The first problem with the culture of bank bonuses is that they have encouraged high risk activity.
- If banks make spectacular profits, bankers will gain from juicy bonuses.
- However, if banks make losses, bankers don't have to pay a forfeit, or even lose previous bonuses.
- Therefore it becomes a one way bet to take risky options that may lead to a big payoff. If you are lucky and your risky approach pays off then you are entitled to high bonuses. If the risky option loses out, you don't personally have to pay. Therefore, there is every incentive to take risky options to maximise the chance of high payouts even at the expense of increasing the bank to risk. And this is exactly what happened.
At the very least bonuses should be paid after good performance in the medium term. I have no objection to paying bonuses for good performance. The problem is banks defined good performance as producing spectacular short term gains. The bonuses should have been paid to those who didn't take unnecessary risk and get involved in buying collateralised debt.
By their own reckless action, the banks have created tremendous problems for the economy and the tax payer. The fact is that without the taxpayer, the banks would be facing collapse. Since, the taxpayer has bailed out the banks, it is right the taxpayer the government dictates bonus pay policy, at least in the short term.
The other problem is that banks have a long history of encouraging reckless behaviour amongst traders. It was the prospect of high bonuses that encouraged Nick Leeson to break Barings bank. It is not as if this is the first time banks have been on the verge of collapse.
Interestingly, Nobel Prize winning economist Joseph Stiglitz has suggested just let the banks collapse and then take over them. There would be no bonuses then. - Let banks fail - J.Stiglitz