Paying b*nkers

A few days ago I wrote an opinion piece on bankers' bonuses for the Edinburgh-based student newspaper called the Journal. It's going to come out later this week, but here's the "preview" (the whole text without editing). By the way, I teach a related topic (compensation contracts) in my Industrial Organization course.

Why do "we" (need to) pay bankers so much?

Whether we wanted it or not, we taxpayers are now the de facto owners of some big banks in this country, because the government bought lots of their shares to rescue them from last year's financial crisis. Now many of us are angry: why on earth do "we" have to pay huge bonuses to those bank managers, who (at least partially) are responsible for the crisis in the first place? A lot of people find this unfair and immoral.

"Immoral" is perhaps too strong a word, but I do think paying them huge bonuses after the crisis they may well have caused is hardly moral, at least in the usual sense of the word. At the same time, however, I am inclined to think that the bonuses are inevitable, especially if we want to avoid further trouble in the financial sector and, much more importantly, the whole economy. Let me explain why.

It takes tremendous expertise to run contemporary financial institutions. We all know how complicated financial products are. Even as an academic economist, I get overwhelmed by the financial terminologies and technicalities involved in my little personal banking account. I have no idea how hard it would be to stay on top of the many big things a large bank does.

Some commentators and politicians say what banks should simplify what they offer, much like traditional high street banks. However, we should never forget that it is this major development in the financial sector over the last two decades that allowed the British economy to do better than many other developed economies. And needless to say, London and Edinburgh are the two British cities that benefited most from it. True, the bankers may not necessarily understand completely what they buy and sell (, which became apparent during the crisis), but still, there are very few people who have even the minimum knowledge and skills necessary to make sure things do not become worse than they were in 2008.

Here's the first dilemma: most or all genuine banking experts are people who were, at least to some extent, involved in the crisis. It may seem insane and immoral to hire those people again to run "our" banks. But moral issues aside, precisely because we are the de facto owners of these banks, we want the best people to do the job. In principle, we can install "clean" people from outwith the financial sector into the banks' managerial teams, but in practice, that is bound to be utterly disastrous. Again, because the expertise required to run banks is fairly peculiar and because there is so much at stake, we don't want novices in there.

But why pay them so much? Shouldn't they work hard for free, now that the government helped them out? Well, another dilemma is that competent bankers are still very expensive to hire. They may be in demand by other financial firms. Or, because they had already been very well paid, they could simply retire and live a quiet life if we offered them modest salaries (like mine). We are in a free society, so we cannot force good bankers to work for us (otherwise it's slavery). Instead, we have to induce them to want to work for us. That's why we need to pay them so well. The fact that bank managers get paid in large part by the bonuses is actually a good sign, because that means they get rewarded only when they have got things right.

It seems to me that we face an uncomfortable choice between being "moral" on bankers' pay and getting out of the current downturn as quickly as possible. Of course, it would be ideal if we could remain "moral" as we get out of this mess, but unfortunately, for the reasons I've discussed here, that seems rather unrealistic. It's really hard for us to agree on what's moral or fair, but insofar as most of us benefit from the recovery of the financial sector (especially in Edinburgh) and the whole economy, I'm not too bothered by how much the bankers get. The amount of the bonuses is tiny anyway, compared to what is at stake.