A friend, apparently with my best interests at heart and mindful of the increased stress levels associated with the January detox thing, kindly sent me a copy of "Falling Down," the Michael Douglas movie about a middle aged man who comes unglued with mounting frustration and anger at modern life. A kind, if not witty thought but given recent events the timing could be better. Maybe I need to get some new friends................. or come off the detox.
There is indeed though, and unfortunately, a simmering frustration and anger across the world which occasionally bursts out onto the streets or in individual meltdowns. Witness the recent food riot by Chinese students in Guizhou over a very modest rise in cafeteria charges, Algerian students rioting over food prices, Bangladeshis rioting over a quick stock market correction after a steep rise, student discontent in the UK and rioting in Greece over austerity measures last year are self evident. Were it not that we are in the middle of a deeply protest unfriendly winter I'm sure the levels of street violence would be considerably higher, both in the UK and abroad.
Voters have much to be angry and frustrated about. Most work hard to provide for their families but are being asset stripped by a combination of growing inflation in the things they need, such as energy and food, whilst seeing deflation in their assets such as their houses, whilst carrying a higher and growing tax burden. Whilst they bear the consequences, most of those who were either at the political levers of power, or those steering the banks onto the rocks, or indeed those charged with regulating the system before and during the financial crisis are either still in place or have disappeared happily into the sunset.
Worst of all, the "had it all," generation who enjoyed years of growth, low inflation, house price growth, full employment and fully funded pensions, (having asset stripped the country at a national level), are now set to retire, put their feet up and leave it to the new workforce to provide the tax income to fund a growing and aging population. Oh, and just to remove any last morsel of incentive, "here's 50 grand's worth of debt to start you off with son." I won't dwell on student financing but it's a fair bet that no one has thought through the structural implications for the economy in 10-15 years time of the proposed loans. It's already created a massive imbalance in applications this year prior to the rise in fees but there will be an impact on the housing market in the future and on emigration rates. I'm not even going to go near the inequity of English taxpayers funding EU students to go to Scottish universities at rates which are far less than their own children can go to university either in England or Scotland.
There is creeping inflation in the system, we see that every day at the petrol pumps and at £6 a gallon of unleaded it's only a matter of time before there are mass protests in the UK. Food inflation is growing too. A combination of harsh winter conditions in North America, the Australian floods and the Russian export ban is sending wheat parabolic. Nothing gets people more angry, or on the streets more quickly, than when they are hungry. Watch this space. For the moment though, inflation in the UK is not running out of control, despite warnings from politicians that interest rates may have to rise. Inflation in the UK ex indirect taxes remains benign; it will change but not yet.
Of course, Westminster has been trying to direct and focus the wrath and indignation of the "people," at the City, but in an unfocused and indiscriminate way. "Billions of pounds," and "bankers bonuses," appear to be the battle cry but insofar as virtually no one in the City understands what they want, apart from money and no spotlight on they own tawdry affairs, the politicians don't appear to understand what they want either. If they do, they've certainly failed to articulate it but they have generated lots of fees for law firms and accountants to whom all the banks have fled to over the past two years in an attempt to get some clarity. Consequently, the governments attempt to increase the tax burden on the City has failed.
Odd though, no one ever mentions the accounting firms, law firms and regulators with regard to their part in the debacle, or indeed their compensation.
If Westminster took the time to educate themselves about the City, rather than turning up very occasionally for lunch and a campaign contribution, they might learn from past mistakes. To date, there is precious little evidence that they have done so.
Before the last meltdown, most investment bankers were compensated with a basic salary and annual discretionary bonus. The salary level rarely went above £100-120k although there were exceptions, notably one German owned former British merchant bank where salaries were a good deal higher. The bonus pool was then approved by the board contingent on the banks profitability for the year and then allocated by department and then by department heads to individuals. Most, but not all, firms paid a mix of cash and shares and some, including Lehman, had a claw-back if profitability in year 2 went into the red. This meant that when Bear and Lehman went down. thousands of staff collectively lost millions of pounds and much of their savings. The obvious aim was to enfranchise and align the staff with the company and enhance staff retention. On the flip side, it is hard coded in the DNA of investment bank staff to orientate themselves and fight hard for their bonus 365 days a year, both as departments jockeying against each other and as individuals.
So how are bonus's calculated? In short, bonuses should be paid for performance over and above what might be expected as a normal rate of return for the business. Bonuses shouldn't be, and normally aren't, paid for people just turning up. Patrick Hosking discussed this with a shrewd explanation in Saturday's Times and is worth a read, (unfortunately, it's behind a paywall).
I would however, make two points. The first is that such is the compensation culture in the City that as soon as Westminster started talking about bonus taxes then banks immediately started ramping basic salaries. Those salaries that I mentioned earlier are now in the order of £200-300k and in some cases up to £500k. Bonus's are still paid and it remains to be seen if the lower level of expected bonus's that staff were told to expect when these increases were announced transpire. Certainly, fixed costs have gone through the roof and without banking friendly central bank policies they would be unsustainable. Most people in the City are, anyway, expecting a vicious round of redundancies this year. Nonetheless, the bottom line is that Westminster was out flanked before they even started the debate which they have now anyway lost.
The second and real issue for Westminster however, and specifically for the government, is that it is more important for them at a macro level to learn what the source of profitability in the banks is that creates the bonus pool, how much leverage is involved and what risk remains on the banks balance sheet, and for how long, after the revenue has been booked. These are much more important than how much a trader is paid. Also, and for what it's worth, it's common to blame everyone in banks for a meltdown which they certainly not responsible for as individuals. For example, many banks over leveraged themselves through decisions taken at board level and entered into structures created by corporate financiers that any floor trader would wisely never have touched. As I said earlier, most of those who are culpable got off scot free, yet the entire population must foot the bill not only for the UK but as a result of that supine fool Alistair Darling we must contribute to the PIIGS too; I'd have him in the stocks for a starter. (I still believe we should demand a national audit to find out exactly where and how the last administration managed to get through quite so much money but it will never happen).
Enquiring minds might like to know what happens to a City foot soldier if he comes under suspicion of illicit activity, and we're not talking major fraud here. Well, you can comfortably expect the front door to be banged on at 3am when you're safely tucked up in bed. Your home will then be filled with police and FSA guys clomping around scaring the children while they remove every bit of paper and anything with a chip in it, including the kids Playstation. You'll be arrested, your name released to the press in an all points bulletin and your assets will be frozen. On completion of a short exploratory interview you'll be sent home with a "we'll call you," farewell but won't be allowed to work. So, with no assets, no way of earning an income and with your reputation ruined you can then expect to wait for a year or more to be called back to be told if there is a case to answer. Fred and his fellow bandits got a couple of hours in front of a clueless select committee for blowing up the entire banking sector.
Anyone wishing to hear a pretty good debrief on the financial meltdown could do worse than watch this clip of Charles Ferguson, speaking at MIT which I found at Infectious Greed. It's as erudite an explanation as you'll find.
Where then does that then leave us? Well, the outlook for the summer is decidedly murky and more protests can be expected, both in the UK and overseas. They will come more quickly with warmer weather though, especially if there is no respite in fuel costs. The financial sector will plough on but there are significant economic headwinds ahead. Little has been done since the last meltdown to restructure both over the counter markets and regulators and rating agencies who previously abdicated their responsibility. Meanwhile, banks accross Europe remain undercapitalised with assets on their books at prices way above market prices. The UK is being strangled by covert tax increases but government spending will be higher this year than last. Our young are being forced to shoulder huge debt to get an education (and face a future of falling living standards which will be lower then their parents and grandparents enjoyed), but without reform of the universities who are the beneficieries of the fees.
Wish I could be more optimistic but then, life is like that when you're on a January detox.