Regulate the people, not the banks!

I do recommend you watch the documentary Inside Job by Charles Ferguson. It details the corruption in Wall St where individuals walked away from failed banks with multi-$100 million dollar packages, regularly took bonuses of a similar size while sending their institution down the taxpayer funded tubes. They went in and out of government in successive administrations, supported by academic economists paid to write what was wanted. Anyone for ethics? The resulting tented cities of newly homeless people was heart-breaking.

Another thing to watch – if your blood pressure and tissue box can stand it – is the BBC Panorama programme about the collapse of the Royal Bank of Scotland.  Again arrogance, ignorance of what was actually going on in the bank – and that’s the most charitable explanation – ‘light touch’ due diligence,  excessive spending on goodies and a flash new headquarters opened by Her Maj.  You can find this on YouTube in two parts.

It is clear that only a few people have been at the centre of this disaster.  While there have been failures by politicians and regulators all round the world – particularly in Basel – it is the perhaps half a dozen people world wide directing a few institutions that have collapsed or caused others to collapse that are the problem.  Not the rest of the industry, the staff, the taxpayers nor the people around the world who have lost their jobs.  As I wrote elsewhere, I can think of nothing short of global war or pandemic disease that could have caused so much damage to so many by so few.

But what is to be done?  In the UK the Vickers’ report is trying to slam the banking door after the hearse has bolted.  Too late, too much and the wrong target.  In the Eurozone, Merkel and her minions are trying to ensure that the rest of the zone suffers because they are mis-understanding the issues, as Frances Coppola has commented.

I have written that excessive pay does not worry me as long as it is merited. By merit, I meant going above and beyond the call of duty particularly in exceptional circumstances, not that bonuses become part of wages. Clever people – analysts, IT experts, modellers and traders – should be paid well in the banks because they have a lot of responsibility.  Not necessarily the Chairman, CEO or the Board. Organisation is one skill but doing the work is frequently much more difficult.  The truth that many CEOs did not understand CDOs let alone Gaussian copulas shows just how little they deserved to be paid, let alone given bonuses.

Banks – and many financial services institutions – are in a very privileged position. They hold the wellbeing of countries in their hands. In principle, de-regulation is not necessarily a bad thing because over-regulation can stifle growth, investment and demand; you cannot envisage all possible scenarios when writing the rules.

These follies have placed many nations and currencies at risk for which ordinary businesses and the individual are paying heavily. Rather than try to restrict what a financial institution can and cannot do, for it to be licenced to work in a particular currency I suggest that regulation should follow this route

  1. Bonuses should be paid only for exceptional work in exceptional circumstances.
  2. Remuneration in the financial sector above a certain (generous) level where the business is a ‘significant player’ should be subject not only to long-term shareholder review but also sanctioned by the Central Bank, ultimately subject to legislative oversight.
  3. Top level bankers should be subject to the same rules as government ministers when moving jobs, particularly into the public sector. In the UK, ministers cannot be involved in the same area as their former responsibility for two years. The revolving door in Washington was disgusting.
  4. Where things go wrong and the currency is put at risk or the taxpayer has to bail out a financial institution, there should be powers not only to null and void remuneration and pension contracts, but also to recover assets along the lines of criminal compensation if a court so decides.

We need well paid brains and skills to run a smooth and efficient financial system. We do not want the pervasive greed, corruption and possible criminality that has led to the disaster that may yet befall us.  Nor do we want to tar the name of good banks and bankers with the treasonable actions of those few bad men.   So the issue is to ensure that those who direct the institutions that hold all our futures in their hands, do so properly.

My remedy is that each financial institution should have qualified senior people who are not only responsible for good governance but with powers conferred by the appropriate Central Bank to override the Chairman, CEO  etc if necessary, which would of course spell the end of the latters’ careers.  But I can’t shed too many tears over those few for whom the Tower of London awaits.

(We apologise to regular readers who were expecting Part 2 of Maria’s Money for all seasons today.  This article leaked out by accident on Sunday so we thought we may as well publish it properly.:-)  Our blogging genius is in Sweden but she’ll be back!  I bet you can’t wait…)

8 thoughts on “Regulate the people, not the banks!”

    1. Yes but it is no excuse. The banks may control the money but they also need to live within a legislative framework for the currency that they are using. It is this control which is lacking.

      Trust me, I’m a banker it seems!

      Many are very good but the greed and megalomania at the top needs to be stemmed. Treason is not too strong a word IMHO!

  1. Prue Leith disclosed this little gem in an interview with The Telegraph:

    She left the board of the Halifax when she became nervous at the complexity of their financial instruments. “I remember saying at a board meeting that I don’t understand these derivatives and being told, ‘It’s OK, nobody understands them.’ I ought to have said, ‘Well, if nobody understands it, what the hell are we doing?’ I’m just glad I got out when I did because I would have felt terribly guilty.”

    I really can’t think of any sensible comment to make except to say it confirmed my suspicions.

  2. Actually CFOs at any rate really should understand CDOs, because they are structured in the same way as a corporation’s capital structure. Even the tranche names – senior, junior, mezzanine, equity – are the same as those used in corporate finance-speak for the same risk level. The real problem in CDOs is the asset base: in a real corporation the assets underlying the company’s capital structure are owned by the corporation, but in a CDO they may not be. If you like, a synthetic CDO is a company with a capital structure, no assets of its own but an insurance policy that gives it a claim on someone else’s assets. Is that helpful?

  3. Frances – I like your definition of a CDO vis-a-vis an ordinary corporation. It makes it very clear.

    Wasn’t the problem also that institutions like Goldman Sachs were holding multiple insurance policies on the same product? If you do that with your house and it falls down, the insurance companies will gang up and pay only the once, if at all.

    CFOs are probably the people who should have the power to go to the BoE if they smell a rat. Or perhaps they already have this obligation. But I wonder what the CFOs of RBS, HBOS and others were doing other than drawing their substantial salaries.

    Surely any simpleton studying financial maths 101 would realise that while gaussian cupolas may have worked OK when everyone else was using judgement or something more sophisticated, once everyone started using GCs 5 years down the line, and the market had increased by many orders of magnitude, the calibration of the models would be at best questionable and in fact faulty as they were using GC calibrations as their input. This recursive approach is a classic modelling error in statistics.

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