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November 28 2008, FT
It no longer makes headlines when bankers turn down this year’s bonus or pay rise. But when ex-bankers at UBS – including the former chairman Marcel Ospel and the former chief executive Peter Wuffli – volunteer to pay back some of last year’s haul, the world has changed.
One is reminded of shoplifters surrendering their ill-gotten gains to try to win clemency from the judge. But Mr Ospel and Mr Wuffli are accused, not of any crime, but of incompetence. They face only the court of Swiss public opinion. Small wonder that the Swiss former executives have been quicker than the non-Swiss to announce their gestures of atonement.
There will be few tears shed for Mr Ospel and Mr Wuffli, and bankers should by all means feel free to hand back money that they now feel they did not deserve. Yet the underlying challenge is deeper: in an ideal world, bankers’ contracts would be guilt-proof because the money would always have been justified. An ideal world is impossible, but better contracts are not.
Many people believe bankers and other finance professionals have been paid large sums for failure. In itself, that is nobody’s business but the shareholders’. The true problem is when payment for failure makes failure more likely – with, as a few economists pointed out years ago, systemic consequences.
It is now painfully clear that regulators have a legitimate interest in how bankers, traders and other financiers are paid. Future financial stability depends on it, and we now realise that the taxpayer is bearing the most serious downside risks.
Too often, contracts have rewarded the volume of deals, or short-term profits that take no account of long-term risks. Too many banks and insurers have been taking the real-world equivalent of a leveraged bet that the number 13 will not come up on the roulette wheel. Such bets can look profitable, and indeed low-risk, for many spins of the wheel. They are guaranteed to end in catastrophe.
The broad principles for pay in the financial sector are clear: it should be paid over a sensible time-frame, perhaps holding back shares while the true profitability of a deal becomes clear; it should be adjusted for risk; and when performance cannot be measured, banks should not pretend to reward it.
The reality will be harder. Different lines of work need different pay schemes; risk is hard to measure; and rewards cannot be deferred for ever. The only practical way forward is for regulators to weigh compensation schemes in the balance when judging the risk of a financial company’s activities, and to penalise poorly designed contracts. The Financial Services Authority is rightly considering this approach. There will be no miracles as a result, but even small improvements are worthwhile if they help to prevent a future crisis.
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