No Bonus Tax, Let the Market Decide

Last Updated Aug 27, 2009 7:26 AM EDT

Rather that propose taxes on transactions to bring down bankers' bonuses, Britain's financial regulator, Lord Turner, should ask why competition is not forcing down City fees and pay. The free market is not working in the Square Mile.

There is no shortage of investment banks -- unlike retail banking, which has shrunk back to a Big Four with Lloyds' takeover of HBoS. Nor is there any suggestion of a cartel of the sort that previously fixed stockbroking fees. And, not surprisingly, there is no shortage of people trying to join the City gravy train to share in the fees bonanza.

The laws of supply and demand by which City firms make their money has been suspended for their own finances. Individual banks justify high pay packages by saying people would go to other banks but there is no reason for the whole industry to pay so much more than other sectors. If so many good graduates want to be financiers, surely the starting pay should fall?

And if lower pay encouraged fewer people to want to work in the City, it might achieve Lord Turner's aim of shrinking the financial sector to a socially optimal size in which fewer shares are churned between fund managers or derivatives dealt by hedge funds. The City claims such business is essential to support its role raising capital for real companies, but the tail is now bigger than the dog.

The Financial Services Authority chairman also mooted a "Tobin tax" on financial transactions to depress bank profits and thus prevent lenders overpaying staff. That would certainly hit banks' values -- not a good idea when taxpayers are their biggest shareholder -- but would it reduce the number of deals or would the tax be added to clients' bills rather than come from banks' profits?
The regulator has identified a problem but the solution lies with those clients. If they didn't pay the banks' fees, the banks could not overpay their staff. Companies that negotiate on all other outgoings, including their own labour expenses, accept City costs without question.

So when an investment bank states it fee for a rights issue or acquisition, companies pay rather than seek a better deal elsewhere. True, a company needing cash is not necessarily in the best position to haggle and secrecy stops them shopping around, but the pressure to pay less must come from the City's customers.

And there is precedent in the City competition cutting fees. The range of alternative stock exchanges has caused share-dealing costs to tumble, for instance, followed by settlement charges.

The City offers specialist services but firms do not have a monopoly. Companies should stop thinking of the Square Mile as a single unit but of individual institutions to play against each other. When it is recognised that banks need customers rather than corporations need banks, fees will fall and Lord Turner will see bonuses return to acceptable levels. The market ought to be the best regulator.

(Pic: riklomas cc2.0)