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Financial Times, October 17, 2009 article and column


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See related column below: Countdown to next crisis

Man crossing a street

The mood in the Maserati dealership on the Old Brompton Road on Thursday was upbeat. That day Goldman Sachs revealed its global staff was on track to earn about $700,000 apiece this year – and in this affluent corner of west London, a favourite spot for City types, the expectation is that some of that will find its way into the showroom. The dealership has already had a record September; it hopes the new year bonus round will herald a return to the time when the luxury Italian sports cars were selling at the rate of one a day.

Goldman – which announced earnings of $3.2bn, a near quarterly record – will not be the only US bank supplying custom to those serving the upper echelons of the market. A day earlier, JPMorgan Chase reported $3.6bn of earnings, close to the boom-time numbers achieved in 2007. UK banks such as Barclays and HSBC are also thriving. All are likely to pay big bonuses, arguing that if they do not, their best people will defect to the competition.

It was not supposed to be like this. In the wake of the financial crisis, there was vociferous criticism of the banks’ bonus culture and widespread hope it would change, ending a system critics said promoted excessive – and highly dangerous – risk-taking.

When the leaders of the Group of 20 richest nations gathered in Pittsburgh last month, they sidestepped the moralists’ argument – that bankers are simply paid too much – and declined to impose pay caps demanded by European representatives led by President Nicolas Sarkozy of France. But they did come up with guidelines to create pay schemes to discourage risky short-termism and ensure a large part of bankers’ compensation is deferred over several years.

However, the scale of the profits racked up this week by Wall Street’s finest has raised fears that such reform initiatives will miss the mark. “It’s going to be just like before, apart from a few cosmetic changes,” says one former Lehman Brothers banker. “All the banks have no intention of changing what they do on pay.”

Meanwhile, the focus among policymakers on the structure of bonuses – rather than the amount paid out – has done little to assuage public outrage. “Goldman Sachs’ profits of £20m a day will stick in the throat of every factory or shop-floor worker facing the sack because of the credit crisis,” railed Friday’s Sun, the UK’s biggest selling newspaper.

Goldman is the main butt of outrage because it has bounced back to generate vast profits just months after receiving government support, but other institutions – spanning AIG and Citigroup – remain in the line of fire.

“Americans don’t resent people who make a lot of money – we all want to make money,” Edolphus Towns, a Democrat who chairs the House of Representatives oversight committee, said in Congress. “But what infuriates people is when bosses at bailed out companies, virtual wards of the state, continue to rake in millions – in effect, our millions.”

A “say on pay” bill is likely to pass through Congress. This would give investors the option of a non-binding vote against directors’ pay – a device copied from a successful rule in the UK.

More dramatic still was the appointment of Kenneth Feinberg, the “special master” on pay, who now sits in the US Treasury with the power to reject pay plans for companies that are the recipients of government bail-out money. He has already ordered AIG, the failed insurer, to cut its planned pay-outs to some executives and told Citigroup that he had problems with a planned $100m bonus payment to Andrew Hall, the bank’s star trader at Phibro, its commodities trading division. Such was the stumbling block that Citi sold the unit.

Outside Congress, activist shareholders have also raised their voices. This week, the Interfaith Center on Corporate Responsibility, a coalition of nearly 300 faith-based institutional investors with more than $100bn in capital, filed a resolution urging Goldman’s board to keep a lid on pay.

Despite rumours of senior Goldman executives being prepared to show restraint on their own pay, and suggestions that the bank could seek to offset criticism by funding a new $1bn charitable foundation, its rhetoric has remained unapologetic.

“We’re aware of what’s going on in the world,” says David Viniar, chief financial officer. “But we have to trade that off with treating our people fairly”.

What few investment bankers will say publicly is that there is a growing rancour at the fact that their industry appears to have been singled out for compensation reform while their high-earning peers in the hedge fund and private equity sectors have largely escaped regulatory scrutiny.

In the UK, in particular, the debate over remuneration has become something of a political football, with Gordon Brown, prime minister, and his embattled centre-left government accused of exploiting antipathy to bankers to distract voter attention from another flare-up in the long-running scandal over MPs’ expenses.

Alistair Darling, chancellor of the exchequer, and Lord Myners, the City minister – and the man who approved the £16m pension pot given to Sir Fred Goodwin, Royal Bank of Scotland’s disgraced former chief executive – have led the charge in demanding that banks adopt the pay guidelines agreed by the G20.

Last month, Britain’s five biggest banks were trumpeted by the Treasury as the first signatories to the new regime. Eleven international banks, including Goldman Sachs, JPMorgan and Morgan Stanley, followed suit this week at a tense meeting with Lord Myners that several participants dismissed as a political stunt.

In the US, the administration of Barack Obama has also found banks to be an easy populist target amid the backlash over healthcare reforms and the growing death toll in Afghanistan.

Sifting fact from spin, there is a growing consensus among both bankers and independent analysts on both sides of the Atlantic that the G20 guidelines will make little difference to banker compensation.

The only significant innovation to emerge from the G20 relates to “claw-backs” that allow banks to reclaim compensation awarded in earlier years if trading activity later backfires. These existed at some banks, such as Credit Suisse, before the crisis, but now all of the leading banks are expected to have some sort of system in place by the time 2009 bonuses are awarded early next year. A number, including Morgan Stanley, UBS and Citi, have already introduced claw-backs.

The other big reform advanced at Pittsburgh – the call for between 40 per cent and 60 per cent of senior bankers’ bonuses to be deferred over at least three years – is nothing new. Goldman, in fact, has among the most restrictive compensation principles on Wall Street, awarding much-vilified “guaranteed” bonuses only in exceptional circumstances and outlawing multi-year guarantees.

Credit Suisse recently went further. It linked a large chunk of bonuses to the performance of a pool of hard-to-value toxic assets, restricting pay-outs for seven years.

But even the modest guidelines agreed by the G20 could prove difficult to implement. In the week after the summit it emerged that the US Federal Reserve was interpreting the bracket of 40 per cent to 60 per cent as “an example” – not a prescription – of how compensation could be structured. As one Wall Street executive noted, with thinly veiled relief: “The US appeared to have found a loophole in the G20 rules” – much to the chagrin of European rivals who are under stiff pressure from national regulators to observe the spirit, as well as the letter, of the G20 rules.

Ironically, Wall Street’s two defunct investment banks, Lehman Brothers and Bear Stearns, were both big believers in deferred bonuses. “They were the two firms that had the most aggressive share-based compensation, with up to 65 per cent of pay vesting over five years,” says one senior banker at Barclays, which now owns Lehman’s US operations. “That doesn’t say much about the correlation of bonus schemes and the success or failure of a business.”

Such observations are the definitive proof, in the eyes of critics, that politicians’ focus on bonuses is both misplaced and cynical.

“The easiest way to destroy this company is for us not to pay our people. Why would anyone think that destroying a company that pays billion of dollars in taxes every year is a good idea?” asks one Goldman spokesman.

Such thinking suggests that policymakers may have lost their chance effectively to change the way bankers are paid. The G20 was seen by many as a unique opportunity to turn consensus into action. If that fails, few believe that alternative proposals, such as national legislation, could be put into practice in such a globalised business.

The final hope may be reform from within. Speaking on the same day as Goldman announced its quarterly profit numbers, Ken Costa, chairman of Lazard International investment bank, delivered a message of hope. He told a packed congregation at St Katharine Cree church in the City of London: “I have observed in over 30 years in the City the driving desire of many to work hard, to be rewarded well, and get out as quickly as possible. That impatience is no recipe for a healthy economy or society.”

Reporting by Patrick Jenkins and Megan Murphy in London, Francesco Guerrera in New York and Tom Braithwaite in Washington




Countdown to next crisis

By Francesco Guerrera

Published: October 16 2009 20:56 | Last updated: October 16 2009 20:56


Tick-tock, tick-tock, tick-tock ... Can you hear that? It is the countdown to the next financial crisis. I hate to say this just as green shoots are sprouting – the Dow crossed 10,000 points this week, banks are reporting bumper profits and the US recession is all but over – but there is a reason why it is called a “cycle”.

The recipe than turns today’s riches into tomorrow’s disasters is a familiar one.

Add a little bit of risk here, a sprinkling of financial “innovation” there, spice it up with greed to taste, let it simmer for a few years and, before you know it, you have a fully-baked hot crisis on your hands.

Investors, bankers and regulators know this but ignore it until the music plays – to use the famous last words of Citigroup’s Chuck Prince. When the music does stop, and it always does, the reaction among regulators and politicians is to sound tough and call for “radical action” to make sure such a mess “does not happen again”. The crisis of 2007-08 has been no different. Congress and the Administration are sparring on big reforms that include giving the Federal Reserve new powers to unwind large financial institutions. International bodies are busy drawing up rules on anything from bankers’ pay to capital requirements and leverage ratios. This flurry of activity would make for amusing political comedy if it wasn’t wasting time and resources that should be devoted to cushioning the blow of the next crisis.

The planned US regulatory overhaul being discussed is a case in point. Just like their colleagues at Homeland Security, who forced passengers to go through metal detectors in bare feet only after foiling a shoe-bombing plot, the financial cops are behind the curve.

Most of the rules being so hotly debated focus on big, well-known, banks. That is fundamentally misguided. Just because Citi and co. were culprits and victims of this turmoil, it does not mean they will cause subsequent ones. The next flare-up is more likely to come from a less mainstream corner of the financial world.

Malpractice, greed and incompetence are chameleon-like: they morph into whatever form enables them to escape scrutiny.

From the South Sea bubble to the 1929 crash, Long Term Capital Management and Enron, the villains in the financial drama have changed constantly. So even if you make policy by looking at the rear-view mirror, as politicians do, you have to look beyond banks.

Logic reinforces this belief. If regulators turn the screws on banks, they will reduce the likelihood of problems coming from that sector but may encourage reckless behaviour elsewhere. Such a transfer of risk is already happening. As banks pull back from high-octane businesses such as proprietary trading and structured finance in the expectation of tougher rules, hedge funds and other less regulated entities are replacing them. The reason is simple: high-risk activities bring the promise of high rewards. It’s a dangerous job but someone’s gotta do it. Members of the “shadow banking system” have been busy bulking up their trading and lending desks to fill the leveraged space being left vacant by banks. Here are some scary data: non-banks hold nearly half of all the “problem loans” in the US, in spite of accounting for just 21 per cent of the total lending pool. What is worse, more than one in three of their loans went sour in 2009, compared with just 11.5 per cent for US banks.

With all the regulatory eyes on banks, their more discreet rivals are quietly stoking up the risk of a new blow-up. In theory, huge hedge funds should be caught by the Fed’s ability to police any institution that is deemed “systemic”. But in practice, keeping tabs on groups that reveal little about themselves will be tough. And there is always the possibility the epicentre of the next crisis might be a medium-sized hedge fund whose network of trading relationships make them “systemic” – a Bear Stearns of the hedge fund world.

As the clock ticks inexorably towards another disaster, regulators and politicians would do well to spread their net wider than the usual suspects.


© Copyright The Financial Times Ltd 2009.




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