The UK’S Financial Services Authority (FSA) has decided to micromanage banks by specifying new rules for bonuses.
Specifically, the FSA has decided that banks that pay their star traders bonuses that are multiples of their salary or guarantee bonuses more than a year out will be considered to have “risky pay structures” and will be forced to hold more capital — essentially diluting their profit.
Never mind that sales traders usually get paid a pretty average wage, but make a serious money if they’re any good. And ignore the fact that door-to-door salesmen get paid many multiples of their salary in bonuses (confusingly called commissions). Clearly, there’s another risky pay structure in need of regulation.
But my favorite provision in the new rules applies to how bonuses can be calculated.
To avoid being classified as having a “risky pay structure”, banks have to tie incentive bonuses to a group rather than an individual team.
Here’s how it works:
Say the equity team is staffed by superstars and rake in millions of commissions for the bank, while the fixed income team is staffed with ex-government goons who somehow make a loss. The new bonus structure ensures that the huge bonuses the equity team earned will be shared fairly throughout the group, after accounting for losses from the fixed income morons.
And let’s assume the derivatives team and commodity team — the other two teams in the group — just broke even. Suddenly the equity team is getting less than a quarter of the bonuses they would have gotten under the old risky system when each team got what it earned.
But at least the pay structure will be less risky, because traders will be less inclined to take risks if they only get a quarter of the incentives… right?
Hmm… well, let’s say a trader had a great idea for making some short term gains, but knows that he’ll only get a quarter of the profits, but is only sharing a quarter of the risk. The two logical changes to his behavior will be to either quadruple the size of the bet, or take a riskier bet to increase the risk/reward profile. After all, his team’s share is only 25%.
What’s funny (if you look at it that way) about these new rules is that the unintended consequences will be the exact opposite of what they’re supposed to achieve.
But not everyone’s happy about the move. Banks seem to think that the new rules “would have adverse implications for the UK as a financial centre.” Gee whiz. You really think that star salesmen being forced to share their commissions with morons is a negative? Where’s your sense of social responsibility?
One group that knows all about banking, the General Municipal Boilermakers (GMB), a union that pushed for the new changes, criticized them as being “about as watertight as a string bag.” This, they claimed, is “individual greed versus social responsibility.”
No kidding. Individual greed is precisely what I work for. But at least the GMB works towards social responsibility, as stated on their webpage:
GMB is a campaigning trade union focused on protecting GMB members in their workplaces and growing the number of GMB members in order to strengthen the Union’s power.
Ok, they’re just power-grubbing chimps, but at least the government is on their side and is dead set on doing away with the risky pay structures. According to Treasury Minister Paul Myners,
The short-term bonus culture in the global banking industry must end. The government is pursuing all options to ensure banks can no longer get away with the risky pay and bonus policies that contributed to the financial crisis.
Ah, so it was risky bonus policies that were behind the financial crisis. And here I was thinking that it was institutions that didn’t pay incentive bonuses — such as Fannie Mae, Freddie Mac, the Federal Reserve, and the government — that were the root cause of the crisis. Damn, how wrong can you be?
But at least the government — which had no more to do with the crisis than the ballooning national debt — is now on the ball and fixing the problem!
