Couze Venn on the link between the bonus system and the financial crisis
Drawing on Ha-Joon Chang’s 23 Things They Don’t Tell You About Capitalism, and Roubini’s Crisis Economics, Couze Venn draws connections between the bonus culture of the 1980s and the economic crisis of 2008, and explains the contemporary significance of collateralised debt and loan obligations
There are key aspects of the bonus system set up in the 1980s which starkly reveal the intimate connection with the economic crisis of 2008. The first is the principle of ‘shareholder value maximization’, and the second is the question of the effects for ‘moral hazard’, that is, the propensity on the part of investors to take risks, especially once the banking sector was freed from restraining regulation. These aspects have become institutionalised as central features of management practice and, in the absence of effective regulation, remain endemic in business culture.
Ha-Joon Chang (2010) in 23 Things They Don’t Tell You About Capitalism highlights the moves which have led to the bonus culture, principally, the principle of ‘shareholder value maximization’, advocated by management gurus from the 1980s to align managers’ interest with the interest of owners or shareholders. It was intended as a strategy to ‘incentivise’ managers, in a business culture in which they had become the principal decision-makers in the wake of the professionalisation of management ( a development J.K. Galbraith perceptively anticipated in The New Industrial State). The trick was to arrange a firm’s financial affairs to ensure it would be in managers’ interest to maximise the returns for shareholders. This was done by tying managers’ reward to the amount they could give back to shareholders. The strategy consisted basically of, 1: Maximising profits by ruthlessly cutting costs to a minimum (through reduction in real wages, anti-union policy, cutting reinvestments, etc). 2: Distributing the highest possible portion of profits to shareholders (this meant reducing investments in research and innovation, encouraging share buyouts, minimising reserves, etc). 3: Paying managers by adding stock options to their accounts or by increasing these options as part of their compensation. The result of the coincidence of professional managers and shareholders interests has been to bypass the interest of other stakeholders such as workers and suppliers. Other consequences of the shift towards privileging the short-term interest of managers and shareholders have been job cuts, the hiring of non-unionised labour after making everyone re-apply for their jobs, the outsourcing of as much as possible to low-wage countries like China and India, the squeezing of suppliers like farmers – as Tesco does, and so on; these are all well-known developments which corporations have pursued single-mindedly from the 1980s and the ascendency of neo-liberalism. Also the situation encouraged companies to use an increasing part of their profits to buyback their own shares, both to boost the price of the shares on the market and to gain a higher return than through savings (corporations in the US used to invest 5% of profits to do this, but the percentage climbed to 90% by 2007, which meant that little was left for reinvestment, development, and so on). Maximising profit in the short term became the ruling obsession. For instance, Chang says GM spent over $20 billion on this share buyback between 1986 and 2002, money it could have saved up and used when the crash hit them. These ingredients of the bonus culture are still in operation today, providing accumulation for managers and shareholders at the expense of workers and the public as a whole.
Another consequence has been the effects for ‘moral hazard’, i.e. the willingness of firms and investors to take high risks because of the promise of massive returns. Roubini (2010) in Crisis Economics discusses this by reference to financial innovations like collateralized debt obligations (CDOs), collateralized loan obligations (CLOs), quickly extended to corporate loans and leveraged loans, which all became the securitized ‘assets’ packaged, or laundered, and sold on to investors – which included insurance companies, pension funds, sovereign funds, institutionalised investors, venture capitalists – through entities like special purpose vehicles (SVP). Amongst these financial ‘products’ one must highlight so-called assets originating in sub-prime loans, credit card debts, insecure borrowing of all kinds, which were highly toxic in that they carried very high risks, yet became one of the main sources of the financial boom before the crash of 2008. The practice for lenders was to ‘originate and distribute’, thus passing on the risk, so that banks no longer faced the consequences of bad loans and could indulge in securitization without due care and scrutiny. The removal of regulatory institutions and measures, promoted by people like Alan Greenspan in the USA, the Washington Consensus and neo-liberal gurus, encouraged the invention of these new financial entities, whilst new informational technologies converted suspicious sub-prime debts into tradeable informationalized commodities on the bond and money markets. Everyone rushed to join the party, including institutions like building societies, high street banks, and public institutions. Michael Lewis in The Big Short gives a spicy account of the obsessive drive to invent these new entities, a task entrusted to bright young things applying the mathematics of complexity and chaos, probability theory and informational technology, whilst Gillian Tett’s analysis in Fool’s Gold shows the formation of a self-enclosed culture amongst the key players in this trade that separated them from reality and fed unfettered greed. An important condition promoting the boom was that central banks were prepared to act as lender of last resort, thus removing the last barrier to irresponsible lending and investment, by providing the safety net that financial institutions relied upon in case of failure. After the crash, central banks have rushed to the rescue through ‘quantitative easing’ – that is, ‘printing’ money which is loaned to banks at a low interest rate and is borrowed back from them by the state at a higher interest – instant profit for the banks at no risk, and no talent required! As we know, quantitative easing and state borrowing have massively increased the national debt whilst ordinary workers and citizens have been co-erced into picking up the tab, although the profiteers continue to enjoy their ill-gotten plunder.
Furthermore, as Roubini explains, ratings agencies, which benefited massively from the new financial operations, gradually deriving up to half of their profits from evaluating the new entities, were generous with their AAA ratings. The mind-boggling complexity of these securitized entities, which by the end included CDOs of CDOs and synthetic CDOs which bunched sets of credit default swaps into new CDOs, together with the laxity of ratings agencies, allowed originators to smuggle vast amount of bad debts into the financial system. Unimaginable profits were made by casino banking, whilst the bonus system accounted for 60% of compensation at the five biggest investment banks in the USA by 2006. As Roubini puts it: ‘The bonus system, which focused on short-term profits made over the course of the year, encouraged risk taking and excessive leverage on a massive scale’ (2010: 69). Moral hazard simply went out of the window, in part because the apparatuses invented to make money through speculation, freed from regulatory checks, made possible unlimited accumulation, and in part because the compensation system offered irresistible temptations for managers and speculators. Those working the system knew what was happening and what the risks were, yet carried on milking it for everything on offer. Who then should be held accountable for the crisis? The apparatuses put in place? The managers of banks and financial institutions? Investors and speculators? The deregulators and their neoliberal advocates? The new informational technologies which converted ‘assets’ into cleaned-up entities for trading in a world of virtual financial transactions? Or the whole capitalist system of accumulation of wealth? And why are those who have the power to change the banking and financial system to benefit the public rather than a few speculators and bankers not prepared to radically alter the rules of the game?
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Couze Venn has been Review Editor of Theory, Culture & Society since 2002, and Review Editor of Body & Society since 2008. He is also a member of the TCS Books Series editorial board. Though he has taught Cultural Studies and Science and Technology Studies for about 30 years, his research interests cover a wide range of topics in cultural theory, postcolonial studies, social theory, science studies, ‘psychosocial’ studies. He is currently working on issues relating to the critique of neo-liberal capitalism, particularly the question of the foundation for alternatives to economies based on growth and the privilege of private property; he continues to keep abreast of developments relating to anything to do with subjectivity.
