Are bankers to blame?

29th February 2012

Instead, those working in the finance industries which has done so much to destroy investor value over the past four years, are mostly people who leave Wall Street or the City each evening for their upscale houses in suburban Connecticut or Surrey or homes near Central Park or in Kensington.

So where did it all go wrong? How did the masters of the universe end up in the gutter of the reviled? Or has their reputation been traduced? Could it be wrong to see them as public enemies?

Into the traders' heads

A book, Conversations with Wall Street, by veteran Wall Street headhunter Peter Ressler and new media specialist Monika Mitchell gets inside the heads of mortgage securities traders and other insiders who are blamed for the crisis.

Unsurprisingly, the participants ticked the no-publicity box. But as these were never celebrities, it does not matter.

Bloomberg columnist William Cohan has read the book. He says it "brings a deeper understanding" of how Wall Street works "stripped of its glamour."  What it shows is a massive disconnect – the people who trade billions in securities often neither understand their construction or nor care about what their activities do.

One character is called "Stan,".  He's one of "those guys Main Street loves to hate," employed (past tense) to trade mortgage-backed paper.

He did that for 10 years until his firm imploded. He got paid more than $1 million a year. "I'm just a moving man," he told the authors. "My job is to move bonds off my books as fast as possible." He gave little thought to whether the underlying value of the homes — the mortgages from which he traded — had risen beyond realistic levels, making the securities he sold terribly overvalued.

If it moves, trade it

"The whole game was about price appreciation," he explained. "We weren't concerned about the value of the housing markets, just the products offered. We are in the moving business. We buy loans and securities and move them within two months." He continued: "We sold them to money managers, pension funds, insurance companies and hedge funds. This was a seller's market. We got paid fifty cents for each hundred dollars sold. If we sold $1 billion, we made $5 million. … We didn't care."

"Sean," was the co-head of the fixed-income division of a major Wall Street firm. In his late 40s, his net worth was more than $100 million. He said he saw some risks coming in the mortgage market, but he could not persuade his colleagues to slow down.

"There are a lot of people on and off Wall Street who are responsible for this crisis," he explained. "One of the main reasons it happened is because the Street got velocitized."

By this, he means that as risk ratcheted up and became the norm, greater risks needed to be taken to get the same adrenaline rush that bankers and traders felt originally. He likened it to driving a car, first going from zero to 60 miles per hour — "you can feel the speed as it increases," he said — but then 60 feels normal so you have to start driving 90 or more for the same feeling of acceleration. "But now you are cruising at a very dangerous speed," he said. "The level of control you have over the vehicle you're driving is substantially reduced. When the car crashes, there are usually no survivors."

There are many other traders who have confessed – but Stan and Sean give a good flavouring.

But arguably, they would have acted in the same way if their bonus had been $1,000 and not $1m. And there is now a growing industry to defend financiers, traders and, most importantly, to ensure the world of bonuses does not go the way of World of Leather.

Fighting for finance

Three years ago in March 2009, Mark Harris of Savills Private Finance (now called SPF Private Clients) made a defence of the bankers and bonuses that formed a good slice of the clientele for the upmarket mortgage brokerage. He said:

"Reward for failure has become a phrase for our time. But in the hysteria surrounding the bonus culture, the facts are being disregarded as it is much easier to tar everyone working for a bank with the same brush of incompetence and greed. There is plenty of ill feeling surrounding bonuses, but are they to blame for the financial mess we are in? If we look at the evidence, most bank staff have delivered the objectives they were set. bonuses are unpaid, they will be penalised by the mistakes of an influential few who get the seven-figure bonuses the public is so up in arms about."

More recently a blog on the World Bank site came out on the bonus side. It says: "Experts in governance would have argued before the crisis that the interests of these CEOs were well aligned with the interests of the shareholders because they had so much skin in the game. The CEOs of Lehman Brothers and Bear Stearns had equity holdings in their firms worth approximately one billion dollars in 2006. With such holdings, it would have made little sense for CEOs to take actions that knowingly decreased shareholder wealth."

A counter argument is that they may have either had little control over their traders or thought their actions would increase their value to two billion dollars.

Don't blame me, I'm only a banker

In December, academics at Bath University claimed bonuses were not to blame for the financial crash. They found no evidence that pay structures led banking bosses and traders to take excessi
ve risks for short term profits, leading investors to wonder just what did.

Professor Ian Tonks, one of the authors said: "It's difficult to see how incentive structures in banks could be blamed for the crisis. They were paid high salaries irrespective of bank profits."

The study found "the pay-performance sensitivity of banks is not significantly higher than in other sectors, and is generally quite low. We therefore question how incentive structures in banks could be blamed for the crisis since there is little evidence that executive compensation in the banking sector depended on short-term financial performance. However, across firms in all sectors we do identify an intriguing asymmetric relationship between pay and performance: when stock returns are high, pay-performance elasticities are also relatively high, but we find that executive pay is less sensitive to performance when stock returns are low."

But the revisionist view of financial history has not convinced everyone.

The glamour generation

Christopher Bones, a professor at Henley Business School talks of the L'Oreal "because you're worth it" generation.

He writes: "The "war for talent" was propounded by smart people at McKinsey in the 1990s. It argues that talent is finite and potential limited. Success would come by getting the very best and then paying them to stay, regardless of cost, as they would inevitably out-perform. Major adopters could be found in financial services, banking and, of course, that bastion of corporate propriety, Enron. Despite this, in business and public-sector organisations today there are still many believers: just look at the RBS board's justification for the size of the pay packages at the top."


More from Mindful Money:

Slash bankers' bonuses? Alternative incentives to bonus culture

The Ordinary Madness of Markets: Inside the minds of traders (video)

Is the media backlash over fat-cat pay fair?

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