Tuesday, August 25, 2009

Bonus-Malus for Bankers

French bankers have agreed that traders should not only be rewarded with bonuses when they do well but punished with "maluses" when their trades go sour. But they note that this can't work if limited to French banks alone, since the financial markets are truly international, and many French banks run their trading operations out of London anyway, where their employees are covered by British, not French, law.

Will the bonus-malus system do what it is supposed to do? Everything depends on the details, and no details have been forthcoming. "Clawback" strategies have been discussed in the US as a way of aligning the interests of traders with the long-term interests of the banks, and the malus system, one assumes, is merely a mechanical sort of clawback. But there is a further question: what will align the interests of the banks and traders with the general interest? We wouldn't really care about bankers becoming obscenely rich if the results of their wheeling and dealing were good for us all. There is abundant evidence, however, that financial liberalization has led to massive misallocations of capital: for instance, far too much money went into US housing, fiber optic cable that lies unused, Web startups, biotech, etc. etc. Penalizing traders for deals that go sour doesn't begin to get at the more general, and far more important, problem of the "efficiency" of financial markets.

Sarko needs a "triumph" that he can herald to the G20 when it meets next month, and the bonus-malus accord will allow him to pretend that France is leading the way toward global financial reform. In fact, France has put up some pretty window-dressing, but what is going on inside remains murky and probably insalubrious.

For additional thoughts from Bernard G., see here.

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