G-20 finance ministers have backed away from a joint pledge to cap bank bonuses. Critics say this could sow the seeds for a future crisis
Since the start of the financial crisis, political leaders on both sides of the Atlantic have decried what they call outsize bonuses paid to top bankers. Such payouts, they've said, have encouraged destructive levels of risk-taking and can't continue if another financial bubble and collapse is to be avoided.
But that talk likely won't amount to an agreement by Group of 20 industrial and emerging nations (G-20) to cap bankers' bonuses. Bowing to arguments by U.S. and British leaders that imposing such limits—a move advocated by French President Nicolas Sarkozy and German Chancellor Angela Merkel—would be impracticable, finance ministers of the G-20 countries are apparently abandoning that idea.
Instead, after talks Sept. 5-6 in the runup to their Sept. 22-25 meeting in Pittsburgh, G-20 finance ministers say they'll find ways to ensure bonuses reward long-term success instead of short-term profits. The overall focus of the conference will be less on bankers' pay and more on capital requirements for banks, as U.S. Treasury Secretary Timothy Geithner and British Prime Minister Gordon Brown have urged.
Taking a Longer View
But many analysts question whether setting rules on bank capitalization levels will be enough to ensure the international financial system moves toward greater stability. "If you look at what has happened [in the financial crisis], it's clear that focusing on only [capital requirements] won't be sufficient," says Christiane Holz, a lawyer at the German Shareholders' Assn. "Bank employees' pay must be structured in line with the company's long-term earnings."
Advocates of direct government action on bankers' bonus levels say that leaving the current remuneration system intact could lead to future financial problems. "We're seeing no negative repercussions for the behavior that caused the economy to collapse," says Sarah Anderson, a fellow at the Institute for Policy Studies, a Washington group that has long been critical of executive pay levels. "It's obvious we're setting ourselves up for a repeat. If people can still make loads of money on investments that blow up a year later, where is the disincentive for doing it all over again?"
But others argue that capping bonus levels—especially across different countries—won't work. "Inherent in the capitalist system is…an open top," says Robin E.J. Chater, secretary-general of the Federation of European Employers in London. "There has to be the possibility of earning almost infinite reward so that people are motivated to take risks." Chater adds that when it comes to pay, the market is "self-correcting."
Some banks have taken it upon themselves to alter payment practices. On Sept. 9, major Dutch banks announced a code of conduct that includes capping executive bonuses and ensuring bonus payments do not encourage bankers to take excessive risks. The code calls for executive board members' bonuses to be capped at 100% of their annual salary and linked to long-term performance at the company.
Just Say No
There have been voluntary moves by banks elsewhere. Deutsche Bank (DB) CEO Josef Ackermann, along with the company's board of directors, declined to take bonuses in 2008 because of losses the bank suffered from the financial crisis. Ackermann, who had been Germany's top earning executive in 2007, slipped to 27th place with a salary of €1.4 million ($2 million). He'd earned almost 10 times that in 2007.
Bankers lost a significant chunk of their bonuses in the U.S. last year as well. In 2008, Wall Street cash bonuses totaled $18.4 billion, down from 2007's $32.9 billion, according to the New York State comptroller's office. But pay consultants expect those amounts to increase this year as markets recover. In July, Goldman Sachs (GS) said it had set aside $11.3 billion in the first half of the year toward bonuses for its employees. Morgan Stanley (MS) is on track to pay an average bonus of $189,000, even though it reported losses in the first two quarters of 2009.
Advocates for limiting bonuses say the debate on executive pay in the banking sector is not yet over. "I was hoping pressure from the Europeans might lead to better international coordination," says Anderson of the Institute for Policy Studies. "But I'm not giving up hope. There will be more public pressure in the U.S., especially as banks continue to hand out big packages."