Posts Tagged ‘investment bankers’

Lehman Brothers

I‘m not going to write much about Lehman’s demise because there will be thousands of column inches out there (most ignoring the equally important news of the BoA purchase of Merrill Lynch and the problems at AIG). Lehman’s British companies have mostly been put into administration. All I want to note is that in a live interview with the Administrators (PwC) it was stated that some of the best assets left in the UK companies were real estate assets, held in special purpose companies and joint ventures. This shows that – despite the current hand wringing about property markets and reference to ‘toxic’ real estate involvements in the Media – owning real estate assets is safer than lending on them. This is a point I will return to in a future post.


Amongst the carnage on the Stock Exchanges around the world yesterday, HBOS shares took a huge battering again in the UK. Quite why still baffles me, although this article suggests that one reason is that the bank is ‘ so exposed to the mortgage market and falling house prices ‘.

In the current climate, the relevance of falling house prices in relation to HBOS is not that important – the ability of mortgagees to meet their payments is the critical issue. Over the life of a mortgage, a house value can fall below the amount of the mortgage (known as ‘negative equity’) and rise well above it. It has happened to me. This is not a cause for concern so long as the borrower can make payments. Therefore, interest rates and the job market should have a greater impact on HBOS’s position, rather than the state of the housing market. When panic spreads throught markets, logic and common sense seem to go out of the window.

The same applies to commercial property loans, but since they are for a much shorter period, the state of values and the market is relatively more important than for residential mortgages. Nevertheless, so long as a borrower can meet their income payments, only a foolish or desperate bank will force the sale of properties in a weakening market. It will only make things worse – for them and everyone else.

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It gets tiring seeing the same issues coming around again with each economic cycle. Once more it’s yet bankers’ bonuses, now viewed with a mixture of horror and indignation at payments made to ne’er-do-wells who do little more than mess up the economy. It may make good copy, but such an attitude is hardly helpful.

First, we should distinguish between bonuses paid to investment bankers and lending bankers. Whilst both are generally paid on ‘performance’, this means something different in each case. Investment bankers can earn money for their organisation through such activities as corporate advice, putting together M&A deals or creating innovative financial instruments. Their bonuses are usually a percentage of the fees earned by the bank, so, if people consider them excessive, they should think about the fees that investment banks charge their clients.

Lending bankers get paid for putting loans on the bank’s books and usually they also will receive a bonus based on the earnings produced. However, because of competition – particularly from the capital markets – earnings from lending are far from substantial and to earn meaningful bonuses (which would still be way below those earned by investment bankers) it is necessary to do a large number of deals.

There is a prevailing view that “big bucks attract the best brains” and I will leave you to judge how well the market works at placing the best people for the most critical functions in the marketplace.

Criticism of bankers’ bonus structures is nothing new. In the past, I have been known to have a go myself. In the late ’80s there was at least one individual who made a good living through heading a property lending unit, putting a large number of ‘ competitive ‘ loans on the bank’s books, earning large bonuses and leaving before any of the loans matured, getting a similar position at another bank before his reputation was damaged by market knowledge of any possible bad loans.

My criticisms of this ‘ hit-and-run ‘ activity were vocal for a time in informal discussions with colleagues and fellow bankers. In fact, one ex-colleague who was establishing a new lending unit at another bank asked what my ideas were for staggering payments of lending bonuses. They were rather similar to those expressed by Joseph Stiglitz in relation to investment bankers’ bonuses. That doesn’t make me a genius (unlike Joseph Stiglitz) – it’s just applied common sense. What matters is the attempt failed. The reason was competition: banks compete for staff and any bank introducing such an ‘ uncompetitive ‘ scheme will not attract staff.

Some might say that it is fat cats and bank bosses that justify criticism over their bonuses. Whilst I find these payouts repugnant, it is patently unfair to have a go at those whose bonuses are deal related – they’re doing what they are supposed to be doing – and remunerated accordingly. They cannot be held wholly to blame for their actions and the large bonuses they earn: that is purely a function of the schemes that were put in place for them.

It’s a result of what I call ‘ Management Mechanics ‘. No doubt, some Management guru has come up with a better name for it, but get used to the term – I will be returning to it time and time again in Building Wisdom.

Ultimately, the blame lies with shareholders who approved these remuneration schemes. They wanted big earnings and big growth and were prepared to incentivise managements to provide that. Partly, this is because most Fund Managers’ remuneration is also based on performance and to maximise their own bonuses, they were prepared to overlook the long-term consequences of putting such ‘ mechanics ‘ in place.

Rather than pointing the finger at one group in the City, those who criticise – and far more importantly, those looking at increased regulation – must acknowledge that the problems lie at a far more fundamental level than the Credit Crunch: it is the business culture that looks for rapid short-term gains and thus rewards, encouraging ‘ hit and run ‘ behaviour.

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