Bankers returning from their holidays won't stay relaxed for long. Top of their list of worries will be pay and jobs. Everybody knows big job cuts are coming. And nobody thinks for a second that banks will match the record and totally outrageous bonuses paid last year when the credit crunch was already in full swing. So how deep will the cuts go?
The dilemma for bank bosses is twofold. On the one hand, no one wants to cut too deep and then find themselves left behind when markets recover. On the other, banks are under huge pressure from shareholders and regulators to shore up earnings and conserve cash.
But how do you conserve cash while hanging on to the staff you need? In a typical downturn, banks have squared the circle by handing out large amounts of stock options to selected staff in lieu of cash bonuses. However, that may be much harder this time. Many bank shares are down more than 50%, and some well-known names are down more than 80%. Many bankers have seen years of accumulated share-based bonuses and options wiped out. Under the circumstances, who would want to be paid in yet more bank shares?
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Trust between different parts of the big investment banks has broken down. Mergers and acquisitions specialists don't want to be left to the mercy of traders who could bring down the bank with reckless bets on exotic structured credit products. Traders may likewise fear mergers and acquisitions specialists betting the balance sheet on an overly aggressive loan deal for a private equity buyout. Given a choice between being paid in bank shares and working for a smaller specialist boutique or hedge fund, many top City folk may choose the latter.
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The banks are starting to face up to this dilemma. UBS is exploring a scheme whereby bankers would be paid in "shadow equity", which would track the performance of their division, rather than the whole bank. But it is very hard to see how this could be made to work. More likely, banks are going to have to make some very tough choices. Major job losses seem inevitable. Expect to see major banks selling or closing entire divisions, with some big names disappearing altogether. Meanwhile, the smaller specialist boutiques and hedge funds will grow in power and that will be no bad thing.
Brown's suicide pill
Meanwhile, in Whitehall, the frantic search for magic bullets goes on. Gordon Brown has made it clear he plans to launch an emergency package in the autumn to tackle the credit crunch. Top of the list of options, according to reports, is a plan to extend the Special Liquidity Scheme the Bank of England's £50bn facility that allows banks to swap dodgy mortgage bonds for government bonds so that banks can swap newer mortgages as well as those issued before December 2007. UK mortgage lenders are convinced this is the only way to get the mortgage market moving again. And the Treasury seems to be seduced by the idea.
However, there are three big problems. The first is that it won't stop the fall in house prices. After all, take up of the existing facilities has been enormous, I'm told. Yet it hasn't stopped house prices dropping like a stone. Extending the scheme to new mortgages won't make any difference if lenders don't want to lend and borrowers don't want to borrow. No amount of Bank funding is going to bring back 100% mortgages at six times salary.
The second problem is that it may prolong the housing crisis by delaying the re-opening of the private mortgage funding market. The Bank would be competing directly with the private sector indeed, undercutting it. Yet re-opening these wholesale markets is the key to reviving the housing market.
Finally, the Bank needs to be alert to Gresham's Law whereby bad money drives out good. Many UK banks look admiringly at the European Central Bank (ECB), which allows banks to deposit mortgage bonds in return for cash. Last month, Nationwide opened an office in Dublin, partly to take advantage of this facility. But while this arrangement has undoubtedly helped eurozone banks during the credit crisis, there is growing alarm at the ECBthat the eurozone is being used as a dumping ground for toxic mortgage bonds, presenting a potential risk to eurozone taxpayers. If a big European bank were to get into serious trouble, the ECB might not be able to get its money back.
Gordon Brown needs to go back to the drawing board. A solution that won't actually solve the housing crisis and may just prolong it and could also expose taxpayers to serious long-term risk is not a magic bullet but a suicide capsule.
Simon Nixon is the author of Credit Crunch: How Safe is Your Money?, available to order from www.pocketissue.com, priced £5.99.
