also own franchises for Batman, The Simpsons, Harry Potter and The Italian Job.

See, now look what your 'Deleveraging and deglobalisation' has done, Gordon? You've made the kids cry.