August 30, 2010
As we now all know, the EU banks mostly passed their ‘stress tests’ with flying colours. But now there are calls for more. Should there be?
The first round of stress tests struck me as odd. I have read repeatedly that US banks (which of course European ones have been modelling) had expanded their financial base relative to capital by 20 or more times in the last 10 years or so. This meant that if just a very small percentage of homeowners or loans defaulted, the bank would become technically insolvent very quickly.
The real assets were apparently down to about 3%. The stress test tested them at 6%. Is that really good enough?
Mind you, it really says something about the banks that failed, even after the turmoil of the last three years! Frankly, I am surprised any of those seven banks are still in business.
But onwards, what would be a good test? What would help to sort out the mess our financial sector is in?
I would instead suggest a stress test for bankers. This could be simple enough. Most of society seems to agree that is seems almost obscene for someone to move money and earn so much.
The test would be a simple task of setting a base number, lets say 3 million euros per year for private equity and hedge fund managers and prop traders at investment banks, asset managers in equity and bond funds at perhaps 1 million per year and perhaps 500,000 euros per year for brokers. That is the new maximum salary (certainly enough to live on!) for their job. If they are still willing to do the job, their pay is cut to that level. If they aren’t, they can go and someone else in society will jump at the chance to earn that much money.
The savings made by slashing bonus and salary levels like this could be kept within the funds being managed and therefore paid out as dividends to investors, kept in the markets and used as working capital by companies or simply maintained in asset form to help the pension funds that we are all to be reliant upon.
Just think of the improvement in financial health of companies that have been bought in recent years by mountains of borrowed private equity fund money. All those firms paying big bonuses to the fund manager and corporate lawyers could be in much sounder health, thus helping to preserve the jobs of the staff in the business. And by helping to secure those jobs, it would help to keep more of the economy running.
Could this work? What do you think?financialguy