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Tuesday, 27 October 2009

Osborne: right or wrong?

George Osborne has spoken out against bankers taking their bonuses in cash, saying that they should be paid entirely in shares, all but a de minimis figure, probably around £2,000.

"I am today calling on the Treasury and the FSA to combine forces and stop retail banks paying out profits in significant cash bonuses. Full stop. That includes their investment banking arms.Then the cash that would have been paid out should be put onto banks’ balance sheets explicitly to support new lending. This should be a condition of continuing to receive taxpayer guarantees and liquidity support.

Well not quite George. The cash that the banks pay out in bonuses doesn't go anywhere it stays in a bank account, from where it might be spent, but it might be spent, but is generally neutral when it comes to boosting the economy. After all banks have no problem raising cash, even if it is at a price, but if there customers are desperate enough for credit those higher costs can be passed on. So 0/10 for your understanding of finance, on that score.

But that doesn't mean you are wrong. In fact, you have a very good point to make, although if I might make one small technical point, paying bonuses almost entirely in shares is not a good idea unless the bonus recipient is endowed with a large personal fortune, because the bonus will give rise to a tax liability that has to be settled in cash, unless you are suggesting that under a Conservative government the Treasury will accept shares in lieu.

But to get back to the main point, Osborne is right and the several City big beasts rustled together by the FT appear to be no more than an aggregation of free market absolutists and New Labour followers and snipers. The chairman of the IOD is not a City bigwig but a spokesman for a West End based business group representing those people in British business apart from bankers who normally extract the largest annual cash piles so we know where they are coming from.

According to another pink paper Osborne's plan would reduce the value of the state’s multi-billion-pound holdings in the banks, have no impact on the pure investment banks that lie at the heart of the bonus culture, fail to stimulate lending and unfairly disadvantage UK banks against overseas rivals.

Well that's wrong or irrelevant on all four counts, but typical of the shallow thinking that passes for financial journalism these days, so let's take those points one by one.

  1. Forcing the bank to issue shares in lieu of paying bonuses might dilute the government's shareholding but it saves the banks the same amount of cash as the market value of the shares, hence does not reduce the overall value of the government's stake in the company. Moreover, since the banks are currently constrained by a shortage of capital, putting in additional capital allows them to add incremental business against a fixed component of overhead, hence probably increasing profitability and eps. Indeed, we are always told by highly paid board members that large share allocations align their interests with shareholders. As an indirect shareholder through my taxes, I like that idea. And finally if the government really thinks this is a problem, they could require the bank to buy the shares off the government rather than issuing new shares.
  2. It may not have any impact on pure investment banks, none of whom are UK-based (Rothschilds - don't make me laugh), but that is no reason to stop less capable retail banks from pretending they are investment banks and making the same mistakes. A poor straw man argument.
  3. It is completely wrong to say that paying bonuses in shares will not stimulate lending. On the one hand it will ease one barrier to lending (Tier 1 capital shortages), and on the other, if value is tied up in the bank, there is more incentive to lend profitability to produce a return.
  4. As pointed out before, this is hardly likely to disadvantage RBS and Lloyds compared with foreign rivals. So what if a few traders threaten to leave? Where are they going to go when there are thousands out of work who could do the same job, and what makes them think they are anyone special? They could make money for their banks because the bank provided them with capital. The bank pays them a bonus to get them to work. A trader who doesn't need to work for a bank because they can source risk capital from elsewhere is called a hedge fund. Go figure.
So on this point, Osborne is more right than wrong.

1 comment:

The King of Wrong said...

Surely, with interest rates hanging around zero, if bonuses were paid in shares then at least enough cash to settle the tax liabilities would be loaned to the recipient (using the shares as collateral) at "commercial rates"?

So it'd be pretty indistinguishable from paying the bonus in cash, except that (if we get a double-dip in time) the bonus paid in shares is likely to be worth a damn sight more when it vests...