Europe shoots itself in the foot….again

Banking in the EU

Government bureaucrats are not well known for doing sensible things when it comes to the economy. Most of the time their aim is to suck resources out of the private sector and funnel them into their pet projects in the public sector. They buy votes and feather their own nests, while steadily destroying private enterprise and slowing down growth. They are parasites. We, the people, are the hosts.

On 28 February 2013 I read that unspecified and faceless “European Union officials” have agreed to put a limit on banker bonuses. This may be well meaning. Most people outside the banking industry think that bankers are overpaid. But it’s still a stupid move.

Basically bank bonuses in the European Union (“EU”) will be limited to a maximum of one times the bankers’ base salaries. The idea is to prevent banks from taking excessive risks as they reach for speculative trading profits. Without speculative trading profits, which come from risky speculative trading activities – so the theory goes – the banks will be safer and won’t need to be bailed out in the future.

“But of course the bureaucrats’ solution is idiotic.”

But of course the bureaucrats’ solution is idiotic. Forged in the furnace of the committee room, using the substandard political ore of compromise and coal of self interest, it will achieve no good. It may play well to the downtrodden voting masses – positioned as controlling the greedy bankers – but it will not achieve its stated goals.

Why? Well let’s see. Say a City of London based trader at a bank – let’s call him Vince – is paid £300,000 a year at the moment but gets only £75,000 as fixed salary. That means his bonus is £225,000, which is three times base salary.

Along comes the EU, with its “officials”, with a new law saying that Vince’s bonus can only be one times salary in the future. Vince is good at his job, so his bank wants to keep him. And he has kids in school, hates learning new languages, and likes English beer. So he doesn’t want to move to Geneva in Switzerland or New York in the US.

What’s going to happen? Is Vince going to take a pay cut, with his bonus reduced to £75,000 and his total pay halved to £150,000? Or is his bank going to double his salary to £150,000 so his total pay can stay at £300,000 under the new EU restrictions? I’d bet that most banks would increase the base salary.

“…fixed salary costs will increase so that total take home pay of employees is more or less unaffected.”

So what will the genius officials from the EU achieve? My bet is they will make the banks less safe. Why is that? Because their fixed salary costs will increase so that total take home pay of employees is more or less unaffected. This means the banks’ cost bases will be less flexible – with more fixed salary costs and less variable bonus costs. So when the revenues dry up in the next financial crisis there will be less room to slash pay. And bigger losses will result – making it more likely that the banks will need emergency bailouts from their governments.

Worse than that, banks could stop investing in the EU. Activities with higher paid staff will be moved outside the EU. A greater share of business expansion will take place outside the EU countries. Maybe Vince’s bank won’t give him the salary rise to allow him to keep earning £300,000 a year. For the difference of £150,000 perhaps the move to Hong Kong or Singapore will be worth the adjustments that he and his family will need to make.

This all means lower banking profits for the EU to tax. And fewer highly paid staff to tax as well. And less demand within the European Union for the services supplied to the banks, such as real estate and technology providers – another hit to the economy. And less spending by highly paid bank employees on BMWs and fancy Parisian hotels.

Well done to the EU officials. You’ve shot yourselves in the foot, yet again. Either the banks will become less safe from having higher fixed salary costs, or highly paid activities will move outside the EU over time.

The EU is dead! Long live the EU!

Until next time OfWealthers,

Rob Marstrand

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.