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As I was
reading of yet another spectacular mismatch between bank managers' competence
and their remuneration, and this time at JP Morgan no less, I realized there
is a simple solution which really could be implemented.
Make the cost
of regulation zero - or very nearly - for unlimited liability partnerships.
Then let judicious self-interest, exercized by the
partners themselves, do the rest.
My father was
what they now call an 'investment banker'. His firm got it wrong by expanding
business into the 1970s' slump, and when it went wrong the Official Assignee
took everything he owned. That was in the days when partners had joint and
several liability, which meant that all the top management of a firm were
personally liable for the entire debts of their business.
Joint and
several liability quickly weeded out the incompetents, the gamblers and the
unlucky (my poor old Dad, I like to think). It made managers look very
carefully at their colleagues' strategies, and concentrated everyone's
efforts on controlling risks, rather than seeking bonus-building nominal
profits.
The approach
was discarded in 1986 after 150 years of pretty effective operation. It
wasn't perfect (what is?) but we were all very stupid to think we could do
better by replacing the natural damper of direct personal liability with a
combination of salaried and bonused managers, and
sixty thousand pages of regulations.
I realised this morning that official regulation of
financial services has become so onerous and so unsuccessful at loss
prevention that joint and several liability could easily be re-introduced.
All it would need would be a subsidiary arm of the regulator, set up
exclusively for the regulation of investment businesses run by unlimited
liability partnerships.
Lots of
reputable financial professionals do not get big bonuses, because they work
competently in the low-risk, low-return areas of the industry. Yet within the
regulated sphere of financial services, there are so many complex rules that
even these firms have to employ more compliance officers than accountants,
while at the same time funding the wretchedly unfair Financial Services
Compensation Scheme in the UK, or Federal Deposit Insurance Corp. in the US -
which is a bit like being forced to pay for the car insurance of your drunken
neighbor.
They should
be given the choice of submitting to financial services, or choosing a
simpler system, where they put up as collateral their house, their car, their
holidays and their children's school fees, and - within reason - are left to
get on with managing their business risks as they see fit.
Making
management collectively liable for their mistakes has lots of benefits.
#1. Size - Because partners all want to be able to understand
their whole business it encourages smaller and less systemically dangerous organisations - ones which are not 'too big to fail'
#2. Growth and competition - It encourages business formation,
something which has ground to a halt now, because of the huge cost of setting
up a compliant organisation;
#3. Attention to detail - It forces revenue generators to be more
critical about risks, rather than leaving it to formulae which pass the rules
and get boxes ticked, but do not work in practice;
#4. Liability - It encourages senior management stability and
accountability, and suppresses the job merry-go-round whereby careers advance
by sweeping problems temporarily out of sight and quickly changing jobs;
#5. Rewards - It directly links remuneration to risk, as well as to
performance;
#6. Clawback - It keeps all prior
remuneration still in the compensation pot, to be reclaimed in the event of
future investor losses.
Our
experiment with rulebooks, regulators and salaried managers has been a bit of
a disaster. Maybe a partial return to the old ways is not such a bad idea.
Paul Tustain
Director and Founder
Bullionvault
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