IN HIS witty column last week, my colleague William Keegan recalled Gladstone’s description of finance as ‘the stomach of the country, from which all the other organs take their tone’. Well, that stomach currently being convulsed by binge-induced indigestion and nausea, and the tone set for the other organs (which means for us) is a throbbing hangover, the effects of which are likely to get worse before they get better.
Coming after the dotcom debacle of 2000, today’s sub-prime saga – which still has some way to run – this indigestion confronts us with an urgent question: how to prevent the stomach’s chronic urge to binge again in another five or 10 years, maybe causing not just a bad headache, like this time, but a cardiac arrest.
One answer could be tighter international regulation: financier and philanthropist George Soros, French President Nicolas Sarkozy and Prime Minister Gordon Brown, to name but three, have all called for reform of international finance. But this is like trying to control obesity or binge-drinking by regulating global supplies of food and drink. What we need is for certain individuals to change their diet.
The origins of today’s financial crisis lie not in the mysteries of the global financial architecture but in the pay-for-performance practices of Wall Street and the City. Basically, these practices push the perverse incentives contained in all such schemes to the extreme. What marks out the financial sector is its offer of unlimited upside for inventors of clever wheezes like collateralised debt obligations (don’t ask) or mortgage-backed securities, with no downside. Not only are the fabulous bonuses paid before the toxic effects on the rest of the body are evident (and sometimes brazenly even when they are: see Stan O’Neal’s $161m and Chuck Prince’s $42m exit packages at Merrill Lynch and Citigroup respectively) – even worse, participants in the system are cynically aware that, as with Northern Rock, they can’t be allowed to go to the wall for fear of bringing down the whole structure.
The upshot is the ultimate moral hazard: as Martin Wolf has powerfully argued in the FT , the financial sector is an industry ‘that generates vast rewards for insiders and repeated crises for hundreds of millions of innocent bystanders’ who, to add insult to injury, then are obliged to pick up the pieces with their taxes. In the terser formulation of playwright Bertolt Brecht: ‘Every 10 years a great man. Who paid the bill?’
We did. And it is at this point that the non-dom issue swims murkily into the picture. Of course, there are non-domi ciled, low-tax-paying UK residents of all trades, shapes and sizes – ship owners and business-school lecturers along with City traders and bankers. But be sure that most of the irritating high-pitched drone you’ve been hearing these last few weeks comes not, as you might have imagined, from the famous ‘mosquito’ device for dispelling rowdy teenagers in our town centres but, just as repellent, from high-earners in the City whingeing about the preposterous idea of having to pay tax on all their earnings.
Putting the two things together, let’s see if I’ve got them straight. To make the City safe as the world’s premier financial centre it needs to be free to pay unlimited salaries to incentivise people to devise ever more arcane, risk-bearing financial vehicles in the future, while it is the job of the authorities to pull out all the monetary stops to keep the music playing, in Chuck Prince’s infamous phrase. But not only that those whose extravagant pursuit of riches actually created the mess are now demanding partial exemption from responsibility for paying the clear-up costs, otherwise, like the Mad Hatter, they’ll move on to the next clean plate. Or am I missing something here?
Of course, we want London to continue to innovate and be a magnet for the financial sector, but for the right reasons, not the wrong ones. Maintaining a dubious status as an offshore tax haven, as the IMF named the UK last year, which is home to the largest community of non-dom tycoons in the world, figures among the latter rather than the former.
London owes it to the world, as well as the rest of the economy, to innovate in ways that improve the sustainability of the body as a whole rather than undermine it. That means embracing transparency and accountability, including, especially, the ways its big shots pay themselves. A system that generates colossal rewards for the few and crises and losses for the many is unsustainable in the long term even if it doesn’t auto-destruct in the short.
The UK’s stomach is out of control, demanding to continue consuming at the present rate even if it threatens to absorb all the other organs in the process. It needs to go on a healthy diet that will also nurture the rest of the organism. If it doesn’t, more unpleasant medicine may be needed. It could take a number of forms, but all of them will taste much nastier than paying pounds 30,000 a year to maintain their non-dom tax privileges.
The Observer, 2 March 2008