Home—Blog—How the bonus culture caused the financial crisis – and how we can stop it happening again
Jan 20, 2012, 01:11
Posted byMerryn Somerset Webb
Comments (22)
Most people like to think that overconsumption caused our current crisis. Thanks to Alan Greenspan’s stupid monetary policy – which kept money far too cheap for far too long – we all borrowed too much, spent too much, and ended up with houses we can’t afford filled with tat we don’t need. The solution then is to run down debt – both private and public – and to consume less in the process.
But not everyone agrees. James Livingston certainly doesn’t. In his new book Against Thrift he argues that we have it the wrong way around. The crisis was, he claims, caused not by overconsumption but by underconsumption. And the underconsumption being caused by the deleveraging we are forcing across our economies will, he says, be the thing that prolongs it too.
If we want times to get better, we need to laugh in the face of austerity and get on with spending more. Saving for a rainy day is "a soul crushing emotional trap as well as an economic dead end".
I can feel the sharp intakes of breath from regular readers here, so let me point out that behind the deliberately provocative prose there is some good stuff in here. The stuff that doesn’t hold up is dealt with in this WSJ review and the comments beneath.
And the stuff that might? Livingston thinks that rich people have too much money; that bubbles are formed by those with excess capital and nowhere productive for it to go pouring into one nonsense after another; and that the solution is for it to be removed from them and given to lower income groups to spend on stuff.
He points in particular to the period from 1933 to 1973, a period when net investment in the US was low, but consumer spending was on a roll thanks to a fast rise in government jobs (so a transfer of cash from high-earning tax payer to lower-earning tax payer via the middle-man of the state) and when the unions were demanding and getting higher wages by the month.
It was a period of regular high growth – of the kind people now think the US is entitled to have in perpetuity – and one that clearly coincided with rising incomes and falling inequality.
That makes it very different to the period in the run up to the crisis – one of fast rising inequality with the share of returns allocated to profits rising at speed and that to labour falling at speed.
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US profit margins are now at a record high and have even achieved the rather odd feat of rising over the last three years even as output has fallen. If profit margins in the US were now at their long-term average US profits before tax would be approximately half their current level.
Andrew Smithers of Smithers & Co puts this unhappy trend (unhappy because it isn’t much good to labour) down to modern management: “The huge increase in bonuses linked to short-term measures of performance, such as returns to shareholders and return on equity, has naturally encouraged the observed changes, including an increased willingness to sack labour, combined with a disinclination to lower prices and a preference for share buy-backs over investment.”
Changes in incentives have meant changes in behaviour and hence a rise in the share of output going to profits over workers (as well as a fall in business investment). In the past, margins have tended to widen and narrow with fluctuations in economic output and employment. In the last few years they have moved together. Management keen to keep bonuses up like to keep wages and employee numbers down.
Those benefiting from profits have become progressively richer; those benefiting from rises in output as a whole and from the share of that output going to labour have become relatively poorer.
The former, who have a lower propensity to spend than the latter, then become the bubble creators of Livingston’s book – chucking their ill-gotton cash around the globe in the search for a further return. The latter, scrabbling around for the rent, fail to spend, to consume and hence to prompt the rises in output that benefit us all.
The result? Crisis – in the form of a toxic mixture of bubbles and low growth. The solution? Redistribution. Livingston would have that happen via the state. I’d just hope that shareholders might see sense and that public revulsion might bring an end to the bonus culture.
Everyone’s jumping on the executive pay bandwagon this week. David Cameron is talking about it and by Wednesday even Fidelity, one of the world’s biggest retail fund managers, had started talking about it being time for shareholders to have binding votes on pay.
This is good, but I suspect that most of the people thinking about this subject don’t realise just how important it is. They think it is a matter of dealing with public anger by making things look fair. But it’s actually about more than that: getting this right is one of the key things in making sure that the economies of the West can start to grow again.
• This post is an extended version of Merryn's editor's letter from MoneyWeek magazine issue no 572 .
Published in Blog More articles by Merryn Somerset Webb
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Leave a comment
(20 January 2012, 01:51PM) Complain about this comment
I couldn't agree more and will get this book asap. The concentration of spending power in the hands of the richest 1% has starved the economy of genuine demand. The net rise in wealth of the Times 1,000 richest Britons last year was over £120 billion. Almost equivalent to the annual Government deficit. I also agree the bonus culture caused the crisis. We all remember being bombarded daily with offers of credit cards and loans to make up for the fact that profits had all been snaffled by the bosses and so greedy bankers could hit lending targets. You spend your way out of a crisis, but hopefully not in the way we did after the 1930's!!
(20 January 2012, 07:17PM) Complain about this comment
@ 1. BorisQuote: 'You spend your way out of a crisis ...'Red rag to a bull!It's spending (money we've not got) that's got us into the crisis. In this context 'we' refers to 'our society'.Society will attempt to get its way out of the crisis by effectively robbing those who have accumulated wealth (except from those who are 'above the law'); ironically, those that didn't cause the crisis; the booty to pay both the feckless's debts and the increasing wealth of those 'above the law'. Redistribution!But the robbing is done by stealth; described by some as 'producing money out of thin air'.In the animal kingdom it is 'survival of the fittest'. In our society it is 'reward the feckless and punish the prudent'; this state of affairs is unsustainable. The parasites, as you know, are killing their host.
(21 January 2012, 08:10PM) Complain about this comment
#2 Got to disagree there Critic Al. Hoarding money ,especially at the top does nobody any good. Getting money circulating ios to the benefit of all.Particularly if more equally shared ot and even if there is little or no growth. The World's poorest billion liv eon less tham a dollar a day. Approx £225 billion a year. The richest 1,000 people in Britain alone saw an increase in wealth of £120 billion last year. The World is starving itself of demand by impoverishing so many.
(21 January 2012, 08:20PM) Complain about this comment
Those evil bankers, forcing us to borrow cheap money so that we could have now and discard months down the line something that our parents would have saved up for and cherished for years. They also made us take out bigger mortgages than we wanted and it had nothing to do with our personal greed or ostentation. Yes, let's give the empty-headed, impulsive rabble more money and they will spend it wisely and take us onto glory! There again, over-consumption amounts to pretty much the same thing that has caused this crisis in the first place: a boom followed by a bust. A proper perspective and adherence to a moral code is the order of the day. Sadly, too many folk won't know what the heck that means. Get rich or whinge tryin' baby!
(21 January 2012, 08:40PM) Complain about this comment
The bonus culture is also not based on real money.It is geared to potential future revenue streams. It is like paying a barman £100 for selling one pint on the basis that the customer potentially may keep returning and buying more ......then again he may not.Bankers were wrongly incentivised to inflate the books and bonuses based on future revenues still have to be paid out of todays income.A few bankers are evil, some are stupid,but virtually all are greedy.
(21 January 2012, 10:05PM) Complain about this comment
@ 3. BorisI agree that hoarding money 'under the mattress' does nobody any good. But isn't pooling money which is then loaned out for others to spend/invest in return for a fair rate of interest/pension doing all parties good? It is when certain incomes/pensions have to be paid from money 'produced out of thin air' that the 'applecart' is upset.Quote:'The world is starving itself of demand by impoverishing so many.'Unless money is hoarded 'under the mattress' it is spent one way or another regardless of recipient. It is the distribution of that money that causes any impoverishment.Growth is one of the oliogarchs' conduits to increased 'wealth'; it is also destroying the planet. Another such conduit consists of stealthily robbing from the acquired 'wealth' of lesser mortals. Humans were probably genuinely wealthier when they were living in harmony with nature, in the days before the religion of money. But now ...
(22 January 2012, 07:14PM) Complain about this comment
Neutronwarp called it right, anything else is just BS excuses for mass stupidity.Give a moron a pile of money, it doesn't make him or her less of a moron, all it does is buy some time before they're wailing that the rich have all the money again.Whether its Gekko capitalism or this neveau Marxism, it always ends with the shafting of the masses. If they haven't learnt that by now then all they're good for is dragging stones to help build the Pyramid.The system should have collapsed back in 2008, that would have been a true redistribution of wealth, where rich and poor could stand together as equals.Allow the system to fail and let creative destruction do its work without fear or interference, it'll be worth it in the end.
(22 January 2012, 08:35PM) Complain about this comment
Interestingly Dominic Lawson in the Sunday Times is blaming an absence of capitalism for the financial crisis. He even suggests an anti capitalism. Marx was of course obsessed with owners of capital usurping surplus value from their overworked employees. Lawson points to a reversal where now employees (albeit mainly at the top end) are usurping value from the owners, often now shareholders. How the worm has turned, or at least those well placed worms with the old school ties and the overweaning sense of entitlement.
(22 January 2012, 08:55PM) Complain about this comment
Interesting debate, but borrowing money should have some legitimate purpose. Governments borrowing money to do "nice things" for the people who vote for them so that they have a chance of getting voted in again is fraud. Individuals borrowing money that they are borderline being able to repay to use to buy luxury items and holidays is madness and both of these things are what has led to where we are today. An individual borrowing money to buy a home, as opposed to renting can make sense. A government borrowing money to keep tax rates lower than they would otherwise be is misleading the population.
(23 January 2012, 09:50AM) Complain about this comment
Wealth comes from production, not consumption. Those who say you need to consume more are putting the cart before the horse. We an economy that encourages savings to drive investment for real expansion in goods and services produced; historically the nations that have the highest growth rate also have the highest savings rate.
(23 January 2012, 09:51AM) Complain about this comment
Perhaps any income (including bonuses) over perhaps £200k should be paid as a percentage of cash and shares (not options) that have to be held for a minimum of 2-3 years.Perhaps 25% shares and 75% cash for £200k-£300k and an increasing percentage of shares as income rises. That would not stop those bonuses being paid but would at least make the recipients pay tax on them (now) and hopefully take a longer term view and share the risk with the other owners of the company.
(23 January 2012, 09:56AM) Complain about this comment
"Wealth comes from production, not consumption. Those who say you need to consume more are putting the cart before the horse."You can't just say let's build more factories, make more 'stuff' and it alone will encourage people to buy it.Maybe consumption is the horse that pulls the cart (production) - but where is the carrot and the stick - oh that's donkeys!
(23 January 2012, 12:28PM) Complain about this comment
The bankers have manipulated the system for their own ends. Most first-time buyers have to decide; rent for life (what happens in retirement? housing benefit? More taxes for all?) or take out enormous loans, perhaps via liar loans, to pay for bankers' bonuses. These bonuses are the bane of our society.This also answers Neutronwarps misguided rant. Many were greedy, others sir were desperate, and still more whop did not take out the loans are trapped in bedsit land. Oh what a lovely neoliberal world we have allowed!
(23 January 2012, 12:35PM) Complain about this comment
Romford DaveWhat about those locked out of a secure home for their family? They did not take out these stupid loans, but they too are swindled. No affordable homes, and their taxes spent to bail out the guilty (bankers).Had we regulated to stop: banks printing money, pocketing enormous bonuses from their loans business, and then simply blaming the "morons" who borrowed, then we would not have today's pathetic UK economy based on debt, and investment in stagnant bricks and mortar. And it is not just NewLabour's fault. They were merely the latest to pile into this deregulation, self-regulating market guff, and held the parcel when the music stopped.Not nearly enough recognise that the end of history was a wild and destructive catastrophe.
(24 January 2012, 06:34PM) Complain about this comment
I consider there to be a more fundamental cause of the financial crisis and there to be a greater crisis of which the financial one is a significant part.Theoretical pure democracy is probably the fairest form of organising a society. Theoretical pure capitalism is probably the fairest form of running an economy. But in the real world, tarnished by human nature (particularly greed), pure democracy and pure capitalism are not practicalities.So we have pure democracy sullied by impure capitalism and pure capitalism sullied by impure democracy; and the situation has got worse and worse and worse ... Democracy has largely degenerated into corporatocracy, and capitalism has largely degenerated into cartelism/monopolism.The leaders of big business are largely running govt and they are riding roughshod over the rest of us. They are setting bad examples and have led society astray. Expect mayhem; and not just financial.
(25 January 2012, 09:57AM) Complain about this comment
@ Barkingmad, comment #12:No. Consumers only consume because they have jobs, because they produce something of value. You have to produce something in your job, which earns you a paycheque which you can then go and spend. It's your productivity that determines your value in the job market. If you don't have a job you don't stay a consumer very long.Where do jobs come from? They don't grow on trees - they come from companies - employers who are looking to produce something to sell for a profit.And I know your comeback will be: "who are these companies selling to - the consumers!", well yes, but if the consumer didn't exist they would consume their own products, so it is the production that creates the consumption, not vice versa.
(27 January 2012, 06:16PM) Complain about this comment
#17 Van. Gosh. I never realised only those in jobs consumed. So with 29 million in jobs the UK has 34 million people not consuming. What a senseless waste.We should start sending children down mines and up chimnets asap.Also the 10 million over 65's could perhaps pick okum to justify thier existence. Bit of advice......if you've nothing of value to say, don't say it.
(28 January 2012, 12:30PM) Complain about this comment
A complete misdiagnosis, grounded in a misunderstanding. The problem is moneyprinting - the symptoms are what the book complains of. The solution is to bring down the entire moneyprinting and fiat money system and return to the classical gold standard. All insolvent banks should be bankrupted immediately with only small depositors reimbursed within the limits of the existing deposit protection scheme. This would rapidly alleviate all of the issues described and there would be very much less capital chasing bubbles. Indeed capital in the form of physical precious metal would be extremely scarce. This would restore the virtue and the necessity of thrift (a very human decision to exercise time preference: to defer consumption today for greater consumption tomorrow). Without thrift most of the capital goods we enjoy would never have been created and we would still be living a subsistence lifestyle.
(28 January 2012, 01:07PM) Complain about this comment
I am not an economist, but it strikes me that the problem is that the majority of the current batch of wealthy people is that they have not acquired their money from entrepreneurial activity. This makes them the aristocracy of our age.Where wealth is created by entrepreneurial activity it is, in my book, well-earned and the successful entrepreneur is welcome to any money they have made. They are, more than likely to put their money back into their own businesses or create new ones.Entrepreneurial activity of previous ages produced things such as the Great Western Railway, The Channel Tunnel and Amstrad computers.Large company employees and civil servants should not be getting bonuses, unless it is in the form of 'pocket money' size amounts for exceptional work over and above their job specification.
(28 January 2012, 02:43PM) Complain about this comment
I agree with both sides of the argument.I agree that the very top are so smart that they do not return the correct percentage of their total earnings back to economy through taxation or productive use by creating employment Some would also dispute the probity of some Governments to manage the economy correctly as a mitigating argument for this behaviour.The second side of the coin is that some people who borrow expect to much and easily become victims of the smarter set This basic human nature is unlikly to change.The way capitalist markets deal with this is by enabling more efficient of providing goods and services by promoting the best and smartest methods.A good example is the Car industry where inefficient manufacturers were forced out of business by more efficient manufacturers.But the whole lot go down if the money to purchase the cars in the first place is not circulating.
(28 January 2012, 05:37PM) Complain about this comment
@ 15. NeutonWarp.It sounds like you are taking the stance that only the borrowers are to blame. Lending is a contract between both the borrower and the lender and both have to take responsibility which we know is not what happened if we cast our minds back a short while. The banks lent too much and over leveraged and made huge bonuses in the process, when things turned down the borrowers could not repay their loans and will have lost assets but these were no longer able to cover the value of the loans- the lenders (the banks) then made huge losses and who covered these? Taxpayers, not the agents who had orchestrated the lending and leveraging. Furthermore we have a society where advertising seeks to be omnipresent (often creating ‘false wants’ as I think Marx described them), where we are very materialistic, and where for a period credit was readily available- it is highly likely that immersed in such a culture people are going to borrow when they shouldn’t.
(28 January 2012, 05:38PM) Complain about this comment
While on the one hand people have to take responsibility for their actions you have to look at the system in place in society and consider how it will encourage people to behave. Also any borrowers who could not repay their debts will likely have lost their homes, assets etc. and won’t have had anything of value left, so realistically (and humanely) they have to be declared bankrupt and given the chance to start again financially. However the irresponsible lenders will at worst have lost their jobs but still walked away with their accumulated wealth having left taxpayers and the economy with a huge burden. So of course the bankers (and other private sector based individuals) manipulated the system (and people) to their own ends and this is quite clear, there is nothing apologetic about stating that. This is arguably a product of human nature in a neoliberal society.
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