A very political pension

It is hard to understand how we reached the current position of Sir Fred Goodwin and his unfeasibly large pension. For anyone who doesn't know the background, Sir Fred was the head of the Royal Bank of Scotland until late last year. Under his stewardship a successful bank was reduced to a pile of steaming debt, posting losses of £24.1billion in the latest financial year. His bank was at risk of folding in 2008 until the government stepped in with vast sums of money and propped up its sagging cadaver. As part of the rescue package it was thought best for Sir Fred to concentrate on mastering crochet and flower-arranging, so his exit from the bank was negotiated. As with all negotiations, his departure came only when both he and the government were satisfied with the terms agreed. He did not insist on being paid in lieu of notice and he gave up certain other entitlements, including his key to the executive lavatory, in return the government thanked him and asked him to close the door on his way out.

The government had two other options. One was to let the bank fold, a course which would have terminated Sir Fred's contract of employment and restricted the amount of money he could get out of the company in the future, but that was thought unacceptable. The other was to sack him and let him sue if he didn't like it. There is only one good reason for not sacking someone who has overseen the total collapse of a previously successful business, and that is that you cannot prove he broke the terms of his contract of employment. Sir Fred was sought out by the bank to be it's big cheese. One consequence of being head-hunted for a major position is that you are very much in the driving seat when it comes to the terms of your employment. It would not be at all surprising if his contract of employment was drafted in terms very favourable to him. Indeed it might well be that his only concrete obligation was to receive his salary and bonuses. Various other obligations would be implied by law even if not expressly included, but each of them would be a difficult basis on which to justify dismissal even for the man responsible for snapping the bank's spine in two.

All this should have been looked into when the government took a majority shareholding in the bank and had to decide what to do about Sir Fred. In fact, even from this most incompetent of governments, it is inconceivable that it was not looked into. A deal was done and that was that. Sir Fred visited the yarn shop and started the crocheted blanket of his dreams. Now news has broken that his pension entitlement is no less than £693,000 a year for life, he is currently fifty years old, and the government is embarrassed. I have to say, I would be embarrassed if I had negotiated the removal from office of someone who had done so much damage and had managed to leave him with a pension pot valued at some £16million. I would ask how I could have been so incompetent.

An exchange of letters has now taken place between Sir Fred Goodwin and Lord Myners, the minister responsible for the negotiation. Sir Fred pointed out that he gave up the equivalent of more than a year's fat salary, that the pension was all recorded on the books and that the minister agreed to him keeping it. In reply the minister said he had believed the pension to be a legal entitlement whereas it now appears it was only discretionary. With the level of skill enjoyed by only this government in the western world, a minister's excuse makes him appear even more incompetent.

When the negotiation was taking place Sir Fred had a legal entitlement to a year's notice yet he agreed to forgo that entitlement, he had a legal entitlement to other benefits and agreed to forgo them, so why would the fact that the minister believed his National Lottery sized pension to be a legal entitlement mean it was not up for negotiation? It makes no sense.

But that's not the worst bit. The worst bit is that the minister did not know the legal status of the pension arrangement. These things are not written in hieroglyphics, they are contracts in pretty standard English legal jargon. They include a chunk setting out the terms on which the pension is payable. If you want to know what it means, the conventional technique is to read it.

None of this is to say that Sir Fred cannot be deprived of his ginormous pension, although it is very unlikely. Poor Gordon, at his most monocular and moronic, has started shouting about seeking ways to prevent at least part of it being paid. Even the grossly over-pensioned John Prescott has weighed-in, calling for Sir Fred to be summarily deprived of the money and putting the onus on him to sue for it. Not for him the rule of law or the law of contract, the idiot Prescott has votes to win so he wants to make the law up as he goes along if he thinks it will result in little crosses against the names of Labour Party candidates come election day.

It's all just political posturing, of course. If the government is to have any chance of undoing the arrangement within the law they face an enormous obstacle in their agreement to the severance package negotiated last year. Obviously we cannot tell exactly what happened. Maybe Sir Fred was given a generous pay-off because of his years of loyal service to the furtherance of poor Gordon's grand economic plan, and this little spat is the price he has to pay for his future income. Maybe he felt he had given up enough by waiving his notice period and other benefits and would never have agreed to cede his pension without a legal battle he felt confident of winning. Maybe the whole negotiation was just conducted utterly incompetently by a government that was in full headless chicken mode at the time. Whatever the true position, one simple fact remains - a deal was done.

And that is where the really important lesson comes from this farce. If it had been Barclays Bank or HSBC that took over RBS rather than the government, there would be no row about Sir Fred's pension arrangements. They would have been part of a the whole takeover package and lost in the small print while the real business of trying to rebuild a once thriving bank would be the only concern. Instead the state of the bank has been relegated to secondary importance behind an issue of no real consequence to anything. That is what happens when governments take over businesses. Headlines and opinion polls are more important to them than the substance of the thing. OK, so his pension pot is worth £16million, a huge amount of money for an individual, but what is it in relation to RBS as a whole? Its losses for the year were £24.1billion and his pension entitlement grew over several years, but let's treat it as a single part of the £24.1billion loss in that single year. £16million is 0.067% of £24.1billion. Heap all the vitriol you want on the man, he had to go, he had presided over ruination, get rid of him. Pay him 0.067% of the losses the bank incurred in his final year and send him on his way, it will be money well spent. Just start running the bloody thing properly.

Yet they will not run it properly. They will run it for political gain. They think there is political capital - by which I mean potential votes - in shouting about how much the failed former boss of the bank is being paid. They might be right, but it's got nothing to do with anything. If they were really concerned about it as a matter of high principle they could have written clauses into his severance contract ensuring he did not receive that money. The issue has cropped up now as a matter of pure political convenience. Just as poor Gordon is getting flak from national and international figures about the way he bankrupted the country he has found a subject to divert attention. It won't divert it for long and in a few weeks or months there will be another scapegoat put up to receive public fury, anything to prevent the government that bankrupted the country being identified as the cause of our bankruptcy.

We saw earlier in the week how Northern Rock is now to be used to make home-purchase loans for political reasons (here). Today the effective nationalisation of RBS is the excuse for trying to win some votes by bashing a man with money. Tomorrow it will be something else. There are endless ways in which attaching government to business allows politicians to engage in populist rants by picking a random example of how the business works, taking it out of context and flogging it for all it's worth.

Oh, and lest you might believe that I approve of Sir Fred's pension arrangements, I don't. But I would rather see contractual arrangements upheld than arbitrary rule according to the temporary direction of the political wind. Maybe we have laws to hold reckless incompetents like Sir Fred Goodwin to account for the vast damage they do, maybe we don't. Maybe that will never be tested. But I would rather he got away with scamming £16million under a freely negotiated contract than we have rule by populist diktat.

Bank bonuses and the Royal Albert Hall

All sorts of people are getting very excited about bonuses. Whether here or in the USA if there is a hint of a bank employee's current contract including a bonus structure bile is spewed like never before. How dare they pay bonuses? It's an outrage! Send in the dogs!

Now take a deep breath and ask yourself two question: (1) should a company honour existing contracts with its employees and (2) how would you draft new employee contracts to incentivise your staff?

All existing contracts containing bonus clauses have to be honoured. It is as simple as that. You can bleat all you want about how those terms should never have been agreed, but if they have they must be met.

Well-drafted new contracts have to reflect the needs of the company as well as providing a proper wage for the job in order to ensure you secure the services of necessary staff. A business that is going through a hard time and has to reduce losses or limit future losses might think it appropriate to pay a basic salary combined with a bonus scheme that pays an additional sum if losses are reduced or restricted to a predefined level. It might or might not work. Maybe the employees will have no effect and the level of losses in the year will be what they would have been regardless of what the staff did. But maybe their efforts do result in a diminution of losses, in which case they have provided a benefit far in excess of any bonus they are paid. No one can tell for sure whether such a bonus scheme will achieve anything but it might, and the job of management is to decide whether it is sensible to take that gamble in the long-term interests of the company.

There is nothing inherently unfair or corrupt in companies paying bonuses to staff in accordance with predetermined criteria. It might, in individual cases, be a bad move because circumstances can change and the bonuses might prove to be disproportionately expensive for the business. For example, a bonus calculated by reference to turnover will be payable if the defined turnover is met regardless of whether costs have increased to such an extent that the additional turnover produces no additional profit. On the other hand, a bonus calculated by reference to turnover will not have to be increased simply because the additional turnover produces more profit than anticipated.

If you choose to pay bonuses in addition to a basic salary you take a chance on those bonuses being affordable. Maybe they will be and maybe they won't, that's the gamble you take by following that path. In most instances the alternative is to pay a higher basic salary with no bonus. You are then obliged to pay the full salary regardless of how well your business does. Maybe it will be better for your balance sheet to pay people a fixed sum of £25,000 rather than £20,000 with the chance of a bonus of up to £7,500, maybe it won't. You have to decide what will work best for your business.

Objecting to bonuses simply because they are bonuses makes no sense at all. Because financial institutions were noted for paying huge bonuses during poor Gordon's boom of doom, there has developed a school of thought that bonuses are somehow inherently evil. It is utter nonsense. Indeed it is such utter nonsense that it is even more nonsensical than those bonus schemes which paid massive amounts on the assumption that all business written would be profitable in the long term. But you cannot reverse time. Stupid decisions were stupid decision, they were taken and have been acted upon. Move on and learn from the mistake.

Objecting to bonuses simply because they are being paid in the financial services industry is equally absurd. They are also paid in numerous other types of business up and down the country and at every level of employee. It is for each business to decide for itself whether to have a bonus structure, and if so what it should be.

More interesting is why people think it is their business to comment on the staff pay arrangements of financial services businesses when they would not presume to offer an opinion on the bonuses payable to Mrs Char, the cleaner and tea-lady at Madam Fifi's Sauna and Hanky-Panky Parlour. Some of the comment is just general observation about the way big businesses operate. Fair enough, that's all fine sport. But much more is comment based on the false belief that it is now the direct business of the commentator. That is what nationalisation and part-nationalisation of businesses does in a developed political system. It gives taxpayers the belief that they are now part of that business and that their opinion is necessarily valid. This belief is encouraged by misleading terms such as "public ownership" (when effective ownership is not with the public but with government ministers), it is also reinforced by the company in question becoming part of the political landscape rather than being just a business.

Of course, once something becomes a political football new forces operate. No longer are business decisions required to be taken on business grounds, now they have to be taken according to the political mood of the time. Are there votes for the governing party in a nationalised industry doing X rather than Y? If so, you find it is encouraged and, if necessary, coerced into doing X regardless of how good X is for the business itself. This influence is all the stronger in the run-up to a general election when the governing party is behind in the opinion polls.

You would have to search far and wide, and then abandon your search, if looking for a government politician who will say "They have to pay these bonuses because they have contractual commitments to do so." Yet that statement sums the position up in the shell of a nut. Where the top tier of bank employees has a contractual right to receive bonuses because their contracts were drafted when poor Gordon's boom of doom was in full swing, political bullying has the potential to force them to forgo their unmerited additional payments. And the difference it will make to the bank will be less than a gnat's fart in the Royal Albert Hall.

The numbers are too big

The government tells us it will borrow £78billion in the current financial year although the actual figure is nearer £150billion because they have omitted the vast sums already advanced to banks and those earmarked to give further support to banks in the coming months. It seems to me we have reached the stage where the amount the government hopes to borrow is so enormous that it makes little practical difference for that figure to overshoot. Today we saw a sign that the Chancellor of the Exchequer might have abandoned any notion of keeping debt under control. When it was announced that a small bank, London Scottish, had folded Mr Darling said that all depositors' funds would be guaranteed by the government. It was only a few weeks ago that the formal guarantee for deposits was increased to £50,000, today that limit was cast aside and an unlimited guarantee was given.

It is easy to see why Mr Darling saw fit to do this. London Scottish is a small bank with total deposits of only £273million and the dent in the public purse is bound to be limited. In fact it would be a modest sum even in good times. But it is hard to see that an unlimited guarantee would have been given just two or three months ago, at that time the increase of the guarantee to £50,000 was seen as an exceptional measure. The only thing that has changed is that the government is now in hock to such a massive extent that adding a few extra millions makes absolutely no difference.

This change of approach comes shortly after it was disclosed that the government is drawing up a list of businesses who will be offered financial support if they go bust. That list is in the sleazy hands of Lord Mandelson and we can have no doubt that a major consideration for inclusion is that the business is in a Labour held seat or a marginal constituency. Bailing out the bankrupt was an old favourite of the Labour Party in years gone by. Their paymasters in the big unions required them to do it and everyone over the age of about 45 will remember how it ended. Vast companies produced goods no one wanted and buckets of taxpayers' finest were thrown at them to keep the workers voting Labour. The cost was so vast that the government ran out of money in 1976 and had to borrow from the International Monetary Fund. Yes, the very same IMF poor Gordon has been keeping sweet with calls for it to receive greater funding from the developed world. A major consequence of the 1976 IMF loan was that it came with conditions, including the need for government to cut its spending. That, in turn, caused the unions to get even more shirty and call strike after strike to "protect" publicly funded jobs. By the winter of 1978-1979 the position was simply bizarre with a Labour government being brought to its knees by its own paymasters. The Conservatives came into office in the 1979 general election and started to undo the state industries.

Now it appears that the natural instincts of Labour politicians are resurfacing. For the last nine years we have seen one aspect of this in a steadily increasing public sector crammed to the gills with non-jobs. But until now even this government did not feel it had a free hand to return to the days of state support for manufacturing and trading companies which could not make a profit. Lord Mandelson, with the keen support of poor Gordon and the hapless Mr Darling, knows he can nationalise vast swathes of business because the huge cost will be just a fraction of existing government debt. If the books were balanced and he announced a plan to spend, say, £30billion in bailing out bankrupt car manufacturers he would face a hostile public and press. As it is £30billion looks like the catering budget and will not cause significant public concern. After all, the government lost £2billion on the day it took shares in the Royal Bank of Scotland just last week and that hardly merited a mention in the press. We seem to have reached the stage where the debt figures are so big and so unimaginable to us little people that the government can add to them without fear of losing any more votes.

I believe there has also been a change in public mood over the last few weeks. When the government started pumping money into the banks to provide them with more capital in an attempt to restore confidence between the banks themselves, most people did not know why it was being done. What they saw, however, was the government using their taxes to help an industry noted for paying large salaries and even larger bonuses. It is hardly surprising that Mr and Mrs Ordinary will say "if they can do it for them, they can do it for us" and "if they can find all that money for the banks they can surely find it for schools and hospitals". These are perfectly sensible and fair observations, after all it is Mr and Mrs Ordinary who will have to pick up the tab and they want that tab to pay for things they value. It is unrealistic to expect Mr and Mrs Ordinary to walk happily from their jobs to the dole queue when a tiny fraction of what was paid to the banks could keep them in employment.

Lord Mandelson knows his party's only hope of reelection lies in getting Mr and Mrs Ordinary back on side. For a couple of years Labour has taken a pummelling in opinion polls and even now they are a fair way behind the Conservatives on most polls but the gap has been closing in recent weeks. They need a lot of Mr and Mrs Ordinarys to vote for them again and one way to do it is to claim credit for saving their jobs. Old-style nationalisation was driven as much by political ideology as vote gathering, many of those in the post-war Labour Governments led by Clement Attlee, Harold Wilson and Jim Callaghan genuinely believed that state owned industries would be more efficient and stable than those in the private sector. I doubt that even a youthful Trotskyite like Mr Darling still believes that because the evidence is utterly overwhelming that state run industry is a black hole for taxpayers' money. Today their primary motivation is the buying of votes.

What an irony it would be if the appalling mess caused by poor Gordon's devastating incompetence during ten years at the Treasury and two as Prime Minister will give him the smokescreen he needs to secure reelection. Horrible though it is even to think it, it could happen because the numbers are now so huge that he can buy votes without the public blinking at the cost.

Nationalisation and profit, the new chalk and cheese

As we enter a new era of nationalisation my mind goes back to the 1970s when vast swathes of British industry were in "public ownership". The railways, the coal mines, steel manufacture, the telephone service, the supply of gas and electricity, shipbuilding and British Leyland (which made things they tried to say were motorcars) were among the largest and best known of the nationalised industries but there were many more. Now we have three nationalised banks, Northern Rock, Bradford & Bingley and the Royal Bank of Scotland and calls are being made for failing businesses to be supported by the taxpayer as these banks have been. It is a staggeringly different position from just fifteen months ago, but what does it really mean?.

Private ownership is easy to define. I own FatBigot Towers and everything within it. I have the right to use my property as I choose provided that my choice does not contravene the law and if anything goes wrong with my property I have to pay to sort it out, either directly in cash or through a claim on an insurance policy. No one has the right to use my property without my permission and no one other than me is burdened with the need to repair it or pay for replacement when it wears out. It is a two-way process which can be put in terms of benefit and detriment, profit and loss or rights and obligations. However one chooses to describe it, the up-side and the down-side both attach to the owner and to no one else.

Businesses are a little more complex because they often involve a company, indeed every nationalised enterprise has involved a business run by a company. A company is not, strictly speaking, owned by anyone. A company operates by having a sum of capital which it uses to do business and, with any luck, to make a profit. In order to raise capital a company issues shares. It says "pay me £1 and you will be entitled to a share of the profit I make using your £1", a million shares are sold at £1 each giving the company £1million to work with. If it makes £10,000 in profit in one year it might pay a dividend of 1p to each of the 1 million shares or it might re-invest all or part of the profit with a view to making an even greater profit next year. The shareholders do not own the company they own the right to participate in profits if those who manage the company decide to pay a dividend. The chairman and board of directors do not own the company, they manage it and work for it. In fact no one owns a company any more than anyone owns you or me.

A company, however, can own things just as you and I own things. We own our cars, televisions, fridges and all the rest of it. Companies might buy their business premises, furniture, carpets, cars and so on (although in practice many such things are rented) they also buy the things they need to be able to trade. A manufacturing company buys raw materials and turns them into finished products which it then tries to sell, a trading company buys goods from suppliers and tries to sell them for an enhanced price to purchasers. Each company owns the things it buys until such time as it sells them, that much is blindingly obvious. What is not so obvious is that companies with an established business have a further assets, goodwill. Goodwill is what causes people to do repeat business with someone. There are two dry cleaning shops in close proximity to FatBigot Towers, I only use one because I tried that one first and they have always provided an excellent service at a good price. When a new neighbour asks where they should take their curtains for cleaning I point them in the direction of the cleaners I use. That is what goodwill is all about. It is a valuable asset of a business and can be sold just as a machine or a desk can be sold.

So, what happens when a company is nationalised? There are various ways nationalisation can occur but the essence is that the government takes over the shares. It might take them all or only enough to give it effective control, but when we talk of a company being nationalised it means that sufficient shares are held by the government that it can dictate how the company operates. As I said above shareholders do not own a company, but they do have certain powers over how it operates. They can dismiss and appoint directors and pass resolutions requiring the managers of the company to adopt certain trading practices. Such decisions can only be made by shareholders if a sufficient number agree and nationalisation occurs when the government holds a high enough proportion of the shares to be able to appoint directors and dictate commercial policy.

In other words, nationalisation is not about ownership but about control. The rather romantic notion that the people of the UK "own" Northern Rock or that they "owned" the coal mines and the railways prior to privatisation is misleading phooey. The people of the country neither own nor control anything about a nationalised company. The government has the right and power to control how a nationalised company conducts business, to suggest that this automatically confers a benefit of ownership on the 60 million is utter nonsense. That not only explains my dislike of the term "public ownership" it also lies behind the biggest problem nationalisation causes. That problem is that nationalised companies are run by government and, therefore, political rather than business reasons dominate decision making.

There are four main political pressures that prevent governments operating nationalised companies as businesses. First, the fear of failure. If you take on an ailing business because it needs to be saved, anything short of saving it is failure and failure can cost votes. As a consequence the political need is to keep the business going even if it makes losses year after year. Secondly, jobs. Loss making companies are, almost by definition, overstaffed. Shed jobs and you risk shedding votes. Thirdly, the need to appear consistent. Businesses often need to change their strategies at short notice when market factors make their established approach inappropriate. It is not easy for governments to do this because a change of tack can be interpreted as indecisiveness, and indecisiveness can cost votes. Fourthly, the effect of the business on other people. We are seeing this at the moment with the government making moves to force banks to lend even where the bank is not sure the customer is a good bet. They are pressurising all banks not just the nationalised ones, but the nationalised banks will have to do it even if it is bad for their own business.

There is also the issue of profit. Profit is a particularly difficult matter for the present government because almost every minister, and certainly all senior ministers, have condemned the making of profit consistently throughout their political careers. For them profit is a consequence of workers being exploited. We should never overlook that every senior member of the current government entered politics as a dedicated Marxist. They will not find it easy to oversee a nationalised business that becomes profitable (not that I expect any of them to do so). What can we expect if Northern Rock returns to the lending policies which made it a successful building society? Either the government will sell it as a going concern far too early and suffer a substantial loss to the public purse or it will rein-back the profit making and force it to break-even.

Whatever happens to Northern Rock, Bradford & Bingley and any other company the government nationalises over the coming year, we can be certain of one thing. It will cost the taxpayers a hell of a lot of money and all notions of us owning them are nothing more than vacuous guff.