3 Mar 2013

Bank Bonuses - the missing element

There's a lot of talk this week about Bank bonuses. The European Union plans to put a cap on all banking sector bonuses at the level of the base salary, unless shareholders agree to a specific arrangement, in which case the bonus could reach twice that level. The very day the new scheme was announced, the Royal Bank of Scotland, which taxpayers were forced to bail out, posted 2012 losses of more than £5 billion - after having paid out more than £600 million in bonuses.

As soon as the EU draft proposals were revealed, Cameron immediately lept in to defend the right of his chums in the City to "earn" unlimited bonuses.

On thursday, the Guardian published something called "Bonuses : the essential guide", in which the paper's six main economics journalists gave a detailed report on questions like "How did bonus culture develop, why is it controversial, and what is the EU doing about it?"

However, at no point in that report was there any mention of the fact that bonuses in the banking sector are not like bonuses in other sectors of the economy. We can complain about massive payments made to football players - but if the presence of those players in a particular club actually enable the club to increase profitability, then it is difficult to see on what grounds those large salaries should be blocked. If a new start-up comes up with a brilliant idea for a new product and makes a fortune for its founders, I personally see no problem with those people earning very large sums. The people who created Apple, Google and Facebook probably deserve their financial rewards (although obviously, I would like to see the tax system fixed so that such multinationals paid their fair share).

But banking is different. Most people have yet to realize it, and indeed it is an amazingly well kept secret, but commercial banks have the power to create new money out of thin air. If anyone else tried it, it would be viewed as conterfeiting. But commercial banks have managed to rig the economic system so that they have the power to create the nation's money supply by issuing loans using money that they don't have. They then charge the rest of us interest.

In such a system, it is not difficult to see how bankers bonuses can be so sky high. Suppose you are a banker, and you get a fixed percentage on all the loans you make. Your bank allows you to create money when you make a loan. The borrower has to pay interest on the loan (let's say 10% for the sake of argument), and the person who makes the loan gets to keep 2% of the amount loaned. This is essentially what happened in the run-up to the financial crisis in 2008-9. Banks were lending out hundreds of billions of money that they didn't have, and the bank staff were "earning" commissions on those deals made with fictitious money.

A neat illustration of how this sort of system works is provided by the case of "Sir"' Philip Green, who started of with a few million of his own money, borrowed billions from the financial sector to buy out a large chunk of the British High-Street, taking over chains like BHS, Acadia and Topshop. Once he got in control, he got those shops to borrow even more money from the banks, putting them massively in debt. And he used a substantial wad of that borrowed money to pay his wife, a Monaco resident, and hence able to avoid UK taxes, a neat dividend of  £1.2 billion in 2005

When you look back at that particular episode, and you realize that all of those buy-outs and dividend payments were made with money that was created out of thin air by the commercial banking system, and that the whizz-kids in the City that allowed the operation to work certainly pocketed hundreds of millions in bonuses in the process, you begin to realize just how sick the situation is.

But it gets worse. Not only do the commercial banks use their money creating monopoly to provide the money needed by the rest of the economy, they can also create money for their own internal usage. When Jerome Kerviel ran up debts of €4.9 billion for the Société Générale, it is extremely unlikely that he was using money that the bank obtained as savings deposited with the bank. No, when an alpha trader is doing well,  the "investment" arms of commercial banks can just open a credit line for them to play the markets. They don't need to have the money in advance. They just create the money internally. And if the trader's deal works out, they can make massive profits for the bank, and huge bonuses for the trader. Occasionaly, as with Kerviel, the trader screws up, and the bank gets left high and dry. But most of the time, they get away with it.

But for me, the worst exampel is the case revealed recently, where Barclays bank apparently lent billions to the Qataris to buy shares in Barclays. It seems incredible, but this sort of operation may not be illegal. Rather, the traders involved in setting up the deal appear to be in trouble for earning excessive fees. Indeed, if Barclays decides to create £5 billion in loans to the Qatari investment agency, which then uses that money to buy shares in Barclays, and the Barclays staff involved in the deal each earned a nice percentage on the the deal, it is clearly fraud. Incidentally, as a recent Panorama program on the BBC showed, Barclays probably set up the deal to avoid having to ask for a public bail-out - and that was because they didn't want the government to be able to put limits on their bonuses.

So, banking is not like the rest of the economy. For my part, I would say that all bonuses in the banking sector should be blocked until it can be demonstrated that those bonuses are not directly related to abuse of the money creation system. Of course, once Positive Money's proposals have become reality, and commercial banks no longer have the power to create money, bankers will be able to start earning bonuses for actually earning money - just like the rest of the economy.

In the meantime, I would say that the re-establishing the right of commercial banks to pay bonuses should be conditional on them accepting a change in the system that prevents them creating money. Simple....


  1. Dear Simon,

    I have only just discovered your blog, and look forward to reading what seem to be many other interesting articles. I found your blog while searching on "Michael Rowbotham", and came up with your review of "Grip of Death", which I've just finished reading.

    Sorry to go off the topic of the above article, but I wondered if you'd ever got a reply to your question in that review, whether anyone had found a mistake in Rowbotham's ideas. I wonder because I notice that although Ben Dyson gives credit to Rowbotham and his book for the initial impetus to form Positive Money, in their proposals, they don't seem to use much of his proposed solutions, e.g. his ideas for tackling the national debt. This seems a shame, since I would have thought you can't really tackle monetary reform _without_ addressing the national debt at the same time.

    But perhaps Rowbotham got some things wrong? Unfortunately, he does not seem to have any public presence these days, so one cannot easily (for example) simply ask him if he is sure of all his facts.

    There is one thing he writes which I'm not sure is necessarily 100% true, which is about building societies. He says that they, just like banks (since the 1980s deregulation) also take part in the money/credit creation process, and don't simply "lend out" the deposits of their shareholders.

    I had a close look at the website of the Coventry BS (which I happen to be a customer of), and if I understand their wording properly, they do only lend out their savers deposits. However, I mean to write to them to clarify, and if necessary ask a question at the AGM. (I'll also ask about their "buy to let" policy, but that's another issue).

    I'll be interested to hear your reaction, if any, and once more, sorry to go "off topic" (for this particular article, but I thought if I only commented on your Rowbotham review, it might just get buried within the body of the blog, and you'd never see it).

    Mike Ellwood, aka "Montmorency".

  2. Actually, I try to reply to comments even for posts that I did ages ago. On the question of whether Michael Rowbotham was right in accusing banks of keeping the money they create as loans, even when the loans are paid back, I'm no further. I've tried asking friends in the banking system to clear the question up, but no-one seems to know. But the recent case of Barclays lending money to the Qataris who used the money to buy shares in Barclays is getting pretty damn close.

    You're also right to ask about whether Building Societies can act as banks. If you find out, do let us know!

    Cheers, Simon