http://www.economist.com/node/21558584THE crisis has taught people a lot about the banking industry and the thought processes of its leaders. These lessons can be distilled into four golden rules.
1.
The laws of supply and demand do not apply. When food producers compete to supply a supermarket, the retailer has the luxury of selecting the lowest bidder. But when it comes to investment banking, wages are very high even though the number of applicants is vastly greater than the number of posts. If the same was true of, say, hospital cleaning, wages would be slashed.
An investment bank, like a supermarket, demands a certain quality standard: it will not hire just anybody. But whereas it may be easy to identify a rotten banana, it is harder to be sure which trainee will be the next Nick Leeson and which the potential George Soros. That gives executives an excuse when things go wrong.
2.
Success is down to my genius; failure is caused by someone else. When banks do well, and profits soar, the bosses are responsible for it all with their strategic cunning and inspiring leadership. Huge bonuses are therefore due.
But, like Macavity the mystery cat, executives were never at the scene of the crime. They did not attend the crucial meeting, read the vital memo or open the incriminating e-mail. Together with this surprising inattentiveness, executives have a remarkably faulty memory which means that conversations are rarely recalled in any detail. It is a wonder, indeed, given their technical shortcomings and early-onset Alzheimer’s, that they make it to the top of their organisations at all.
But executives do tend to remember one vital fact. When scandal breaks, the blame should lie with a few rogue employees who have ignored the corporate culture. Managers cannot possibly be expected to keep track of the actions of junior staff. And that leads to the next rule.
3.
What is lucky for an individual trader may be unlucky for the bank as a whole.There is a survivorship bias in both fund management and trading. If your career starts with some bad losses, it will quickly come to an end. So, by definition, veteran traders will have had initial success. But that could be down to luck, not skill.
Successful fund managers attract more clients and thus manage more money. This will keep happening until they have a bad year, when clients will desert them. Their worst result will thus occur when they have the most money to look after. They may end up losing more client money in cash terms than they ever made.
Similarly, successful traders will be given more responsibility, first heading their departments and then leading the bank itself. They will gain a reputation as the kind of person who can handle risk, and they will believe their own publicity. The likes of Dick Fuld of Lehman Brothers and Jon Corzine at MF Global seemed to regard caution as a quality for wimps.
This is a variant of the Peter principle, which holds that managers get promoted to their level of incompetence. The trader-cum-executive will make the biggest mistake when he is in charge of the whole bank. By this stage, he will be personally rich and will remain so even if the entire bank fails, not least because:
4.
Resigning can be a retirement plan. When ordinary folk resign, they are lucky to get paid to the end of the month. But when bankers leave in awkward circumstances, they make out like a lottery winner (Bob Diamond, formerly of Barclays, has done worse on this score than others). The bank may want to avoid a lawsuit, with all its unfavourable publicity. The more trouble the bank is in, the less publicity it will want and the better the negotiating position of the executive. This may not be the ideal incentive structure.
Moreover, if the bank is big enough, the government will not be willing to let it fail. Take the Royal Bank of Scotland. Had it gone bankrupt, then the pension scheme might have fallen into the hands of the Pension Protection Fund (PPF), a collective-insurance plan. That would have been bad news for Fred Goodwin, the then chief executive, since individual pension payouts are capped under PPF rules. The limit at the time was £24,000 ($44,500) rather than the £703,000 he originally claimed.
Bankers get such generous payoffs because it is in their contracts and airtight contracts are needed to attract the best people. But is this right? The BBC just appointed a director-general on a salary that is one-third less than that of the previous incumbent. Even so, there was no shortage of qualified applicants for the post. Back to the first rule: in banking, the laws of supply and demand do not apply.
