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In the UK, “bonuses are back” is the new phrase reverberating around the financial district, the City of London. This came after some banks reported a rise in profits for the first half of the year this week. Barclays Capital, Barclay’s investment banking arm has announced that it has made profits of £1bn on the first six months of this year. This implies an average pay out of £100,000 for the 22,000 people that work there just for this period.
This tasteless behaviour of the financial sector is simply staggering. Taxpayer’s money is being used to support an industry which is in turn paying out astonishing amounts to its employees in compensation.
Barclays, was one of the few banks that did not take any state aid, but we should not be fooled by the idea that these profits are only a result of their own ingenuity, the government has played a very active role.
In order to understand why we must return to the original reason why we bailed out banks such as the Royal Bank of Scotland, that they were too big to fail. These banks were perceived to be too big to fail because of the potentially disastrous effect on the whole financial system a bankruptcy could generate, the failure of one bank threatened to tear down the whole financial system, and all the other banks with it.
The reason for this is the interbank market. Every day, in order to settle claims or to meet capital requirements banks lend enormous amounts of money to each other on the interbank market. The interbank market is a necessary tool for managing the capital requirements and liquidity of banks on a day to day basis.
This implies that the failure of one bank would mean large losses for other banks as the failed bank would default on their loans and other banks would no longer be able to borrow as much money on the interbank market.
A study published by the Bank of England in 2002 predicted that a failure of one large bank would not have devastating consequences on the financial system, that even in an extreme case of a 100% default from one large UK bank, the result would be insolvency in 4 additional banks. These banks would most likely be small banks.
However, last year we were dealing with multiple large bank failures in the context of a very weakened banking system. If the government had not stepped in the results would have been truly devastating, even for Barclays. Many more banks would have failed and the ones that survived would have been severely damaged.
If this wasn’t enough to justify more humility from the banking sector, something popped out of the page whilst reading the Guardian’s article on the matter. The article reports that, (emphasis added)
banks with major investment banking operations are benefiting from a reduction in competition, fees earned from governments raising money on the bond markets, and companies raising funds with new shares.
So we learn that at least part of the profits earned today come from the fees on the billions of pounds of debt that the government had to issue, in order to save the financial system!
The bottom line is this, all banks have benefitted from the government bailout of the financial sector. Taxpayer money and the taxes of generations of future tax payers was committed to the banking system in order to save it from collapse. In the future we will have less investment in public services and pay more taxes for it, because of the money we have spent to save the financial system today.
Barclays, HSBC and any other banks that report profits this week say that they will not pay any bonuses until the end of the year. They should use the time remaining to think about better ways to use those profits rather than on bonuses and dividends. A very good use of it would be to contribute to paying down our now enormous national debt. We have seen that banks are too large to fail, but the question remains, are they are also too large to care?
A version of this post originally appeared on Liberal Democrat Voice, an unofficial blog of the Liberal Democrat Party of the United Kingdom
5 Comments
This is truly frigthening. If we continue to give the banks our business, they continue with this sort of unabashed greed. But if we take away our business and, for example, start hiding our money in jars in the backyard, the government steps in and bails the banks out – with our tax money! Could the only recourse left be to refuse to pay taxes?
no, none of those ideas would be good, for anyone! what we need to have is a government that actually stands up and takes some action. Look at the way the US government treated the Auto industry, fired CEOs, surgical bankruptcies and refused to hand out any money until they displayed real intent to change their ways. The comparison with the treatment of the financial sector has been laughable
and I add, tragic.
Very true, George. But what can we do if the government refuses to take action? My point is that the consumer is powerless in this instance, unlike in other industries where our choices can make a huge difference.
Barclays has been doing much the same kind of speculations in the UK as Goldman has here. Neither is performing any market function. Neither is creating any wealth. Both are draining off money from markets and the rubes who have been encouraged to re-invest in them.