Has banker bashing gone too far?

Public feeling against highly rewarded bankers has reached new peaks. But is the anger justified? Matthew Partridge reports.

What's the problem?

It's not a good time to be a banker. Royal Bank of Scotland chief executive Stephen Hester was forced to give up a near-£1m bonus after a public outcry. Barclays is under pressure to follow suit, by cutting bonuses for its staff.

Meanwhile, the removal of ex-RBS chief Fred Goodwin's knighthood has seen a call for other bankers to be similarly stripped of their honours. It's all symptomatic of a wider loss of faith in the financial industry, notes Margareta Pagano in The Independent.

Media intelligence research group Media Tenor has published Trust Meltdown, a report which shows that "the reputation of the financial and banking sector is now far worse than that of the tobacco and chemical industries at their lowest".

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

And it's not just about banks and bonuses. Consumers believe that the products they sell are toxic too. The report even suggests that if bank boards fail to clean themselves up, "they are dangerously close to losing their licences to operate".

Is this fair?

Some believe the attacks on bankers have gone too far. Digby Jones, former head of the Confederation of British Industry (CBI), claims that "banker bashing" risks damaging the status of the City of London. Simon Walker, director-general of the Institute of Directors (IoD), is also worried about "anti-business hysteria".

Others are more concerned about the political cynicism of the Goodwin decision. As former chancellor Alistair Darling noted, regardless of what you think of the ex-RBS boss, "we will be in an awful lot of trouble here if we go after people on a whim".

However, the public doesn't agree. According to YouGov, two-thirds of people want all those involved in the banking crisis to face the same fate as Goodwin, with only a quarter siding with the CBI and IoD.

What are the possible solutions?

One option is simply to ban bonuses altogether. The Guardian's Simon Jenkins claims that such rewards "are mad" and "should be considered a malpractice". "Any minister who can't ban bonuses should pack up and go." Nigel Lawson, writing in the Financial Times, suggests that bank reform is more important.

"The RBS disaster and the excesses of the bonus culture in general, are symptoms of a complex cancer at the heart of modern banking." He thinks investment (the casino' side of banking) and retail banking should be split more quickly, rather than by the end of the decade, as is the current target. Accounting rules also should be changed, with a specific regime for banks.

Others argue that banking simply needs to become more competitive: high profit margins are what allow huge bonuses to be paid in the first place. Removing advantages, such as implicit state backing for banks, would cut profits and pay.

So what are governments doing?

Given the painful nature of complex restructuring, pay caps and taxes are becoming popular as short-term fixes. Spain has limited the pay of executives in bailed-out banks to €600,000. French presidential frontrunner Franois Hollande has proposed new bank taxes and a ban on their use of tax havens.

Indeed, whoever wins, France will implement a domestic financial transactions tax in August, which it is pushing to be adapted Europe-wide. Ernst & Young warns that, even if Britain opted out of the charge, the City would pay 60% of the total revenue raised.

Regulators are also getting tougher. The European Banking Authority is pushing banks to increase their levels of capital, while banks in America are still trying to settle lawsuits over various problems with mortgage loans.

How will this affect bankers and banks?

Salaries, bonuses and profits are all likely to suffer in any case, both from new regulation and the state of the economy. The Dodd-Frank reforms in the US, effective this summer, mean that firms are closing trading desks. The demise of mortgage lending has also cut a major source of revenue.

Indeed, further action may not be needed. Research by US-based economists Thomas Philippon and Ariell Reshef shows that financial sector wages relative to the rest of the private sector hit a peak of 1.7 times in 1929, the year of the Wall Street Crash. After the crash, wages took a while to adjust, but by the late 1930s were back to parity with similarly qualified employees in other sectors.

Ironically, the FT's Gillian Tett notes, the 1.7 times peak was hit again in 2006. Since then, there are signs of change. Morgan Stanley has capped cash bonuses at $125,000 (tiny compared to previous years). Goldman Sachs is also slashing pay. "By 2017, bank pay could look very different from 2007; and modern capitalism will look all the better for it."

The problem with modern banking

Professor Mariana Mazzucato of Sussex University argues that the problem with modern banking is that the perceived relationship between risk and reward is all wrong. Economic orthodoxy says, roughly, that shareholders are the only ones who take risks, so should also get the most rewards: that means top employees too.

In fact, taxpayers, lower-ranking employees (whose jobs and pensions are not guaranteed) and small savers also take plenty of risk, and are "owed a return too", as Margareta Pagano puts it in The Independent. High-paid bosses are "taking value out of their companies at the expense of value creation and the taxpayers and workers who have contributed to it... Only when that is understood, and acted upon, will Fred's head have been worth the chop."

Dr Matthew Partridge

Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.

He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.

Matthew is the author of Superinvestors: Lessons from the greatest investors in history, published by Harriman House, which has been translated into several languages. His second book, Investing Explained: The Accessible Guide to Building an Investment Portfolio, is published by Kogan Page.

As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.

Follow Matthew on Twitter: @DrMatthewPartri