Bailing out the Bonuses (2012), D.J. Webb

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Bailing out the Bonuses?
by D.J. Webb
Published on the LA Blog
28th January 2012

The £1m bonus to be received by Stephen Hester, chief executive of the Royal Bank of Scotland, 83% owned by the taxpayer, raises interesting issues for libertarians.

The government should not be dictating board-level pay in private companies. But, by the same token, this is not a private company: it is owned by the state.

A lot of unintended consequences have flown from the refusal to allow the collapse of the financial services industry in 2008/09. It was argued that the collapse of financial services was equivalent to the collapse of the real economy. Surely, the collapse of financial services would have entailed a sharp fall in economic output. Nevertheless, we should be wary of any attempt to equate one industry (a vested interest) with the whole economy.

During a financial collapse, the impact on the wider economy is normally less severe than on the financial services industry itself. Iceland is an example: the banks collapsed, and the economy entered a sharp downturn, but the Icelandic economy is now growing again, and the Icelandic state has regained access to the bond markets. In a true systemic collapse, as in Iceland, it is simply not possible to repossess every house in arrears: for a start, there would be no buyers. A true cash-only property market (we are not quite there yet in the UK, as mortgage lending is proceeding, albeit at a lower-than-normal level), the banks simply have to lengthen or alter the mortgage terms, as it makes no sense to do otherwise.

By bailing out the banks, we have ended up transferring huge debts to the public accounts. The end result is a zombie economy, with years of low or no growth ahead of us. The banks remain in crisis, and will not lend, and a large risk is transferred to the national accounts as it remains unclear if the money sunk into outfits like RBS will ever be recouped.

Once the bond markets revolt over the astonishing annual increases in our public indebtedness, then things could get really interesting. A rise in interest rates could force much greater cuts in the state, which would have to devote much larger sums to debt servicing, and mortgage-holders could find their mortgage payments going much higher, in a situation where many are telling surveys even a one percentage point rise in interest rates would see their mortgages pushed into arrears.

It would have been better to take the hit in 2009. A strong downturn in the economy would have been coupled with a quick working through of the debts, mainly in the form of bankruptcies.

This is where Stephen Hester comes in. His task is to get RBS back into the private sector, with the state apparently hopeful of making a gain on its ill-thought-out investment in the bank. I would not query any bonus payments, however high, that shareholders of a private company approved. It is not for us to make rulings on footballers’ pay and financial services’ bonuses generally. But Mr Hester leads a bank in crisis, a bank that foundered and then imposed itself on the national books, a bank that continues to imperil the wider British economy.

We shouldn’t have taken over RBS, but the in the circumstances, I don’t see how a bonus payment can be justified. This amounts to a recycling of the bailout funds in the form of executive bonuses. True, banks need to be able to employ the best personnel, although such bonuses are poorly correlated to individual performance by a chief executive. Is there any evidence that had Mr Hester phoned in sick every day for the past year that bank performance would have been any different?

My solution is that no bonuses—not even a single penny—should be permitted at the state-owned banks. But these banks should be sold off as soon as possible, to return them to the private sector and allow the bank boards to hire and fire and pay bonuses according to their own view of the banks’ best interests.

Waiting for the bank share prices to soar in price seems a little forlorn: these bank stocks are likely to remain depressed, at least compared with the pre-2007 share prices, for a long time to come. Having made the foolish decision to take them over, the state should simply accept that it has to take a hit on these shares. RBS should be prepared to be sold to the private sector at a loss to the taxpayer, with a no-bailout law passed making clear that further trouble at RBS will lead to bankruptcy, not bailout.

Banks should not be told how much money to hold in reserve. All such intervention should cease. However, a full publication of RBS’ exposure to subprime mortgage debts in the US and to euro zone sovereign and private debt should be made, to allow shareholders and depositors to assess the financial position of the bank. There should be no further depositor protection: if the bank collapses, the depositors and shareholders should lose their money. Most people do not have great savings or deposits. However, banks should also be forced to take the hit on repossessed houses sold off at a loss: the non-recourse principle used in the US, which prevents the banks from pursuing householders for the remainder of the debt, should be introduced here, in order to encourage the banks to consider their lending quality, and to prevent the “moral hazard” occasioned by turning mortgage loans into a one-way bet for the banks.