Bonanza! A year ago, the financial system was in meltdown and bankers were the villains of the piece. So how can it be that Goldman Sachs and JP Morga

First published in the Telegraph on 16 October 2009

Anyone looking for an example of the bizarre turn our mutant economy has taken in the wake of the financial crisis should have been in Istanbul a couple of weeks ago. In the granite conference centre that looms over one of the city’s seven hills, the world’s leading finance ministers, attending the annual summit of the International Monetary Fund, concluded that the global problems have only just begun: that rising unemployment is set to exert a crippling social cost; that now is no time to rest easy.

But only a few miles away, it might have seemed to the untrained eye as if the crisis had never happened. Having hired an entire floor of an Ottoman palace on the shore of the Bosphorus,

Bob Diamond was holding court.

The head of Barclays Capital – the investment banking division of Barclays Bank – was not in town to participate in the droning misery-fest of the IMF and World Bank meetings. Instead, he was taking advantage of the presence of the finance ministers, the vast majority of whom have had to raise masses of cash in the wake of the crisis, as well as countless other private-sector participants on the fringes of the summit who needed to raise money.

It was an investment banker’s paradise, and all of the world’s surviving banks had sent either their chiefs or high-ranking officials to participate. They entertained guests in lavish style, plying them with expensive meals and nights out on the town.

In the meantime, it was the politicians and policymakers in the centre of Istanbul who bore the brunt of public disgust, facing a series of small riots and, in the case of the IMF’s managing director, Dominique Strauss-Kahn, having a shoe thrown his way by a disgruntled student.

It is hard not to conclude that the bankers have somehow “got away with it”. Unapologetically, although far more discreetly than at the height of the boom, they are making millions again. This week, JP Morgan announced profits of $3.6 billion in the third quarter, leaving it on track to pay as much as $29 billion in salaries and bonuses this year.

Goldman Sachs, the bank everyone loves to hate and fear in equal measure, revealed yesterday that it is heading for a similarly staggering $22 billion pay pot for its employees (an enormous sum when you realise how few of them there are compared to the staff of other big banks).

How have bankers managed to make such significant sums again, barely a year after the entire financial system came to within an inch of collapse?

One reason is competition – or lack of it. Despite the fact that the recession has taken hold, life goes on and companies still need to invest, to grow, to borrow and occasionally to take each other over. Each of these tasks necessitates a visit to their investment bank which, in the same way that a high street bank will provide money services for an individual, will do everything from lending money and helping sell bonds, to issuing shares and insuring against future collapse.

The difference between now and a year ago is that Wall Street and the City are significantly smaller places. With the disappearance of so many of the old names, Lehman Brothers and Bear Stearns most notably, plus the fact that there are a significant number of walking wounded such as UBS and Merrill Lynch, the remaining banks can get away with charging significantly more for simple “vanilla” services. Quite simply, whether you’re a business or one of those finance ministers in Istanbul needing to raise money, there are fewer places to go for help.

Another explanation for the bankers’ success is that the markets have been flooded with cheap money by central banks, the Bank of England and the US Federal Reserve chief among them. The by-product has been that, with interest rates so close to zero, there is next to no incentive to save. So money has flown around the system in search of any kind of investment that can offer a decent yield.

Given that investment banks are usually the middlemen in the process, they have benefited immensely from this central bank-created search for yield. Quantitative easing – by which the Bank of England has been creating money and using it to buy government debt in order to boost the economy without bringing down interest rates any further – has also created a nifty carousel for investment banks to buy gilts on the cheap and sell them back to the Bank at a profit. And so the merry-go-round has sped up again.

The few surviving investment banks have generated so much money that it has inevitably trickled down to a small band of bankers and investors. So house prices in London and New York have staged an unexpected recovery as the cash flows in, while the more downtrodden areas of Britain have seen property prices fall yet further.

Although plenty of rich financiers have lost much of their wealth, the evidence of this week suggests that the historic highs in inequality that preceded the crisis have not been reduced. Nevertheless, this time the bonuses may look rather different. New G20-endorsed guidelines have ruled out the practice of guaranteeing multi-year bonuses to try to lure the best bankers from one firm to another, but financiers – an intelligent lot – are already devising novel ways of constructing pay packets to get round such strictures. Denied the chance to pay bumper bonuses, some are opting to pay their folk with “forgivable loans” – lump sums that are destined never to be paid back. Others are, more brazenly, simply paying basic salaries that are double or even triple what they would have been previously.

Catch a friendly banker off-guard and he will confess that he, too, is mystified as to how, in the wake of the worst financial crisis in living memory, he and many of his colleagues are still pulling in such significant pay-packets.

But would you, if you were in their position, turn down the cash? And would doing so make any difference? Surely not, since the latest binge is principally an unwelcome consequence of decisions taken by governments and regulators to try to revive the financial system.

The profits are due, in addition, to the fact that the financial sector is sorely lacking in real competition – it is effectively a cartel that fixes its fees higher than they ought to be and in crowding out genuine competition.

But blaming the system does not mean that bankers are innocent nor that they deserve their plunder. In David Hare’s new play at the National Theatre, The Power of Yes, the author depicts himself asking, incredulously, how bankers like Sir Fred Goodwin of Royal Bank of Scotland can believe that they do not owe the public an apology.

The bankers’ riposte is that while they may have needed state support for a few months, most of them – Goldman Sachs included – have paid this back, with interest, and no longer need direct taxpayer help. “Do you,” adds one of Hare’s characters, “take any notice of what the critics write about your plays?” Touché.

But, Hare responds (in rather more colourful language), “my plays don’t screw everyone over”. And that, in the end, is the point. Banks should be compared to big industry.

Just as a manufacturing company emits a certain amount of pollution for every car or computer produced, so a bank pollutes the world’s economic system as it makes profits, by creating systemic risk – increasing the likelihood of another bubble being created.

Occasionally, the factory goes up in smoke and innocent bystanders are killed. And just as major polluters are having to face up to the fact that they must pay a price to mitigate these previously uncosted emissions, so banks ought in future to have to compensate the public for the pollution they create.

This may mean having to issue more shares (and so effectively earn less in profits); it may mean being told to cut back lending when the markets are at their most frenetic. In the long run, it will mean having to write “living wills”, so that they can fail like normal companies rather than needing a government bail-out.

Most controversial is an idea mooted by Dominique Strauss-Kahn at the IMF meeting. He said that the fund is investigating plans for an effective tax on financial transactions worldwide, which would build an “insurance fund” to help mitigate financial crises in the future.

The fact is, however, that such restraints remain some way off. Until they are imposed, or until the next crisis appears, there is little reason to suspect that bankers will not carry on earning sums that bear little true relation to their ability or their contribution to the economy or society.