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Thursday, October 13, 2011

On the E.U. Banking Proposal: Comparative Context

“Under proposals outlined by the European Commission president, José Manuel Barroso, banks would be required to temporarily bolster their protection against losses. . . . Extra capital for European banks should be raised first from the private sector, then from [the state] governments, according to the proposal. Only when those avenues have been exhausted should a euro zone bailout fund be tapped, it said. Banks should not be allowed to pay dividends or bonuses until they have raised the additional capital, according to the proposal” (NYT 10/13/2011).

After Lehman Brothers failed in September 2008, the U.S. took “swift action to ensure its banks had a strong cushion of capital,” according to The New York Times. The same logic is said to be in the European proposal. Perhaps in general terms this is true, but a major difference is worthy of note. Specifically, the American banks receiving TARP funds were allowed to pay dividends and bonuses. To be sure, executive compensation faced limitations, but this constraint pales in comparison to that in the E.U.’s proposal, wherein no dividends and bonuses would be permitted. Also, the U.S. Treasury allowed banks to pay back the funds earlier than perhaps advisable because the bankers wanted to be free to pay whatever bonuses they saw fit to sanction for themselves (assuming they controlled their boards, which generally holds, given the separation of ownership and control).

The difference on whether dividends and bonuses should be allowed at troubled banks reflects a rather basic cultural difference between the E.U. and U.S. concerning whether economic liberty ought to be limited even at the extreme. The difference also reflects a different historical experience (and thus value-set) with respect to comfort and convenience.

I contend that dividends and bonuses are inherently “extras.” Admittedly, the bonus system on Wall Street has made its way into calculations of standard or basic compensation. However, if a bank itself is at risk, the need to increase reserves should trump any compensation that depends on the bank’s performance. Otherwise, the implication is that large profits in the short run are to be sought even at the expense of ignoring the impact on systemic risk.

I suspect that the culture of Wall Street has come to embrace surfeit compensation as an entitlement regardless of performance. The aspect of entitlement is particularly disturbing, even if it has become akin to an ingrown toenail (i.e., difficult to eradicate once it has become ensconced—like a house-guest after a week or so). A similar mentality inheres in the dynamic wherein private companies profit while the taxpayers are presumed liable in covering any losses. An entitlement exists, in other words, to enjoy the benefits without having to face the risk of suffering a loss. As the generation that lived through the Great Depression undoubtedly knows, this sunny-side up mentality is a manifestation of being too accustomed to comfort (i.e., having it too good for too long).

The bloody twentieth century in Europe gave Europeans a more realistic perspective on the entitlement of comfort at the turn of, and even a decade into, the next century. Accordingly, European officials have an easier time saying no to dividends and bonuses as long as the banks are at risk. It is a pity that the Americans have such a hard time with this; they unwittingly fall into the hands of the vested interests on Wall Street that have had it too good for too long (especially as investment bankers are “paper entrepreneurs” or middlemen rather than producers).


Stephen Castle, “Europe Tells Its Banks to Raise New Capital,” The New York Times, October 13, 2011.