Fertile fallacies in the finance system: a theonomic response

Well it seems the TV journalist Paul Mason has reached the end of his tether with the banks. Just look on YouTube at his recent Channel 4 ‘outburst.’ Good man, he said some of the things that need to be said.

There is a lot of rubbish spoken about life in the Square Mile and other major financial centres. I can say this from experience having worked in the investment management industry between 1990 and 2007. Towards the end of my time in the City I became sensitive to the extent that mythology drove corporate behaviour.

The financier George Soros coined the term ‘fertile fallacies.’ Fertile fallacies are stories (myths) that keep growing, gaining ever wider acceptance despite being built on a false set of premises.

Fertile fallacies are weeds peddled around the market place as flowers.

Before I provide a fairly straightforward list of the most peddled fallacies let me give you a little bit of ‘testimony’:

In 1997 I held my first ‘senior’ position in an investment management company. I had reached the sort of level (Assistant Director – a fairly meaningless term) where I started to become privy to various bits of carefully selected information.

I remember being astounded to discover that the average (the arithmetic mean) of all employees of the company had just gone through £100,000. Now investment companies, just like banks, employ lots of low paid workers: cleaners, receptionists, clerks, post room workers and so forth. Their pay was, obviously, substantially – embarrassingly – below the arithmetic average. An investment management business also requires an army of middle ranking, middle paid, staff to keep the whole shooting match afloat; I.T. support staff, investment writers, compliance officers, pay roll staff, HR bods etc. The ‘infantry’ regiment are reasonably well paid but, not that well paid. I worked in what we might think of as the ‘artillery;’ sales and marketing. My salary was £55,000 (plus bonuses). So you don’t need to be Einstein to work out that some people were being paid an enormous amount of money, dragging up the arithmetic mean.

Now let’s wind forward to 2005.

In 2005 I was Sales and Marketing Director of the U.K.  asset management subsidiary of a multinational financial services business. We managed £3 billion (which sounds a lot, but in investment management company terms isn’t) of assets in a mixture of pension fund, insurance funds, unit trusts, offshore investment companies (quoted on the Dublin Stock Exchange) and hedge funds (‘domiciled’ for tax reasons) in the Cayman Islands.

In 2005 we had a bumper year. Our funds performed really well compared to both the market and their peers and we ended up paying our ‘excellent’ fund managers significant annual bonuses (in excess of 100% salary) whilst, also, adding to their long-term incentive schemes. I, as one of the five person executive team, also enjoyed a bumper ‘bonus season.’

In 2006 many of funds performed extremely badly. Not just averagely but really, really badly. So what did we do? How did we adjust performance related pay in the light of that year’s reality?

We didn’t! (I argued we should but lost – the first time I remember being on the receiving end of one of the arguments fed to you: ‘you just don’t understand.’)

We paid our poorly performing fund managers, in many cases, 100% of their substantial base salaries in bonuses.

Here was the rationale:

They had proved in 2005 they were really good at their jobs, in 2006 market conditions were not suited to their style of investing (silly, spiteful market!) and, in 2007 all would be well again. There was no sense, in our discussions, that gratification should therefore be deferred for a period of twelve months.

I remember going home on the train that night and thinking what sort of industry am I complicit in?

When things go well you earn a lot of money and when things go badly you also earn a lot of money in compensation for the rotten luck you had had to endure. The game in other words was rigged. Risk-reward, forget it. The rationale used to justify these bonuses was that our fund managers were really good at what they did – despite the evidence that they weren’t – and that if we didn’t look after them someone else would ‘steal’ them! We, like executive teams across the industry, had developed a level of corporate (and personal) neuroses, and you can’t make good corporate decisions when suffering with corporate mental health problems.

Oh one more thing: we spent countless hours discussing how we might pay bonuses in a ‘tax efficient’ manner, just in case our army of fund managers simultaneously  packed their kit bags and departed for Dublin, Geneva, Cayman, Luxembourg, New York etc. Despite our inability to beat the tax man, we never lost a fund manager to either an international tax haven or another international centre for finance. Why not? Well, most of them, even if they were talented enough, had kids in school, active social lives where they lived and so forth. How bizarre to spend hours and hours thinking about how we might react to a risk that didn’t really exist! Oh, the power of fertile fallacies!

I also remember, and this is absolutely true, we had to write a letter to one fund manager’s wife detailing how we proposed to remunerate him over the next few years, and what guarantees we were prepared to give.  Despite all of this, he still left. His wife still negotiates his – wait for this – his ‘economic rent’ with his employer, so I am told.

So we get to 2007, the year I resigned, in disgust, at the system in which I had been complicit (I felt like I was the rich young ruler, Luke 18, 18-23).

What happened?

Another bad year of performance and some of the fund managers who had been paid astronomical amounts of money in the previous two years were made redundant (with pay offs, mind you) because the business no longer had confidence in their ability to generate satisfactory investment returns ‘across a range of market conditions.’

Let’s do some figures to give a rough approximation of the price of failure:  2 years base salary £250k i.e. 125 k per annum -not including pension and life assurance contributions, annual bonuses over two years equalling £250, redundancy payments equating to half a year’s remuneration £125, payments from long-term incentive scheme £125: total cost of failure over 2 years £750,000 (and this is a conservative estimate).

So from this little testimony let’s see if we can identify some ‘fertile fallacies,’ the weeds masquerading as flowers you and I are still being asked to buy:

  • To work in banking and finance requires super human, market defying, amounts of skill and intelligence. It doesn’t. (My own school and undergraduate qualifications are raving average).
  • Everyone working in the industry benefits from the super returns sometimes generated. They don’t, we never paid 100% bonuses (or even 10-20%) in good times to support staff. In bad times they received the lowest levels of bonus.
  • ‘Talented individuals,’ unless they are locked in are likely to be recruited by competitors, ultimately leading to a complete drain of talent as the ‘very best’ talent chooses to move either to domestic competitors or overseas. Our poorly performing fund managers weren’t recruited by others (they were ‘let go’) and, our super star, guided by his wife left anyway!
  • Unless the tax burden is reduced the result will be a ‘mass Exodus’ of biblical proportions. Utter rubbish!
  • It isn’t the amount of pay that is the problem; it is the structure of pay. Couldn’t disagree more.

So here we have some of the fertile fallacies. Please don’t buy them; they are a bouquet of weeds.

Unfortunately a range of fertile fallacies are being peddled as the solution (they may be part of the solution but they are not the solution):

  • Governance and regulation will sort everything out. It won’t the system is fantastic at finding, inventing and exploiting loopholes.
  • It’s all down to corporate structure. It isn’t! Barings, followed by Equitable Life were early miscreants; Co Op bank has been one of the latest. Greedy and inept people are quite capable of rising to the top in any form of organisation.

So please don’t but these fallacies. When they are offered to you reject them.

Change starts with people and virtue. If we want to see a flourishing finance system we need to start with values and, we need to recruit people into the system who seek to serve others and not simply to feather their own nests. We actually need to reduce take home pay, substantially, (it will still be a well paid industry – no one is going to starve). We need people in the banking system who understand appropriate the Theonomic principles of: community, solidarity, gift, service and subsidiarity. Then, and only then, will the industry truly be ‘the financial services industry.’

A finance industry animated by religious virtues now that would be a thing of beauty.


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