Lack of wealth creation means bankers should not become “indecently rich”

Bruce Anderson is wrong to claim that without rich bankers, we would all be poorer. Banking activity is not in the game of pure wealth creation but instead, the City operates as a giant, informal cartel charging what most independent observers believe to be excessive fees.

In an article in the Independent today, Bruce Anderson claims that without rich bankers, we would all be poorer:

“Think of the indispensable contribution bankers will make to Britain’s recovery, on one condition: that they are allowed to become indecently rich. It is a small price to pay.”

This might be the case if banking activity was in the game of pure wealth creation – expanding the size of the cake from which we all benefit. But the evidence is the opposite. The City operates as a giant, informal cartel charging what most independent observers believe to be excessive fees – ‘the croupier’s take` – for activity that often involves the transfer (or sometimes the destruction) of wealth towards themselves and their clients rather than its creation.

Take the fees charged for merger advice. In 2007, Merrill Lynch pocketed the lion’s share of the estimated $400 million fees paid out by the consortium led by Royal Bank of Scotland for its successful bid for ABN Amro, a deal that turned out to be seriously ill-advised. Then in 2008, the investment bank picked up more fees for advice on the rescue rights issue forced on the Bank because of the takeover. What one insider has described as the “incessant pressure to transact” explains the increasing emphasis on merger and acquisition activity, financial engineering and big top-down cost reduction strategies which may have limited benefit for long-term performance but which have bene the source of the massive fortunes earned by top bankers.

The giant profits (the source of huge bonuses) made by investment banks – described by one inside as “supernatural” – do not reflect the greater contribution to the economy made by the banking sector. Rather they are the result, first, of a lack of proper competition within the industry with other industries enjoying similar levels of surplus profits subject to enquiries by the Competition Commission. Secondly, they are encouraged by the unwillingness of the banks’ clients – large companies and institutional investors – to challenge the excessive transaction fees for takeover advice and/or financial engineering they are able to charge. This is because the costs are being paid for by someone else – it’s our money, depositors, pension fund holders, savers and taxpayers. Thirdly, they have been protected by the government’s wider economic strategy of an increasing reliance on financial services to propel economic growth.

As one senior investment bank trader has claimed:

“What the vast majority of City staff get paid is much too high. Most people, whilst being talented, are doing roughly the same kind of job that they could do in any other industry yet seem to get paid 2-3 times as much.”

Indeed, the evidence is that accelerating bonuses have not just led to excessive risk-taking. They have also greatly distorted the economy by skewing the pattern of rewards for talent, while the high rates of return available on much financial activity from private equity to mergers has helped create a deeply unbalanced pattern of investment.

Once one of the City’s main roles was to provide medium and long-term capital for business development, contributing to the patient organisation-building on which enduring companies and long-term wealth creation have been founded. Today there has been a shift towards short-term, ‘fast-buck’ making deals – activity dismissed by Lord Turner as “socially useless.” Investing in companies of the future, in contrast, has become an increasingly fringe activity compared to speculating on share prices, interest rates and currency and commodity price movements. Yet financial speculation, the source of many modern fortunes, is rarely associated with creating value.

Consultants Ernst & Young have warned that the finance industry has become “the cuckoo in the nest,” crowding out industries that would otherwise have flourished. It is the City that has sucked in the pick of Britain’s brightest graduates with some of the best young PhD mathematicians and physicists behind the fiendishly complex mathematical formula used to run arcane financial instruments.

Increasingly Britain’s home-grown super-rich are drawn from financiers rather than traditional entrepreneurs. According to the Sunday Times, 17 per cent of the richest 1000 in 2008 obtained their wealth from hedge funds, financial speculation, private equity and other financial activity. A mere 11 per cent made their money from industry and engineering and 5 per cent in construction and housebuilding.

Yes the tax paid by the City has helped to fund big public sector programmes, but this tax take is the product of a distorted economy. Without such distortions, the tax would have accrued from other sectors of the economy that have been choked off. Moreover as academics at Manchester University have shown, the total tax revenue from the City is less than the costs to the taxpayer of the bank bail-out of the last year. Reining in the fees and bonuses of multi-millionaire bankers is not an expression of the “politics of envy” as Anderson claims. Rather, without it, we will continue the failed economic strategy of the past.

Our guest writer is Stewart Lansley, author of Londongrad: From Russia with cash and Rich Britain: The Rise and Rise of the New Super-Wealthy.

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