The de-knighting of former Royal Bank of Scotland (RBS) head Fred Goodwin last week wasn't the end to Britain's high drama over "bonus culture." This week, the House of Commons will vote symbolically on whether bank bonuses are out of control.
American investors shouldn't look on the British morality play with bemusement. The same theatricals are playing out here with less flourish - and adding an extra layer of unpredictability to stock prices.
Last week in Britain, Conservative prime minister David Cameron showed us how to do the wrong thing - public flogging of high financiers - with panache. The target was Fred Goodwin, who led the Royal Bank of Scotland into its 2008 meltdown. That year, Her Majesty's Treasury had to prop RBS up with $72 billion, plus priceless government guarantees.
Goodwin slunk off, but he still had his eight-figure pension pot. He gave about half of that back in mid-2009, when it became clear public rage wasn't abating. But he still had his knighthood, for "services to banking." No longer. For three and a half years, the press has hounded "Sir Fred." Last week, the government brought out the big gun: the Queen. A government panel directed the monarch to decree Goodwin no longer a "sir." Goodwin joins a short list of the de-knighted, a roster that includes Robert Mugabe.
The tabloids were gleeful. The Daily Mail called it "the humbling of MISTER Goodwin" for having "caused … the biggest banking disaster and British history."
Slaying one knight, though, won't sate the bloodthirsty. Last week, too, the government claimed a smaller prize. After criticism from the media and from the Labour Party's opposition leader, Ed Miliband, Cameron bullied Goodwin's successor at RBS, Stephen Hester, into "voluntarily" declining his scarlet number: a $1.5 million bonus. Hester relinquished the pay despite the fact that Hester had nothing to do with RBS's pre-bubble woes. He has been doing a good-enough job of shedding the bank's bad assets, exactly what his government bosses want him to do.
British politicians and editorialists aren't confining their criticism to payouts at state-owned banks. This week, Barclays (BCS) chief Bob Diamond is set to announce his bonus. He'll take hits if it's a big figure, even though Barclays never got state aid. As the Independent observed last week, "Although Barclays is not part-owned by the state ..., [the] Labour [Party] argues that it was rescued by the Government's bailout during the 2008 financial crisis, which prevented the contagion spreading to banks that remained in private hands."
Then, Miliband, in calling for the Commons vote, has ensured lots more mean comments about the big, bad bankers.
As fury defines policy, bankers are perplexed. They can't understand why everyone's still so mad. They shouldn't be so confused. Britain has dithered on enacting the dispassionate rules that the financial industry needs. On that subject, the Tories issue paper after paper without fixing anything. Cameron's latest goal? To regulate the banks properly … by 2015.
Why the delay? The political class - both the leadership and the opposition - doesn't really want to fix the banks. It likes the money that it thinks a a government-coddled financial industry can still throw off both in tax revenues and to ex-politicians. Tony Blair, the former prime minister, is a walking specimen. He's reviled at home - but he's got bank fees to comfort him.
The Cameron government won't do the obvious: simply sell its ownership in RBS. The government says it wants to protect the taxpayer from a loss. What the taxpayer needs protection from is not a one-off loss, though, but another decade of mutually beneficial dysfunction between the government and the banks: the banks can expect bailouts, and politicians can expect rewards.
Cameron should sell RBS, now. He should embrace the public outrage that would accompany the $36 billion loss (or more). He should tell voters that the anger such a sale would achieve is taxpayer money well spent. Public rage at bailouts and their costs is the only thing that will ensure that bailouts never happen again.
The Queen could behead Mister Fred, Cameron should say. But that still wouldn't stop global investors from lending too much to financial institutions, if those investors think they can expect a rescue later.
Indeed, the best guarantee against unjustifiably high bank bonuses is for the government to allow the market to work. Over the past two decades, banking in Britain got too big. Without government aid, it would shrink, along with its bonuses.
The heat surrounding Goodwin and Hester obscures the enlightened fact that this market correction is already happening. Let Barclays chief Bob Diamond take a lower payout - not because of public bullying, but because of investment banking's abysmal 2011.
The same dynamics are playing out in America. President Obama loves to complain about bankers - but the Dodd-Frank bill he signed into law nearly two years ago doesn't end the government's arbitrary "too big to fail" policy; the law institutionalizes it.
Despite this impediment to healthy markets, it's lower profits, not government fiat, that are cutting bonus payouts this year. Last week, Goldman Sachs (GS) boss Lloyd Blankfein saw his 2011 stock bonus fall nearly in half from 2010.
What does the deficit of political honesty mean for bank shares? On both sides of the pond, it depends what investors think is more important:
- the prospect of random government bailouts for the banks, even if such guarantees come wrapped in tough words?
- or the private-sector freedom to succeed or fail, both at the awarding of bonuses and more generally?
If people prefer rationality, they may come to understand that free markets are a better guarantee of it. You can short a failing bank, but you can't monetize a revoked knighthood.