bonuses

Reckless, short-term and ultimately creating dangerous risks that undermine the safety of the world's financial sector.

That's a fairly common assessment of the investment banking bonus culture (you can pretty much guarantee the media's take on a particular issue when they start referring to it as a "culture") but it might surprise you to know that the very same warnings can be applied to the European Union's roundly-rejoiced plans to demand upper limits for incentives in the financial industry.

In short, it's a stupid decision that reflects both politicians' innate desire to appease the braying masses and deflect attention from their own manifest failures.

So how best to puncture this bright red balloon of conventional wisdom (filled with a helium mix of self-righteousness and envy)?

Well, let's start with the basic premise from which the proposed legislation was built: Bankers' bonuses caused the credit crisis.

Codswallop.

Comprehensive studies on both sides of the Atlantic - from the University of Southern California's Marshall School of Business to the University of Reading School of Politics, Economics and International Relations - have ground that theory into dust a long time ago.

"It is perceived that bankers' bonuses were to blame for the financial crisis, but our research has found that there is no evidence to show the relationship of pay and performance of senior directors of banks were out of step with other sectors," said one of Reading's economists, Dr. Sarah Jewell.

Kevin Murphy, USC's 'Kenneth L. Trefftzs Chair in Finance', said he found "no evidence that the Wall Street bonus culture provided incentives for risk-taking for top-level banking executives: indeed, the general structure of low base salaries and high bonus opportunities paid in a combination of cash, stock, and options should mitigate excessive risk taking."

So let's repeat: the asleep-at-the-switch regulators, who have a vested interest in covering their own failures, blame bonus culture. Scores of academics, with no incentive beyond research and no direct ties to "Wall Street" or "The City", say it isn't so.

Pay me now or pay me later

But capping bonuses - or, in the EU's case, limiting them to a fixed proportion of base salaries - wouldn't change that "risk-taking" culture even if it was proven to exist in the first place.

If you're an oil trader, for example, working for a German bank in London, you're still going to have an annual assessment of your performance based on the amount of money you've generated for the firm in a given year. If your bonus is going to be limited to your base pay, you're simply going to negotiate for a higher base after a successful year and get paid the amount you normally would over a 12-month period instead of a single one-month sum. Either way, you'll take risks to earn it.

And, at least with defined bonus payments, banks have the ability to claw-back some of that cash if a short-term decision to boost profitability suddenly (or ultimately) goes sour. You can't claw-back a salary.

EU rules, then, will simply neutralise a risk that may not even exist in the first place while simultaneously limiting the amount of financial redress that could correct it.

Excellent stuff.

That's not the only portion of this proposal that will weaken banks' finances.

Bonus payments are really not that different from standard commission (too often it's forgotten that underneath the veneer of the global financial markets is little more than a securities bazaar: no one gets paid unless something gets sold.) Investment bank managers simply add up the revenues (sales) and fix a portion of those as commission to their sales force (the bankers) and their support staff (everyone else).

Doing this with the hindsight of "facts on the ground" at the end of the year, it seems, is far safer (and more sensible) than allocating the cash at the start of the year when you have no idea what's going to happen. Why commit £250,000 to a gilt trader who might generate a tiny profit (thanks to low rates and sparse liquidity) when you can pay her £100,000 and a smaller bonus based on the year-end data?

A bank that pays smaller salaries and larger bonuses has more dry powder than those which do it the other way around.

It also has more flexibility: in a bad year bonus pools can be trimmed, salaries can't.

Actually, they can, but that usually requires getting rid of the person earning the salary at the same time. Which means, from the government's perspective, an employee that would have paid a higher rate of tax on a smaller bonus is now paying no tax at all and is instead drawing revenue in the form of jobless benefits.

In Britain, the Office for National Statistics says £13.3bn in financial sector bonuses were paid in the 2011/2012 tax year. Not all of it would be taxed at the 50 percent rate (despite what excitable things you might have read about vampires and squids) but a safe assumption might yield an extra £5.3bn for Her Majestry's Treasury. That same pool spread over a full year and taxed at various marginal rates will yield much less.

In Switzerland, which was a first-mover on much of this, (thanks to the embarrassment of its two main banks losing billions during the crisis and threatening the safety of its treasured wealth management business) there's an even more interesting impact.

JPMorgan analyst Kian Abouhossein says fixed salaries have risen 66 percent post-crisis to 86 percent of total compensation while bonus payments have fallen 34 percent. Oh, yeah, the bank's also cutting 3,500 jobs worldwide at the same time.

In other words, the EU grandees who sat helpless while a far-simpler-to-understand crisis torched five economies and millions of jobs (hint; it had the sum total of nothing to do with bank bonuses), have instead decided to club together on new rules that will neither make banks less risky nor more responsible and generate less revenue for the tax payer.

But it'll sure win them a lot of support.

London