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Banking Bonuses And The Financial Crisis

2780 words - 11 pages

The bonus culture & management incentives in banks were a key factor in the Irish and US Crisis. The system was flawed from the beginning; bankers took risks to get short term bonus, with no regard to long term consequences to the economy. Within the financial system the bonus culture is unique. The banks present a high percentage of it award based on bonus driven remuneration. For the employees of the bank it became a high percentage of their annual salary. This gave bank employees the incentive to offer risky loans and mortgages.

During the boom years from the mid 90’s to 2006 in the U.S. housing market experienced a boom. During this period many mortgages were offered to people who were in the high risk category of defaulting. This was very relevant in the investments bankers took, including in the profile of mortgages they gave out. The culture that evolved was get as many mortgages on the books as possible, even if the recipient of the mortgage was not a sound investment and in many cases had not the wages to cover the mortgages they received from the banking institutions. Ridiculous coverage of 100% mortgages was being issued to folks who could never ever pay back the loan. These customers did not have to go through the normal credit checks, these loans became known as subprime loans. These high risk mortgages were processed as securitisation; this is a financial practice of combining mortgages into one large pool. Most of the pools became mortgage – backed security (MBS) and were traded on the financial markets by firms such as Fannie Mae and Freddie Mac. These MBS delivered high rate of return for the traders increasing their bonus but were not sound investments for the bank. This careless disregard of the company’s assets in effect, made the banks insolvent when the folks started to default on their mortgages.

In Ireland alone, the percentage of mortgages for greater than 95% of the property value increased from 6% to 16% in the period 2004 to 2007.See Fig1 Irish Mortgage Loan-Value. Vulnerably arose in the Irish banking service because they hugely over exposed on the asset side of the domestic.

Fig1. Irish Mortgage Loan-Value
Moral Hazard problems played a big role in both US & Irish Crisis in relation to risk taking by bankers to get even higher bonus year on year, financial Institutions, developed a “God like Syndrome”, they believed they could do what they wanted, when they wanted without any consequences for their actions. This lead to them taking large risks that returned large bonus to the fat cat banker’s short term & long term, damaged the banks they worked for with poor investments. These bankers knew Governments would bail them out when they got into difficulty – lead to this problem of Moral Hazard as previous bailouts re-enforced the belief that they were untouchable & too big to fail & tax payers money would save them from ruin.

There has been a sharp increase in the levels of finance sector pay...

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