Debating Hester’s Bonus and Mr. Fred’s Knighthood Is Futile: Focus on Volcker’s Rule and Break Up the Banks

Smoke and mirrors. Forcing RBS’s Stephen Hester to forgo some bonus and stripping Fred Goodwin of his knighthood, are only illusionist’s games; demagogic attempts in election times. The only real facts are the trillions of dollars of public money already spent to save the banks and the continuing government guarantee to monolith banks and other disproportionate entities now bigger than before.

As suggested by former FED Chairman Paul Volcker, the remedy to resolve this Moral Hazard would be simple. I re-propose some readapted excerpts from an article published a year ago: Beyond the False Bonuses vs. Real Wages Debate.

Four years into the most significant structural crisis of modern history and the flaws that caused it are still yet to be fixed and looming around like the stroke of midnight in a horror movie.

The main problem is Moral Hazard. Briefly, some banks and other enterprises have reached such a big size that their failure would jeopardise the entire society. These entities are allowed to defy the gravity of capitalism and of its free market rules and enjoy an implicit rescue guarantee from governments that with taxpayer’s money are ready to intervene to prevent failures.

The largest public rescue has already taken place. As Bank of England Governor Mervyn King stated recalling a phrase from Winston Churchill, “Never, in the field of financial endeavour, has so much money been owed by so few to so many”. Without the rescue and the promise of an unlimited guarantee, few banks would have survived the crisis.

The situation is worsened by widespread public spending cuts imposed upon most of Europe which are mainly affecting those who underwrote the rescue of the banks. These measures further depress consumer spending, which would instead ignite the possibility of recovery. These “austerity” measures appear to be socially immoral and technically depressing in an already comatose situation. Making one part of society (or some weaker country, e.g. Greece) bear the costs will not avoid a further crisis, but rather the opposite. Therefore, the “fortune bonuses” appear to add insult to injury.

Yet, only focusing on bonuses is a fake issue, which risks creating further confusion and uncertainty let alone political unrest.   Horse trading will not help, “pay as you go politics” are a shamble, and while the founding fathers of modern free markets and democracy are turning in their graves, we should not be in psychological denial; and still hope that the “efficient markets hypothesis” will automatically fix things.

The continuation of emergency behaviors that frantically followed suit since the crisis began calls for systemic action. The whole reaction has been to fight fires without addressing their causes; but beyond staying afloat, the core problems have not been addressed.

We have seen more oligopolistic consolidations, higher risk concentration and wider conflicts of interest, greater moral hazards, more misalignment and tensions between corporate management, shareholders and the public, and an increase in the general level of corruption.

If, as an entrepreneur, I risk my capital by putting it to work, then when I succeed, I should reap my rewards. If I fail, I should pay the consequences and lose my capital.

Yet, some individuals are enjoying billions of dollars, without having made any investment, but de facto risking public money. They enjoy an unlimited upside and do not have any downside. Most banks are still assisted by a public guarantee (let alone those owned by governments) making their entire operations “distorted” and a problem of Moral Hazard. As clearly indicated by Mr Paul Volcker, action should be taken to eliminate this guarantee, breaking up the banking activities, and promoting a proliferation of players, re-establishing partnerships, unbundling oligopolistic concentrations, and perhaps the best reward of all, promoting managers to become real owners.

This is logical, and feasible. It happened in the past with the oil, railroad, and more recently the telephone industry.   There are no economies of scale that justify such dimensions and concentration of functions, conflicts of interest and the implicit public guarantee. The financial services business is malfunctioning and failing to perform the fundamental role of support to the real economy and society.

The breakup of the financial activities would unleash huge value. It is necessary to bring back the “skin in the game”, that ownership/responsibility element, that is so important to any human activity. It will make taking calculated risks and receiving proper rewards sound and possible.

Failing to resolve the issues will only deteriorate matters. An oligopolistic totalitarian world will only bring distortions and misery. (Time Horizon and Capital Flows Redirection for Growth). Europe is in a state of confusion, gambling with its future and, the economy is anemic and with several real systemic risks about to bust, including the collapse of the European common currency. Consumer confidence and trust are at a minimum and the general feeling is that of fear and mistrust.

Yet, this can be changed if we fix the structural flaws, generating a virtual cycle of consumer spending and a rebalancing of public finances. The banks should be broken up immediately. A proliferation of players should be promoted in all sectors of economic activity, re-establishing partnerships. This would go to stimulate the re-growth of the pivotal medium size firms. The latter should be favoured to be the direct investment focus of long-term institutions, and capital rich companies. This would create a new flow of capital to the real economy and a sustainable investment methodology.

How else will the huge public deficits be repaid?

6 Responses to "Debating Hester’s Bonus and Mr. Fred’s Knighthood Is Futile: Focus on Volcker’s Rule and Break Up the Banks"

  1. Michael   February 15, 2012 at 10:15 am

    Exactly! Return all types of investment activity to the partnership format, so that risk failure causes personal personal failure.

    • Carlo   February 16, 2012 at 5:50 pm

      Yes Michael,

      I really thing that a key to resolve matters forward will be to re-establish ownership.

      So, that capital can be again invested into enterprises.

      Nobody would object profits obtained that way.

  2. sierra7   February 15, 2012 at 11:57 am

    France had an instrument to level the playing field: The Guillotine!
    When Americans loose their fear of their oppressors, they just might revolt against this system…but, don't bet on it…….
    This is what we get when we indulge a corrupt political system…..a corrupt financial one….

    • Carlo   February 16, 2012 at 5:54 pm

      Sierra7,

      You really have hit the target.

      The current problems have nothing to do with the economy or the financial system; they are political problems. The system became corrupt and violated its own rules of the game.

      Yet, we can change things if we get organized and we act smartly.

      And if it all collapses, the wealthiest have more to loose than anyone else.

  3. Eoin   February 27, 2012 at 3:40 am

    It is clear that government accepts the need for more competition in banking. Pay as you go government needs deep pocketed backers. Will not large deep pocketed banks shrink if they are starved of deposits? The Move Your Money campaign encourages people to ditch the High Street Banks and switch to smaller ethical providers for current accounts, savings and mortgages.

    Almost the whole issue of the March Ethical Consumer magazine is given over to this campaign.

    • Carlo   February 28, 2012 at 8:24 pm

      Yes Eoin,

      Consumers, and the public in general, could act according to ethics, and with proper choices, change things.

      Influencing large investors is also paramount. Breaking the chain of corruption and lobbying, that all is able to purchase, from governments, to religious groups.

      Yet, we must admit that technical financial knowledge, organization, and proper ingredients are needed.

      Enabling policies could also play a key role.

      So far too little of all this has happened.

      Maybe only a catastrophic development can save us.