A matter of great concern over the years for the US economy, along with several other developed ones, is the exponentially increasing amount of money paid to bankers in the last two decades. According to banks that have their filings with US securities and exchange commission, the sum paid to banks over the last several years amounts to a mind boggling $2.2 trillion. If this trend continues over the coming years, the number would reach $5 trillion, which is an amount that is much larger than what the Obama administration and his opponents would be willing to cut from the government deficit.
Unfortunately this $5 trillion dollar projection is not capital that has been invested in development projects such as roads, educational institutions or miscellaneous long term projects, but on the contrary is transferred from the ailing American economy to the accounts of bankers. It comes as a paradox that today’s financial and economic troubles are a result of the very policies of banking institutions while these people continue to be those who are least affected from the economic crisis that has hit the world at large today.
Large banking institutions, contrary to popular belief, have operated mostly as mammoth sophisticated compensation schemes, and have successfully masked probabilities of low risk, but rather high pitched “Black Swan” events. They have greatly benefited from the unfulfilled and rather implicit public guarantees. A major source of their profits can be attributed to excessive leverage rather than skill, which have accordingly flowed inequitably to employees and their massive losses being borne by the shareholders of these institutions and tax payers.
In simpler terms, banks take risks, and get rewarded for the upside while simultaneously transferring the rotten debris over to the taxpayers, shareholders and pensioners when things turn sour. In order to rescue the US banking system, the Federal Reserve employed a policy of artificially low levels of interest rates, which has been disclosed quite recently, while at the same time providing loans to bail out banks to the tune of $1.2 trillion. In essence, rather than the banking system taking the hit of the global economic meltdown that was a consequence of their flawed policies, they have been aided to generate bonuses by softening their exposure.
At the end of the day, what ensued was that taxpayers eventually ended up paying for the exposure along with the pensioners and others who relied on the returns on their savings. These flawed low interest rate policies transferred inflation risk to savers and the coming American generation. The greatest slap on the face of the American taxpayers, however, was that bankers’ compensation has been brought back to the same pre-crisis level.
The puzzle however remains to be the investment manager who continues to buy stocks of banks that go on to pay handsomely a massive proportion of their earning to their employees. It can be understood that the promise of replicating returns of the past could not possibly be the reason, owing to the inadequacy of returns. The filtering of stocks in accordance with their payouts would have lead to the lowering of the draw-downs on investment to half by the financial sector in the last 20 years, with little loss on returns.
The question then comes down to elementary rhetoric, that why portfolio and pension-fund managers persist in their hope to receive impunity from investors? Is it not obvious to these people that they are willingly aiding in the transfer of funds to the coffers of bankers? Aren’t fund managers grossly miscalculating and violating their fiduciary responsibilities and moral regulations? Are they really missing out on the only opportunity to take banks to task by compelling them to take a greater role in risk taking?
It is rather hard to comprehend why the market mechanism has not worked to eliminate such questions. A well functioning mechanism would produce outcomes that push banks to face the right exposure, right compensation schemes, risk sharing and in effect corporate governance based on minimal levels of moral integrity.
Investors in the past have, on ethical grounds, excluded various corporations for instance tobacco companies or corporations that were a party to apartheid in South Africa and have been successful to a great extent in generating the right pressure on the underlying stocks of these corporations. What needs to be understood is that in the present scenario of global economic meltdown; investing in banking institutions constitutes a double breach in the form of ethical and professional obligations. The general public would therefore be better off if the same funds flowed to more productive organisations with an amount equal to the enormous amounts of compensation received by bankers’ bonuses redirected to charities.
The writer is News Editor, Profit