Some new research by David De Cremer, a professor at Rotterdam School of Management, Erasmus University and visiting professor to the London School of Economics, raises a few interesting questions about bonuses, the main one being – should anyone trust bonus-driven bankers?

In his research involving 15 top Dutch banking executives, De Cremer, also of first concentrated on the importance of bonuses for the interviewees themselves. The focus then shifted to how important these bonuses, in their view, were to others in the financial sector. The findings clearly reveal a psychological preconception: all top executives believed that bonuses were more important to others than to themselves.

According to the research executives also believe it is only their colleagues who are spurred into better performance by bonuses, and not themselves. De Cremer said: “The findings of my research demonstrate that the need for giving bonuses within the banking world is a self-created myth.”

The final series of questions put to these executives inquired about the type of bank they preferred to consult for their private investments. They were given a choice of two types of bankers: Banker A was presented as someone driven by self-interest and financial gain, while Banker B was painted as an individual who put the interest of the customer above anything else and was keen to provide good service. Without exception, all the executives taking part in the study opted for Banker B, while having earlier made clear that they would appoint Banker A within their own banks.

In summary then, no-one in the study was motivated by bonuses and no-one trusted bankers that were.

Doesn’t that suggest that bankers are either untrustworthy (and motivated) or unmotivated (and trustworthy)..?

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Reinforcing some of the statements in my piece on customer retention in the current issue of  Banking Technology, is this amusing comment from Stan Demarest, SVP of segment management at Hibernia National Bank:

“There was an article that came out probably 15 years ago in one of the banking trade journals, saying banks were so product-focused they’d build Cinderella’s slipper first, then go find someone it fits. CRM may be on the cutting edge for the banking section of the financial industry; the retail industry has had several years’ head start. But it’s not rocket science.”

Demarest said the bank got serious about customers after realising it knew some were profitable, but it didn’t understand why.  After making some calls, they realised profitability could result from high account balances, but it could also come from late fees, interest, and insufficient fund fees.

Once the bank determined profitability, it segmented customers into Retention, High Growth, Limited Growth and Cost Management.

Cost Management is presumably a euphemism for a negative retention campaign, or “Just go away!”  Bankers and CRM vendors will say, although never for attribution, that getting rid of unprofitable customers is a common goal – probably in retailing as well as retail banking.

Forget those clichés about the customer always being right – that’s too expensive, as Larry Selden and Geoffrey Colvin point out in their book, Angel Customers and Demon Customers. The goal is to lavish attention on the former and transform or dump the latter.

I was pleased to learn in my conversations that banks are increasing their focus on their Internet channels for customer interaction.  When I see a toll-free number but no email or web site contact, I figure a company is a technology laggard which is best avoided. Of course, one also sees the web sites with no contact information at all. That’s just rude.

Or maybe a cookie on my computer has identified me as a demon customer and the web site is trying to send me away. Hmm, hadn’t thought of that before …

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Word has it – from respectable sources – that Michel Barnier, the incoming Internal Markets Commissioner, thinks Stock Exchanges should be part of the national infrastructure. Hmm.

In some eyes, an exchange should assist with the creation of an orderly market.

You can certainly put a case for MiFID creating a disorderly market. Outgoing Commissioner Charlie McCreevy and the EC has run the market through hell and high water putting MiFID in place. Shaking it up any more would be disastrous.

Could he effect changes anyway? Would Sarko back such changes? Is it ’populist twaddle’ as one esteemed observer put it? But the chaps at the bourses can’t be too happy. They are presumably lobbying like the tobacco industry right now. They all want competition. The US has invested heavily in competitive Europe.

On the 11^th January Barnier will be in place and we shall see whether he still holds this view. It could be a ploy, letting him start on the front foot. It could be populist twaddle. But it could be madness.

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In Financial Speculation, Gerald Ashley has some advice for investors.

But he doesn’t really expect them to take it.

With 30 years experience in finance, including Baring Brothers in London and Hong Kong and the Bank for International Settlements, he knows his way around the markets. Despite the changes in technology – fast computers and immense increases in bandwidth – he notes that “… however good the data, or indeed the computational prowess or the organisation, the weakest link in the chain still remains human judgment.”

Ashley illustrates the lack of human judgment, and calls into questions the wisdom of markets, with the example of 3Com in March 2000 when it floated off 6%t of Palm, Inc. – maker of a handheld PC and later a smart phone. Planned for an IPO of $14, it launched at $38 and hit $165, or 1,800 years earnings. Even weirder, although 3Com held 94% of Palm’s shares, its valuation remained stable.

He is a strong believer in simplicity, and urges investors to take the time to understand what they are buying and to steer clear of exotic instruments whose complexity is often designed primarily to hide the profit margins of the issuers.

Sounding a little like Woody Allen, who described a broker as someone who invests your money until it is all gone, Ashley reminds would-be investors, or speculators, that the handsome buildings on Canary Wharf were built on the fees they pay to brokerage houses. Day traders might win or lose, but the brokerage always wins, fee upon fee, not to mention the earnings on traders’ accounts that don’t pay interest.

He urges investors to expand beyond equities and bonds to include commodities, especially gold, oil and copper, and also to consider investing in currencies. A little research into the way prices move  –  gold and stock prices often move inversely – can open up some investment opportunities.

He also warns of group-think, especially around risk measures like VAR: “The VaR approach has caused herding of selling activity that often spills over unto totally unrelated markets. The denouement of such activity could be the equivalent of a financial nervous breakdown.”

He watches the relationship between gold and oil – how much oil will an ounce of gold buy – usually runs between 10 and 30 and is a “an extremely good indicator for understanding global inflationary pressures. The gold market is the single best asset class with which to understand most other markets.”

Keep it simple and don’t T get bogged down in equations.

“When you are trading, it’s your discipline that counts, not just the most elegant mathematical solution. It’s likely you will find simple rules the easiest to execute, so stick with them.”

And keep a diary of all the details of trading, the simple act of writing down your investments strategies seems to help keep focus.

Ashley sees three dimensions to successful investment – direction, timing and money management – and disciplined money management is the most important.

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Nice comment from criminologist and broadcaster Professor Laurie Taylor on BBC Radio 4′s Today Programme this morning: “If you steal someone’s savings or pension you’re more likely to end up with a yacht than a jail sentence.”

He’ll be expounding on this in a full Thinking Allowed programme this afternoon, and there is a wider debate to be found at the programme’s website.

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The announcement that the London Stock Exchange is in talks to buy Turquoise signals the death of the Bourse.

Tied to the Exchange’s departure from the Federation of European Exchanges, it suggests a seismic shift in strategy. FESE has been campaigning for a level playing field of regulation to be run across exchanges, multi-lateral trading facilities, dark pools and internal crossing networks.

The regulations for exchanges (they argue) are making it uneconomic to run an exchange instead of an MTF for example.

It would seem the LSE, having lost significant market share over the last year, not only agrees that this is true but sees arguing for justice to be pointless.

Chief executive Xavier Rolet recently said that regulatory burdens have held back the launch of the LSE’s Baikal, a dark pool and aggregator of liquidity. As Turquoise performs those functions it will presumably replace Baikal, cutting the red tape that held the LSE back.

The move is a shrewd one. Combined with the recent purchase of MillenniumIT to replace its TradElect system, Rolet now has the old LSE head on a much younger body.

While the older exchanges appeal to the referee, he is continuing to fight, by the same rules as the new kids on the block.

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I am preparing a story for the Sibos issue of Banking Technology, and if there is a discernible trend it is that experts think Asia will come out of the financial crisis before Europe and North America. And along the way, Asian banks and multinationals have acquired some attitude.
Two different sources talked about “flexing muscles,” one referring to expected increases in M&A activity, another talking about Japanese banks, particularly Nomura, which has bought up significant chunks of Lehman and plans to make good use of them.
Look for it in the post shortly, or on the magazine racks at Sibos.

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Uh oh – FT columnist Gillian Tett is quoting a French sociologist …
This sort of thing could get dangerous, but it looks intriguing. Drawing on her time in Japan, which prompted me to pull her book about the experience off the shelf, she reminds readers that westerners were constantly telling Japan they had too many middlemen, especially in sectors like retail.

“However, amid all that debate about American efficiency, one point that western commentators almost never discussed was the proliferation of middlemen in America’s financial world.

“If you were to sketch a map of how credit has been sliced and diced in 21st century banking, there would be so many stages and commission hungry middlemen in that process, that the Japanese dairy industry might seem positively rational …
“Three decades ago, Pierre Bourdieu, a French sociologist, observed that elites in a society typically maintain their power not simply by controlling the means of production (ie money), but by dominating the cultural discourse too (that is, a society’s intellectual map). And what is most important in relation to that cognitive map is not what is overtly stated and discussed – but what is left unstated, or ignored. Or as he wrote: “The most successful ideological effects are those which have no need of words, and ask no more than a complicitous silence.”

Her new book recounts the invention of credit derivatives and Tett gets back on the topic here, showing how financial markets are based on a concept of freely flowing information, yet credit derivatives have become so complex they are almost never traded and have to be valued by model.

One does suspect that banks, and their associations such as ISDA, like it that way, because once you break complex derivatives into components that can be listed and traded on an exchange, the margins go away.

In the past I have criticized Tett and the FT for glancing at this topic and moving on without examining the banks’ arguments that OTC derivatives have saved nice guys like pension funds substantial amounts of money. Perhaps it will take some smart investigators – has the SEC hired any at last? – or the nonpartisan Congressional GAO — she cites Adair Turner as a potential source of clear thinking – to delve into these issues in more detail.

Maybe she will take it on. As she notes:

“…one reason why this doublethink persisted for so long is that bankers and policy makers alike have all been trained in recent years to take economic theories at their face value, shorn from social context, or power structures.

But if regulators and politicians are to have any hope of building a more effective financial system, it is crucial that they start thinking more about power structures, vested interests – and social silence.”

She promises to go further into the topic next week.

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I was surprised to see a chairman of the Federal Reserve Bank of New York was resigning, and then realised from the reports it was a non-exec. Institutional Risk Analyst put it in perspective:

“And speaking of the fall of the elites, FRBNY Chairman Steve Friedman finally resigned yesterday, ending a scandalous period when the greater community of present and past employees of Goldman Sachs  JPMorgan Chase  and other dealers was arguably in control of the most important arm of the US central bank.

“The fact that the Board of Governors appointed former GS banker Freidman as a “C” class director, who are meant to represent the public interest and not be past officers of regulated banks, was scandal enough. But then, when GS formally became a bank holding company last year, the Board failed to remove Friedman when his conflict became acute. The Board also failed to appoint another “C” class director, making it almost seem that the Board wanted to assist in the GS operation to influence the operations of a Federal Reserve Bank. ”

The governance issues in US economics has been a sad joke, with public rep appointments to major boards, and in arbitration, often heavily stacked in favour of finance insiders. Apparently this continues even at the highest levels.

“Remember that the board of directors of the FRBNY selected Tim Geithner as President, who then bailed out AIG to the benefit of GS and the other OTC derivatives dealers that were facing AIG. That is why a congressional inquiry is needed to understand just why the Fed Board and, in particular, Fed Vice Chairman Don Kohn, tolerated the Freidman conflict and arguably neglected their statutory duty to ensure the proper governance and operation of a Federal Reserve Bank.”

Looks like a lot of opportunity for Congress to investigate, if it could get off its backside.

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 Better add Vanity Fair and yes, Rolling Stone, to your reading list if you want to understand the financial crisis. No longer are Banking Technology, the Economist and the FT enough.
In the current Vanity Fair  Michael Lewis, of “Liar’s Poke” fame, delves into the role played by AIG Financial Products.

“Here is an amazing fact,” writes Lewis. “Nearly a year after perhaps the most sensational corporate collapse in the history of finance, a collapse that without the intervention of government would have led to the bankruptcy of every major American financial institution plus a lot of foreign ones too, AIG’s losses and that trades that led to them still haven’t been properly explained.”
The US government apparently made its bailout decisions without ever investigating who had done what. When Ed Liddy, the retired Allstate executive who was brought in as CEO, testified before Congress, he didn’t know the names of the people who had caused the problems. As a congressman asked, how can you clean up the place if you don’t know who the people are?

Using AIG’s AAA credit rating, the group provided guarantees for subprime mortgages which came to make up 95% of its portfolio, although the guy in charge didn’t know it. Everyone in the business assumed house prices would never fall so the risks were minimal.

Of course, they did fall and AIG couldn’t make the payoff to counterparties like Goldman Sachs and Merrill Lynch until Hank Paulson, former CEO of Goldman, stepped in as Treasury Secretary and made good the full payments. That’s risk management for you – put your boss in charge of the US government checkbook so if you face losses, he can make the payment from the Treasury.

“How could the US government simply hand over $54 billion in taxpayer dollars to Goldman Sachs and Merrill Lynch and all the rest to make good on subprime insurance AIG. F.P. had sold to them – especially after Goldman Sachs was coming out and saying that it had hedged itself by betting against AIG?”

For the answer to that, turn to Rolling Stone and Matt Taibbi’s excellent article on Goldman Sachs “The Great American Bubble Machine.”

He cites the Goldman connections, including Ed Liddy who was a Goldman director …”There’s John Thain, the asshole chief of Merrill Lynch who bought an $87,000 area rug for his office as his company was imploding; a former Goldman banker, Thain enjoyed a multi-billion handout from Paulson, who used billions in taxpayer funds to help Bank of America rescue Thain’s sorry company. And Robert Steel, the former Goldmanite head of Wachovia, scored himself and his fellow executives $225 million in golden parachute payments as his bank was self-destructing …”
Taibbi is an amusing writer who has done some great research, shows how Goldman contributed to the internet bubble by lowering its underwriting standards and using laddering to create momentum in new issues, and spinning – which Taibbi says were bribes to newly public company executives in return for future business.

In an echo of Philip Augar’s book “The Greed Merchants,” Taibbi says “Such practices conspired to turn the internet bubble into one of the greatest financial disaster in world history. Some $5 trillion of wealth was wiped out on NASDAQ alone, but the real problem wasn’t the money that was lost by shareholders, it was the money gained by investment bankers, who received hefty bonuses for tampering with the market.”

Goldman has proved expert at using Washington to further its business.

When the CFTC wanted to regulate derivatives trading and maintain capital cushions, Robert Rubin pushed Congress to strip the agency of its regulatory authority, which occurred with a bill inserted in an 11,000 page spending bill passed on the last day of the session.

At the same time Goldman was packaging subprime to sell to institutional investors like hedge funds, it was shorting the market for its own positions, and bragging about it. Taitti describes a $494 million issues where many of the mortgages were second mortgage borrowers, average equity in their houses was .71%, and 58% had little or no documentation. Yet Moody’s and Standard & Poor’s rated 93% of the issue as investment grade.

And the hike in gas prices last year? In large part a result of Goldman’s driving speculation in oil markets, where the amount of speculative money grew from $13 billion in 2003 to $317 billion in 2008. The average barrel of oil traded 27 times even while demand was dipping. A Depression era regulation to limit the number of speculators in order to protect farmers, was modified by the CFTC in response to a request from J. Aron, the commodities trading arm of Goldman, in 1991.

Amazingly, the letters to Goldman and 14 other exemptions, were made secretly, without the head of the CFTC knowing, and came to light only by accident with a Congressional staffer talking to CFTC. When the staffer asked to see the letter, the CFTC said they would have to clear it with Goldman Sachs – a letter that had been issued 17 years before. Great reporting here — I haven’t seen a mention of this anywhere else.
Coming next? Making a fortune off carbon trading. Instead of the government simply raising taxes on carbon, and collecting the money, the cap and trade bill would turn the tax over to Wall Street firms, like Goldman Sachs. The bank paid out $4.7 billion in bonuses and compensation in the first three months of this year; its 2008 federal tax bill was $14 million, an effective tax rate of one percent.
Where will it go from here? The head of the New York Fed is a former Goldman banker, the treasury chief of staff is a former Goldman lobbyist, the bank gave the Democratic party $4.4 million in the last election.

His conclusion –“It’s a gangster economy running on gangster economics.”
These are two ground breaking articles with information that hasn’t appeared before.

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