Let Banks Choose: Bonuses or Bank Charters?

L. Randall Wray

Now here is the best idea we have seen yet. Britain’s Financial Services Authority has come up with the ultimate response to bank claims that they must pay high bonuses to the geniuses who caused the crisis. Just as Timmy Geithner claimed, while trying to protect his Wall Street handlers, UK banks always say that contracts are contracts and so no matter how repulsive it might be, they have to pay out bonuses as spelled-out in their contracts. The FSA said fine, go ahead, but if you do you will lose your license to do banking in London. In other words, it is the bank’s choice: be a bank, or pay bonuses. You cannot have it both ways (see here).

So here is the deal. President Obama should direct his administration to offer our bankers the same choice: either forgo all bonuses until the US unemployment rate drops below 5%, or lose your bank charter. Indeed, he should go further. Banks are really public-private partnerships, and bank management and other employees should not receive pay in excess of civil servant pay. Assign the appropriate civil servant pay grades to our regulated and protected banking institutions. Any banks that wish to pay higher salaries than that to retain “rocket scientists” can do so, but they will give up their bank charters. They will slip into the dark “shadow banking” sector and will lose all access to government protection.

Then adopt a strict version of the Volcker rule. Should any of those shadow banks find themselves in trouble, they will not be bailed out. Instead, they will be “resolved”—that is, shut down, with creditors paid whatever the government can recover on assets. If that rule had been in place two years ago, no more Goldman Sachs. Instead, Goldman was handed a bank charter, which allowed it to stay in business, to hoover up manufactured profits, to manipulate government policy, and to pay out bonuses using government bail-out money.

As to the complaint that banks will not be able to retain all the geniuses that helped to create the crisis, Obama’s response ought to be: Goodbye and good riddance. Go find jobs in the Caribbean. Banking does not need rocket scientists. It is basically a simple business: assess credit worthiness, make loans that have a high probability of repayment, and issue deposits. It used to be known as the “three-six-three” business: pay three percent on deposits, charge six percent on loans, and hit the golf course at three p.m. That was good banking and it did not need high remuneration. Tens of millions of Americans bought homes, started businesses, and sent their kids to college. It was good enough.

4 responses to “Let Banks Choose: Bonuses or Bank Charters?

  1. If you don't pay huge bonuses to banks' management, then the profits accrue to shareholders. Either way it's an obscene concentration of capital into private hands that was only possible through political favoritism.The outrageous think in my view is not bankers' compensation, it's fiscal/monetary policies that favor a sector of the economy that is non-productive and purely extractive.I struggled for the longest time to understand why it is that international bankers were supposedly early supporters of communism. Now I know why; finance capitalism (by this I private-sector credit creation) ends up concentrating wealth just as well as communism.

  2. Hi Alexis: the bonuses are paid in good times and in bad; "profits" are easy to manufacture. Take a look at what has happened to equities over the past 3 years. Mostly across the board huge losses for share holders. But the rocket scientists have done just fine.The more important point is that if you remove bonuses, there is no incentive to produce phantom profits through fraudulent trades. Get banks back to making loans. The financial sector will be at least two-thirds smaller.LRWray

  3. Sounds great to me.Then again, do any kinds of corporations *ever* lose their charter these days?

  4. We want the same thing but I guess for me it's a matter of which comes first, the chicken or the egg? What came first in the financial industry? Is it huge bonuses or high returns on capital (relative to the manufacturing sector)?My understanding is that the high returns came first, during the Carter/Volcker era as the National Banking Act was repealed which essentially removed the cap on interest rates. In my opinion, from that point on, it was a matter of time before the financial industry accumulated sufficient capital to buy off pretty much all three branches of government. Once that was done, it was game over as Glass-Steagal was repealed and non-regulators were appointed in key regulatory positions (CFTC and SEC).I think we have to be careful when we talk about limiting compensation because this is partly how we got here. When limits were put on executive compensations in the 1990s for tax purposes ($1M deduction became the maximum deductible amount allowed for management salary), this led us straight into the era of stock options. Michael Lewis in his book Liar's Poker has the former CEO of Salomon Brothers confess that stock options changed the game. You just don't think the same way about a company if you have an option on it as opposed to actual equity. Warren Buffett himself has already talked about this assymetric alignment (management shares on the upside but has no downside). Anyways, just an example of how unintended consequences can arise out of playing with compensation.For me the simpler path is to get rid of the higher returns on capital in finance. I agree that the industry should be at least 2/3 smaller and focused on making productive credit flow. The financial sector should be there to serve the economy, not the other way around.