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Since Autumn 2008, when
the global financial systems went into melt-down, people all over the
world have been asking 'how did this happen?'
What baffles most people is how a multi-trillion dollar system which
year-on-year was paying huge bonuses to already overpaid staff could
suddenly have run out of money.
This new book, by Monkton Prestwyck and Meylan
Allevard, explains just how the banking system works, where the money
comes from, and, most importantly, where it's all gone.
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Here are some current news stories highlighting the
enormous salaries and bonuses banks and big businesses are still paying
despite government bail-outs, dividend cancellations and massive staff
lay-offs:
 Bob
Diamond to be new Barclays chief
Robert Peston, the BBC's financial analyst, asked a leading member of the
UK government what he thought of the recent appointment of Bob Diamond as
chief executive of Barclays: "Bank taken over by casino," he said.
The well-timed purchase of the US arm of bankrupt Lehman Bros in the
autumn of 2008 and years of recruitment and investment means Barclays now
owns one of the world's biggest and most successful investment banks -
Barclays Capital.
Barclays weathered 2008's worst financial crisis in living memory far
better than RBS and Lloyds raising a colossal amount of new capital to
protect itself against losses from Middle East sovereign investors rather
than British taxpayers.
Barclays also benefited from emergency loans and guarantees provided by
the Treasury and the Bank of England, because of the government's
assessment that Barclays is too big and important to the UK economy
to be
allowed to fail.
The success of Barclays Capital is built in part on the ability of the
investment bank to raise finance at cheaper rates than would be available
if creditors didn't believe that Barclays as a whole would always be
rescued in a crisis by UK taxpayers.
And so there is an argument to be made that taxpayers are, in effect,
still subsidising Barclays Capital's more speculative activities and that
the huge bonuses earned by Mr Diamond and his colleagues are arguably
generated to an extent thanks to this state safety net.
Barclays was heavily reliant on investment banking in the first six months
of the year, with Barclays Capital's £3.4bn accounting for more than 80%
of overall profits.
Bank and casino
Business Secretary Vince Cable says the appointment of investment banker
Bob Diamond to head Barclays illustrates the dangers facing traditional
High Street banks in having investment arms.
"We are worried about this combination of the casinos and the traditional
banking," said Mr Cable on the BBC Radio 4's Today Programme.
"It does illustrate the wisdom of the government's decision to set up a
banking commission to look at the structure of banks."
The UK government set up the commission, on which Mr Cable is deputy
chairman, in June to investigate the banking industry but it will not
report its findings until September 2011.
Following the financial crisis, concerns have been raised on both sides of
the Atlantic about "universal" banks like Barclays, that combine
traditional deposit-taking and lending with higher risk investment banking
activities.
Retail deposits are insured by the government, and Mr Cable and others
have expressed concern that banks that benefit from this guarantee should
not be gambling on the international capital markets.
Mr Cable's predecessor in the post, Lord Mandelson, was none too keen on
Mr Diamond.
In April, before the general election forced him out of office, he
launched a personal attack on Mr Diamond as the "unacceptable face" of
banking, saying he made money by "not by building business or adding value
or creating long-term economic strength, he has done so by deal-making and
shuffling paper around".
Mr Diamond, an American whom The Times newspaper, which broke the story
that Mr Diamond is taking the helm at Barclays Bank, labelled "Britain's
£100m banker",. has made about £100m as head of the bank's investment arm
Barclays Capital, by gambling on the stock markets in order to accrue
unimaginable rewards.
The promotion means that Mr Diamond can expect to earn up to £11.5m a year
- comprising salary and bonuses as detailed by Barclay's:
"With effect from 1 January 2011, Bob Diamond's compensation arrangements
will reflect his new responsibilities. The compensation arrangements have
been benchmarked against a peer group of global universal banks,
industrial companies and financial services institutions. Bob Diamond's
salary will increase to £1,350,000 and his annual incentive award
opportunity will be up to 250% of base salary. It is intended to award a
long term, performance-based share incentive of 500% of base salary in
2011."
Although Barclays Capital total income did not increase in the last
accounting period it will be another good year for investment bankers' bonuses
at Barcap. For the first half of 2010, average
overall pay for Barcap's 25,000 employees was nearly £120,000
per head.
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HSBC chairman Stephen Green to become a government
trade minister
Mr Green, currently chairman of HSBC, will take up the position of minister for trade and industry from
January 2011, at the request from the UK prime minister.
The relationship between Mr Green and Business Secretary Vince Cable,
chair of the newly established banking commission, will be closely
watched, as they appear to disagree on proposals to
break up big
banks.
In April 2010, prior to the UK general election
Lib Dem leader Nick Clegg also said his party would dismiss the boards of
directors of Lloyds and RBS if they failed to lend enough money to
customers and business.
"It's an outrage that banks have taken billions from taxpayers to bail
them out of the consequences of their greed and are now hoarding that
money instead of lending it," he said.
"It's time to force the banks to help those who helped them - the millions
of taxpayers who bailed them out."
Mr. Green, who will not be paid for his government position, but
will receive a peerage, has
amassed a £19.1m pension pot while at HSBC. He admitted there was "understandable public
anger" in some countries at "the egregious reward of management failure".
Bank avoiding bonus tax:
Credit Suisse was recently
accused of "sophisticated and aggressive tax
avoidance" after the investment bank and wealth management group
told hundreds of its London-based
staff that an
unexpected one-off 'discretionary leadership award' would be paid
immediately – less than five months
after the UK
government's 50% levy on bank bonuses expired.
In the bank's 2009 annual report it said: "In response to the UK levy on
variable compensation exceeding £25,000 we have ... significantly reduced
the amount of variable compensation for 2009 of managing directors in the
UK. These measures will absorb the majority of the levy's expected cost."
Some US newspapers are speculating that other investment banks
might join Credit Suisse in announcing early bonus awards, given that the
possibility of a similar tax on Wall Street firms was under discussion on
Capitol Hill.
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Costcutting US bosses earn 42% more than rivals, says IPS research
US bosses who sacked most staff during the recession earn more than their
rivals, according to IPS research.
The good times keep rolling for "slash and burn" managers in America.
Bosses of the 50 US companies that sacked the most staff during the
recession earned 42% more than their peers, according to research published
on
1st Sept. 2010.
A report by the Washington-based Institute for Policy Studies (IPS)
concludes that US chief executives shared little of the pain felt further
down their workforces
as house prices slumped, consumer spending dried up and unemployment
peaked at 10.2% last year.
Those who took the most aggressive approach to cost-cutting often fared
the best - the average chief executive pay was $12m in the 50 companies in the S&P 500 index
which shed the
most employees.
The highest paid was Fred Hassan, former head of drugs
company Schering-Plough, who earned $49.7m, largely through a $33m golden
parachute as
he left following a merger with rival Merck. As a result of that deal,
around 16,000 employees lost their jobs.
Other top-paid bosses who slashed jobs included Johnson & Johnson boss
William Weldon who received $25.6m despite 8,900 layoffs,
Hewlett-Packard's former
boss Mark Hurd who got $24.2m after 6,400 job losses and Walt Disney
supremo Robert Iger who made $21.6m after 3,400 redundancies.
America's layoff leaders
- Schering-Plough Fred Hassan $49.7m, 16,000 job losses
- Johnson & Johnson William Weldon $25.6m, 8,900 job losses
- Hewlett-Packard Mark Hurd $24.2m, 6,400 job losses
- Walt Disney Robert Iger $21.6m, 3,400 job losses
- IBM Samuel Palmisano $21.2m, 7,800 job losses
- AT&T Randall Stephenson $20.2m, 12,300 job losses
- Wal-Mart Mike Duke $19.2m, 13,350 job losses
- Ford Alan Mulally $17.9m, 4,700 job losses
- United Technologies Louis Chenevert $17.9m, 13,290 job losses
- Verizon Ivan Seidenberg $17.5m, 21,308 job losses
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 Just
what
do investment banks do?
What is investment banking, why is it so controversial and why does it
make so much money?
Adviser AND dealer
Investment banks carry out two very different - and sometimes conflicting
- functions in the financial markets - financial advisory work (for
customers) and financial dealer (for itself).
For example, a big corporation might ask for the bank's help if it wants
to borrow money in the bond markets, or float itself on the stock market,
or buy up another company and in this capacity, the investment bank acts as an impartial adviser - like
a solicitor or an accountant - using its expertise to help its client in
return for a fee.
But investment banks also do something else quite different - they deal
directly in financial markets for their own account.
An investment bank's "markets" division makes money by buying financial
assets from one client, and then selling them to another - often with a
hefty markup.
Profit and loss
It is banks' capital markets dealers who were behind the
boom in "derivatives" - complex contracts that allow clients to speculate
on financial markets.
For example, the investment bank may know a pension fund in London who
wants to buy Russian mortgage debt, while its Moscow office may know a
local home loans company.
The bank may offer to buy the Russian client's loans, and then sell them
on to the London client through a derivative contract, but at a much
higher price.
The profits on these kinds of transactions were enormous during the boom
years - and have become enormous again during the recovery.
And these transactions are supposed to be risk-free for the investment banks -
it is the buyer who should end up with all the risk.
But as the demise of Lehman Brothers and others demonstrated, the business
can contain many hidden risks that only come to light during a financial
crisis.
Conflicts of interest
Unlike advisory staff, the salespeople and
traders of the markets division do not have any obligation to take their
clients' interests into account.
This creates a well-known conflict of interest - the risk that
confidential "inside" information given by clients to the investment
bank's advisory people may be abused by the bank's traders.
For this reason, all investment banks are required by law to have a
"Chinese Wall" that prevents information passing from the advisory
division to the markets division.
However, the latest financial crisis revealed a new source of controversy -
the
US financial watchdog found investment banking giant Goldman Sachs had
misled clients into buying bad investments.
The case has led to calls by some US politicians for new rules that will
ban traders at investment banks from exploiting their clients'.
Splitting up
Investment banks do not do traditional
"retail"
banking - taking deposits from ordinary folk and making loans to local
companies. However, most investment banks have teamed up with a big retail
bank -
Warburgs, Salomon Brothers, JP Morgan, Merrill Lynch, Bear Stearns are all
big investment banks that have been bought up by High Street banks.
Retail banks
Deutsche Bank and Barclays grew their own investment banks from scratch.
Only Goldman Sachs and Morgan Stanley remain as pure investment banks.
By becoming "universal" banks like this, the investment banks can put
all the retail deposits to much more profitable use by gambling with them.
Since the financial meltdown, there have been calls on both sides of the Atlantic
to split these banks up again.
In the US, former central banker Paul Volcker successfully argued that the
government should ban universal banks from their more risky
activities that gambled depositors' money on global markets.
In the UK, the independent banking committee has been tasked among other
things to look at the complete split-up called for by Liberal Democrat
Vince Cable, but this may be thwarted by Stephen Green's appointment as
trade minister.
Just desserts?
The level of profits and pay earned by investment banks far exceeds that
at most other industries. Why should that be?
Hard work and aptitude play a part. Bankers - especially juniors working
in corporate finance - are well-known for working 12 or more hours a day,
seven days a week.
Bankers will also argue that the high pay reflects the importance of their
work. By channelling money from those who have it spare, to those who can
put it to good use, Wall Street and the City help drive the investment
that underpins economic growth.
One could then ask why - if investment banks make such huge profits -
other banks do not enter the market and undercut their profits?
Part of the answer is that very few companies have the necessary global reach.
To make money, an investment bank needs a global presence to be able to
pair investors with borrowers .
And
Lehman Brothers' catastrophic failure showed that the profits come with risks attached
The most profitable transactions come when a bank identifies an
opportunity to match buyers and sellers that is not apparent to anyone
else.
There is also a case that much of the investment banks' reported
profits are not real. Bankers are paid such big bonuses which are
dependent on profits so they seek clever ways to report
higher profits while concealing the true risks from their own management
or shareholders.
One may also ask whether a business that makes money through the
creation of ever more debts has already reached the limits of its social
usefulness.
Who's who?
Barclays: Known in the UK as a
major high street name, the British bank
makes most of its money in international finance these days. The bank had
a "good" crisis, famously refusing bailout money from the UK government,
then picking over the bones of Lehman Brothers.
Deutsche Bank: Like Barclays, the German retail bank grew its massive
markets division from scratch. Although headquartered in Frankfurt, the
real centre of power and profits is London.
UBS: The Swiss bank bought up Anglo-American investment firm Warburg,
Dillon Read in the 1990s. It took heavy losses during the financial
crisis, which it was forced to explain by the Swiss government.
Credit Suisse: UBS's big rival, the Swiss private bank's reputation was
badly tarnished when the dotcom bubble burst, but it has come out of the
2008 crisis much stronger.
JP Morgan: The blue blood US brokerage, which was bought up by retail bank
Chase Manhattan during the credit boom, has weathered the financial crisis
and its political fallout better than most.
Bank of America: This big commercial bank came to the rescue of Wall
Street firm Merrill Lynch during the financial crisis in a deal that
turned controversial due to the scale of Merrill Lynch's losses, revealed
only after the deal was sealed.
Citigroup: Once heralded as the future model of universal banking, the US
giant needed a special rescue package to avoid bankruptcy in 2008. Now it
is widely criticised for being too big and unwieldy to manage.
Goldman Sachs: Often credited with being the smartest investment bank, the
Wall Street firm became a lightning rod for criticism in the US in the
aftermath of the financial crisis.
Morgan Stanley: Along with Goldman, the only pure investment bank to
survive the financial crisis intact, although both firms converted into
traditional "bank holding companies" in order to qualify for a financial
lifeline from the US authorities.
Prestwyck and Allevard have discovered documents
that show how the banks have manipulated the regulations to their own
advantage and to line the pockets of the 'Club'.
If you have savings, a pension fund or any sort of
investments you need to read this book.
Read It Now - Only £4.99
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