Heads I win, tails you lose

The credit crunch was due to an orgy of reckless lending by the world's banks. But for the people wh

You don't have to be a financial genius to understand where responsibility lies for the credit crunch. The main culprits are the world's banks and their managers. Driven to accumulate ever-higher profits, which translate into mega-bonuses for senior executives and traders, the bankers embarked on an orgy of reckless lending.

In the first instance, the current crisis began soon after 9/11 when interest rates fell to 1 per cent in the United States, and the banks went on a desperate search for yield or higher returns. The worse the credit risk of the borrower, the higher the interest rate charged.

The bankers then wrapped the loans up in neat packages, gave them exotic names like collateralised debt obligations, and sold them on. But as the great liberal economist John Kenneth Galbraith famously noted: "All financial innovation involves, in one form or another, the creation of debt secured in greater or lesser adequacy by real assets."

In the case of the packages created out of sub-prime, the assets were horribly inadequate. The result is a toxic mountain of an estimated £250bn of debt, which every individual or firm seeking a mortgage or loan is having to pay for. Among the reasons that such bubbles arise is the way in which financial players are incentivised.

The bonus system rewards the princelings in the City and on Wall Street on the volume of exotic instruments sold and the number of deals struck - not on the quality of the transactions. So even in a year like 2007, when so much went wrong for shareholders and investors, the people who brought us this mess walked away with fabulous rewards.

In Britain the most conspicuous example of an executive escaping with a bag of swag, despite horrendous mistakes on the part of the bank concerned, is Bob Diamond, the American president of Barclays Capital. In 2007, Barclays was required to write down £2.8bn of loans because of sub-prime and related debt. This was not all. The bank's just-released annual report reveals that exposure to exotic instruments (of the kind Galbraith skewers) climbed from £138bn to £248bn and its loan exposure to the sinking US economy climbed from £17.5bn to £29.3bn. Indeed, the Barclays balance sheet is so overwhelmingly complex that there is some doubt as to whether anyone understands what its business model might be.

Yet despite all this and an horrendous fall in the Barclays share price, Diamond was virtually unaffected. The Chelsea-supporting tycoon carried off a remuneration package of £21m, only marginally down on the previous year. He also collected a cheque for a further £14.8m in cash and share bonuses for his brilliance in previous years.

But why should we be surprised by the insouciance of Diamond and the Barclays remuneration committee? Adam Applegarth, the chief executive who drove Northern Rock so hard it fell over a precipice, received a pay-off of £760,000 for his trouble. He also has a pension pot of £2.6m, which could pay him benefits of up to £305,000 a year when the 45-year-old banking pariah reaches retirement age at 55.

Yet this is the bank which through its reckless lending model did immeasurable damage to new Labour's reputation. It has gobbled up to £55bn of government money in the shape of deposits and guarantees, it has been nationalised and has damaged the reputation of the City. The government seems to have learnt nothing from the experience. The Rock's Alistair Darling-anointed executive chairman, Ron Sandler, is being paid £90,000 a month to clear up the mess. And despite this role, Sandler remains non-domiciled for tax purposes.

Much the same has been the experience on the other side of the Atlantic. Stan O'Neal, the boss of the brokerage house Merrill Lynch, who did eventually fall on his sword after unveiling nearly £5bn of sub-prime losses, cried all the way to the bank with his pay-off of £80m. At Morgan Stanley the chief executive, John Mack, is hanging on by his fingertips. He won some plaudits when he waived his 2007 pay of £20m because of the firm's losses. But he showed no willingness to repay any of his bonuses, built on the shifting sands of past earnings.

For the bank bosses who brought us the credit crunch it is a case of "heads I win, tails you lose". The connection between rewards and taking responsibility for past mistakes is tenuous. Payment for failure is as widespread as ever. The banks live in fear that their best deal-makers will be poached by competitors and refuse to end the short-term bonus culture.

So while in the UK homeowners struggle to refinance their mortgages and 74 per cent of small firms complain of tighter loan conditions, those who created the post-2001 financial euphoria can spend more time on their yachts without fear or conscience. Nice work if you can get it.

Alex Brummer is City editor of the Daily Mail