Leading article: What the banks deserve is not just rage, but reform

Political leaders need to meet the structural challenges head on

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Bonuses are back with a vengeance at the world's most notorious investment bank. Goldman Sachs yesterday revealed that it will pay $16bn in compensation to staff for their efforts in 2009. There was a weak attempt from the Wall Street giant to fend off public anger over the announcement, with Goldman claiming that it is paying staff the smallest proportion of its revenues in bonuses for many years. Few were impressed – and rightly so.

These revenues are not to any meaningful sense the result of the brilliance by Goldman's staff over the past year. Goldman has been able to borrow exceptionally cheaply from the Federal Reserve in 2009. Its cost of funding has been driven down by the US government's guarantee of its debt. And fiscal and monetary stimulus from states around the world has driven up asset prices across the board. It does not take a genius to make money in such benign financial circumstances.

As the most politically well-connected of the Wall Street banks, it is easy to demonise Goldman, the "vampire squid" of media legend. But this really misses the point. Goldman is no better or worse behaved than any other large investment bank; it is simply more successful. Consider remuneration. Other large US banks have also announced vast bonus payments for 2009. Citigroup is paying its staff huge amounts even though the bank itself actually registered a loss in the year. We wait to see whether our own giant banks – Barclays, HSBC and the Royal Bank of Scotland – follow. The likelihood is that they will. And the explanation is that investment banks have a malfunctioning remuneration system. Firms tend to be run in the interests of employees and executives, rather than shareholders.

But remuneration is far from the only scandal. The majority of the revenues of investment banks in the past year have come from trading, not lending to the real economy or other economically beneficial activities. Indeed, business loans are being squeezed as banks attempt to contract their balance sheets, undermining the recovery. And then there is the unreformed nature of the sector, stuffed with institutions which have the comfort of knowing that they will be rescued if they stumble because they are "too big to fail".

The public and politicians are entitled to rage against the myopic greed of the bonus culture, the fact that the banks have been bailed out but have not bailed out the rest of the economy, the fact that that they are returning to their reckless ways with a de facto government guarantee if their bets go wrong. But rage is not enough. And unless harnessed in the cause of serious structural reform it can be positively harmful.

What is needed is a concerted push by political leaders to break up the handful of large banks which dominate the sector. There needs to be a separation of the functions of investment and retail banking to prevent bankers using the funds of ordinary depositors to back their risky bets. And the way needs to be cleared for new entrants to the sector, to bring down the economic rents which banks are happily extracting from the global economy.

The White House's bank levy (to recoup losses from the bailout) and Alistair Darling's bonus tax here, while both have their merits, do not address these structural challenges head on. President Obama's proposals yesterday to ban deposit-taking banks from engaging in proprietary trading represent perhaps the first serious attempt to drive reform in the necessary direction. The plan needs to be followed up with all the zeal that bankers display in pursuit of their bonuses.

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