When the G20 leaders meet in Pittsburgh this weekend they are likely to clash over priorities when it comes to reforming the financial sector.
The Europeans favour strict international limits on banker compensation while the US is pushing for deeper structural reforms. At its heart, this is a clash over the causes of our crisis.
In Europe there is an iron-clad consensus that risk-encouraging banker bonuses were a primary cause of our crisis. They plan to push for mandatory deferrals of bonuses, clawbacks, and a greater role for stock options in bonus plans to link pay to long term performance. While there are differences—the French and Germans see a greater role for tax penalties and strict caps while the Brits want to be more flexible—they are unified by the view that banker pay caused our crisis and limits must play a role in any solution.
US officials don’t outwardly disagree on banker pay but they want to emphasise deeper structural changes. Treasury Secretary Tim Geithner has been pushing for higher and better structured capital requirements, including eliminating the reliance on ratings agencies for satisfying the requirements. He seems to have taken the correct view that our crisis wasn’t caused by compensation but by errant views of credit risk and an accidentally under-capitalised financial system.
Why the split? The best explanation is that the European politicians are just pandering to populist outrage about banker pay.
“We will see social tensions in our societies, given that we’re in a precarious situation on the labour market,” said Anders Borg, whose country holds the rotating EU presidency. “It’s important that we as politicians should give a clear message that the old bonus culture must come to an end.”
“Our citizens are deeply shocked at the revival of reprehensible practices, despite taxpayers’ money having been mobilized to support the financial sector at the height of the crisis,” a joint letter from the UK’s Gordon Brown, Gernmany’s Angela Merkel and France’s Nicolas Sarkozy said.
An editorial in the European edition of the Wall Street Journal explains that this view of the crisis is just wrong:
Of course, blaming the whole panic on bankers’ bonuses is not merely dishonest. It also gives bankers far too much credit for their powers of foresight and risk assessment. The implication is that all these highly paid bankers knew just how risky their bets were, but decided to make them anyway for the sake of chasing bonuses. It’s far more likely that they didn’t see the panic coming any more clearly than did their less-well-paid regulators or the political class that is now so sure it has the answers. This matters because if we get the diagnosis of the panic wrong, we’re not likely to forestall the next one through reforms. That goes double if one’s chief explanation for the crisis is a fairy tale born of political expediency, as Mr. Borg suggests.
It has to be hoped that the US view triumphs. Because it addresses the wrong problem, the European view creates the risk that investors, regulators and bankers will assume the system is much safer than warranted by reality. Convinced that once the banker pay issue was resolved, the public may assume that the financial sector would stabilised. This would be a dangerous mistake.
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