Why bankers love the people’s recession

David Smith, Robert Watts

The estate agent knew he had struck gold. He was showing an £8.5m flat in Belgravia, central London, last week to a client looking for the perfect bachelor pad. Sporting an expensively tailored suit and a Swiss watch, the 42-year-old banker had all the swagger of the boom years.
“The flat was immaculate, yet he wanted to rip it apart and do it up from scratch,” said Charles McDowell, who runs his own estate agency. “He said he wanted to throw an extra £1m at it, including installing a cinema room. People are scattering the cash again.”

Figures from Knight Frank, a top-end estate agent, show the number of City buyers as a proportion of applicants has grown to 38% — the highest since March last year.

“The bonus effect is only just beginning to be felt,” said Liam Bailey, head of residential research at the agency. “The hitherto weak £5m market has sparked into life.”

Vintage champagne is also flowing again at Coq d’Argent, near the Bank of England. For years a favourite of the Square Mile’s bankers, the wallets and belts of its clientele tightened when the credit crunch struck. That has changed.

“In the last few months we’ve seen more people happy to spend a few thousand pounds on wine with a meal,” said Sean Gavin, the general manager. “Even during the bad times champagne continued to flow, but there’s a good deal more vintage bottles being drunk now than a few months ago.”

The restaurant’s 48-page wine list offers bottles of 1982 Bollinger for £505. Those feeling more flush, or who prefer claret to champagne, can sample the 1982 Château Lafite Rothschild at £1,975.

It appears to be win-win in the City. Some bankers are benefiting from big bonuses and those who are not are benefiting from higher salaries. Every bank is hiring, according to headhunters. Jobs that were left vacant at the peak of the crisis are being filled again.

With bonuses under public scrutiny, basic salaries are being increased instead. Morgan Stanley has raised basic pay by 50% for its middle managers. Similar moves have been seen by Bank of America Merrill Lynch, UBS and Citigroup.

A former investment banker starting his own City firm said the “witch hunt” against bonuses had had perverse effects. “Those who are interested [in joining his firm] are demanding double the salaries of a year ago — largely because of this government hate campaign against bonuses,” he said. In many cases they were succeeding in getting the extra money.

The contrast with the wider economy could not be greater. On Friday grim official figures dashed hopes of an early end to Britain’s downturn. Instead they confirmed that the recession the bankers had caused is both deep and very long.

The 0.4% drop in GDP in the third quarter was the sixth fall in a row, making this the longest continuous slide since records began in the mid-1950s. The economy has shrunk by 6% since the spring of last year, putting the recession on a par with that of the first Thatcher downturn of the early 1980s.

The economic numbers are a severe blow for the government. Amid rising public anger, it now has to explain why the people who caused the recession appear to be the ones doing best out of it and what it intends to do about this perverse situation.

Last week the critics found a powerful champion in Mervyn King, the governor of the Bank of England. King makes what he describes as four “big” speeches a year. He chose his latest one — delivered in Edinburgh where both Royal Bank of Scotland and HBOS failed spectacularly — to deliver a broadside at the banks and the government.

“The sheer scale of support to the banking sector is breathtaking,” he told Scottish business dignitaries. “In the UK, in the form of direct or guaranteed loans and equity investment, it is not far short of £1 trillion (that is, £1,000 billion), close to two-thirds of the annual output of the entire economy.

“To paraphrase a great wartime leader, never in the field of financial endeavour has so much money been owed by so few to so many. And, one might add, so far with little real reform.”

While calling for further reforms to make the banking system safer, King will have been aware that one of the reasons the City is making money again is that it is benefiting from the action being taken by his organisation and other financial authorities.

The Bank’s programme of “quantitative easing” — effectively creating money — has lifted the price of the stocks and bonds the banks hold and trade. The Bank has spent £175 billion buying bonds with money created at the flick of a computer switch. As well as adding to bank reserves, this money has helped to fuel the surge in global stock markets in the past six months.

The huge volumes of debt issued by governments in an attempt to boost their flagging economies have also created windfall profits for banks. Governments pay the banks to act as salesmen to find buyers for their debt among the world’s pension funds, insurance companies and other national governments and central banks.

With dealing houses like Lehman Brothers and Bear Stearns out of the picture, and other banks crippled by the losses they suffered on sub-prime investments, there has been a big reduction in competition. That has allowed the surviving banks to charge higher fees.

They are also making money out of companies. The global downturn has forced some of the world’s biggest companies to restructure their finances. Globally, firms have raised about $700 billion (£430 billion) from investors. The banks earn fat fees on this business.

With this background the renewed row over bonuses is embarrassing for Alistair Darling, the chancellor, who last month struck a deal with Britain’s five biggest banks to limit their bonus payments this year. Shortly afterwards Lord Myners, a Treasury minister, came to a similar agreement with investment banks based in London.

The fear among ministers is that if they go too far, City firms will move to Switzerland or other countries, taking with them a portion of the estimated £70 billion that the financial services industry contributes to the exchequer every year.

Although the Treasury has denied plans for a windfall tax on the banks, the increase in the top rate of income tax to 50%, due next April, has already led to some hedge funds and other businesses deserting London.

Some believe the backlash against bankers’ bonuses has already gone too far. Yesterday the Duke of York caused controversy by saying bonuses were “minute” in the wider scheme of things.

Lord Griffiths of Fforestfach, vice-chairman of Goldman Sachs International and a former adviser to Margaret Thatcher, said last week that he was not ashamed of the bank’s bonuses and people should learn to “tolerate the inequality” implied by such payouts because they were for the greater good of the economy.

Such tolerance will be difficult to find among people who are struggling with their own finances as the wider economy remains in recession.

Critics will note that in America, which is instinctively averse to state intervention in financial markets, the government is proposing direct action to clamp down on the swollen salaries and bonuses of firms bailed out by the government.

Last week Kenneth Feinberg, President Obama’s “pay czar”, announced that the top 25 executives at the seven firms that received the most government help will, on average, have their total compensation cut in half this year. The cash portion of their salaries will be slashed on average by 90% and the rest will be replaced by shares that cannot be sold for years.

There are some in the British financial community who, like King, recognise the extent of the problem. The Financial Services Authority, the City regulator, is targeted for abolition by the Tories if they win power next year, but its chairman, Lord Turner, does not intend to leave without making his mark. The banks, he said last week, had a duty to build up capital as protection against future crises, not fritter their “exceptional, post-crisis profits” away in pay and bonuses.

“We will be talking to the banks as to whether those bonus pools they are making at the moment are compatible with the level of capital build-up that we believe is appropriate,” he said. “If it is not, we will be engaging in frank discussions with them.”

Frankness is the least an angry public will expect. In an article for today’s Sunday Times, David Cameron promises action against banks that channel profits into bonuses rather than new lending. “If that doesn’t happen, then we reserve the right to take action to ensure that it does, including through the tax system,” he writes.

Just as pressing a concern for the government is the state of the recession. Labour ministers were banking on positive news to give them a boost in the opinion polls. But while Japan, Germany and France came out of recession in the second quarter, and figures released this week are set to show that America did so in the third quarter, Britain has yet to escape.

Gordon Brown will once again be reminded of his claims that the country was better placed than others to weather the financial storm.

Although Darling has stuck to his script in recent months, insisting he expected the economy to recover only at the end of the year, the Treasury was bemused by the figures, which it had expected to be flat. So was the Bank of England, which had pencilled in a small rise.

The Tories yesterday made hay with the new figures. “There is now no confidence in Gordon Brown’s economic policies: he has no banking plan, no debt plan and no growth plan,” said George Osborne, the shadow chancellor. “The whole country is suffering from this lack of leadership.”

Vince Cable, for the Liberal Democrats, said Britain was suffering because of the failure to fix the banks and kickstart lending again. “For all that has been thrown at the economy to try to stimulate a recovery, it is clear that massive structural problems remain, particularly in the banking sector,” he said.

Although economists questioned the accuracy of the data — Goldman Sachs put out a research note on them headlined “Unbelievable. Literally” — they rekindled the political debate on the economy ahead of Darling’s pre-budget report, due in late November or early December.

The Treasury had hoped to present new projections for cutting the budget deficit, knowing that the economy was growing again. Now it will have to take the recovery on trust. (David Smith, Robert Watts, The Sunday Times) http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article6888924.ece

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