Killing Goldman Sachs' Goose, Across the Pond Style

Saturday, October 24, 2009 , , , 0 Comments

It's nice to know that it isn't just us. I think.

Foolish bonus rage will kill our Goldman Sachs goose (Dominic Lawson via the UK Times):

What is it about the name Goldman Sachs that makes otherwise sensible people foam at the mouth? Over the past few days it has become mandatory for any public figure to fulminate about Goldman’s announcement that it would be paying billions in bonuses to its 5,000 London-based employees. Alistair Darling declared that this was a grievous mistake and that no bank “would be standing here today if the taxpayer had not put their hand into their pocket”.

Lord Mandelson spoke darkly of an “unacceptable return” to past practices. Lord Myners, the minister responsible for the financial sector, lambasted people “being grossly over-rewarded for their contribution to the value added”. Even Boris Johnson, as London mayor the City’s stoutest defender, wrote that Goldman’s decision was “unbelievable ... what Asperger’s afflicts them?”.

At the risk of appearing like the man in Bateman’s cartoons who commits such social solecisms as to give everyone else in the room apoplexy, I beg to differ from all of the above. First of all, Mr Darling, it was not the taxpayer that “put their hand into their pocket” to bail out any banks — it was you who put your hand in our pockets. Second, no British taxpayer paid a penny towards mending the balance sheet of Goldman Sachs; that was a purely American exercise. Third, Goldman had been ordered by the US Treasury to take public funds — the firm had lined up refinancing from the world’s biggest private investor, Warren Buffett. And, fourth, Goldman rapidly repaid the US Treasury its money — at an annualised rate of more than 20%.

One of the elements that doubtless irks the British government is that by flooding the capital markets with money — via so-called quantitative easing — it has itself engineered the conditions in which so astute a trader as Goldman can make thumping profits. Yet it’s simply not the case that the London-based recipients of Goldman bonuses are scooping their millions off the back of British government largesse. Goldman Sachs, in common with many other US and multinational finance houses, bases all its European trading operations in London. No more than about 10% of those revenues flooding into the City stem from transactions involving British-based companies or concerns.

That’s right: this so-called casino is based in London, attracting players (bidding via the telephone or the internet) from all over the world. We simply pick up the vast croupier’s take. I say “we”, rather than just Goldman and its fellow traders, because their corporate profits are taxed here; most significant of all, so are their bonuses.


The truth is that the British government knows the score. That is why, when the Germans and French tried at the recent G20 meeting to limit the size of bankers’ bonuses, Brown and Darling blocked the plan. They could see that it was nothing to do with the public interest, and everything to do with Franco-German jealousy of the City of London. This is what makes their posturing over the Goldman bonuses so transparently insincere. They know we know they don’t mean it. This is especially true of Lord Myners (who made a stonking fortune in the City himself).

Last week Myners expostulated: “We are simply not going to tolerate high levels of remuneration which are not justified and earned. The nation is angry and I’m angry.” Is anyone fooled by this mock tantrum? Myners went on to single out RBS for a warning. It’s true that the state holds a 70% stake in that benighted bank, so the government can do whatever it likes to RBS executive pay packages. Yet Lord Myners did nothing to block a £10m “incentive” for Stephen Hester — the new RBS chief executive — which would pay out simply if the RBS share price happened to reach 70p.

WaPo has 5 myths about executive pay and bonus "misunderstanding" numbers among them.

Better yet, Richard Posner addressed the issue over at The Atlantic (the first part may be found here):

Here are two questions about the bonuses that I did not discuss in my blog yesterday:

1. Could the bonuses be compensating for the risks of a career in finance?

2. Shouldn't Goldman want to limit the bonuses paid its employees?

1. Consider actors' careers. A handful of actors have huge incomes. Most actors have such meager incomes that they abandon acting as a career. The lucky handful are like lottery winners. The only way you can motivate people to buy a lottery ticket is to have a big jackpot for the winner of the lottery. Similarly, the only way you can motivate people to attempt a career in acting is to provide a jackpot for the tiny handful of aspirants who succeed.

Could finance be the same? It is, after all, a risky business. The question is what happens to employees of Goldman Sachs or other financial firms if they engineer or approve a very risky deal, and the deal is a flop. Are they exiled from the industry? Do they end up as waiters? If so, the huge incomes of successful financiers would be justified as compensation for the risk of failure. My impression is that the failed traders, deal makers, etc., do not end up as waiters, or in other relatively impecunious jobs (I say "relatively" because waiters in elite restaurants are well paid by ordinary standards). Their training and experience equip them for a variety of good jobs in the financial industry. They can look forward to a soft landing, and therefore it is unlikely that the high incomes of the most successful financiers are compensation for the risk of failure.

It is true that anyone who is risk averse will seek compensation for taking risks, but the people who gravitate to risky occupations are unlikely to be risk averse. Put differently, as long as there is an ample supply of risk preferrers, an employer will not have to pay a premium based on risk aversion. And, as I have just suggested, the career risks in being a trader or deal maker for a major financial firms like Goldman Sachs are probably very small.

2. A "monopsony" is the converse of a monopoly. A monopolist reduces output in order to push price above the competitive level. A monopsonist reduces his purchase of an input in order to drive the price of the input below the competitive level. If a firm faces an upward-sloping supply curve--meaning that the more it buys, the higher the prices it must pay--then if it buys less, thus moving down the supply curve, it will pay lower prices for its inputs. Suppose the input in question is labor. If the relevant labor market is competitive, monopsony won't be feasible; workers offered a lower than market wage will quit and work elsewhere. But suppose all the firms in an industry conspire to reduce their hiring; then wages will fall because the affected workers will not have good alternatives.

So why don't financial firms welcome pay caps, or, in Goldman's case, since it isn't subject to the caps, voluntarily compress the compensation they pay? There are three answers. The first is that if the firm does so, its best employees will quit and work elsewhere. This is not as compelling an answer as it seems, since demand for financiers has fallen and, more important, because Goldman Sachs is regarded as the world's premier financial company and (therefore) immensely profitable, so it is unlikely to hemorrhage employees merely by cutting bonuses; and if it loses some, it should be able to replace them.

We're back to the same question of whose risk but I guess we'll have to get into that another day.

Jr Deputy Accountant

Some say he’s half man half fish, others say he’s more of a seventy/thirty split. Either way he’s a fishy bastard.