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Jan 29 2009

Another culprit found for financial crisis

Published by at 11:50 am under Opinion,Top Stories

South African investment fundi Prieur du Plessis pointed to a very interesting video interview with US asset manager Jeremy Grantham in his latest newsletter. It’s worth a watch.

It touches on many topics, but I thought Grantham’s reference to the role of “career risk” in the current financial crisis was the most interesting. (But, also note his views on Alan Greenspan and his view that China is going to disappoint in the next few years.) 

On “career risk”: I’ve long been of the opinion (and this interview convinced me finally) that the remuneration models used in the banking sector are inappropriate and should be reviewed. Specifically, the use of performance bonuses should be banned – it doesn’t belong in such a “crucial” sector (with a license to create money). 

Money is the lubricant of the economy – as important to it as oil is to the machine. Without a properly functioning banking system the economy grinds to a halt. The banking sector is not just another sector. It’s a “strategic sector”. One could almost say it’s as important to a country’s security as the military.

Noticing (from media reports) the potential the current financial crisis has to destabilise countries politically (read this blog with all the comments below), I would go so far as to say the international community should consider bringing the banking sector back under state, or quasi-state control – and leaving it there. 

As a “semi-state sector”, the remuneration of employees should, among others, be regulated. (As is done in §219 of the SA Constitution with the “remuneration of persons holding public office”.) Remuneration models which rob banking sector employees of their impartiality and good judgment, such as performance bonuses, should be banned.

Articles like this one in the Wall Street Journal suggesting we need performance bonuses in the financial sector, don’t convince me.  

Salaries can be as high as they want to be, but “variable parts” which are linked to performance, should be banned from this sector. And here I include the remuneration model used by the asset management sub-sector, namely “a percentage of the assets under management”. That is, in its essence, also a remuneration model which robs employees of their partiality, objectivity and good judgment. (Check out what Grantham has to say on this.) 

In short: No performance bonuses, or similar models, in the financial sector – the complete remuneration package should be fixed.

It seems as if the international banking system is going to be overhauled drastically. I think the overhaul will be ineffective as long as remuneration models encourage the circumvention of regulations to chase above average returns for clients so employees can earn above average pay packets.  

With a strong enough incentive, ways will be found around the upcoming regulations – no doubt about that. And then we’ll be on the road to the next financial crisis.

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