Bankers are about to take a 50 percent pay cut

Pay levels in the banking industry are falling faster than snowflakes in winter. US president Barack Obama wants executives at state-rescued banks to get no more than $500,000.

UK Chancellor of the Exchequer Alistair Darling has promised an investigation into bonuses at the banks that his department now largely owns. French president Nicolas Sarkozy said in a television address last week that bonuses based on taking risks had "led to catastrophe and should be outlawed." At this rate, the pay rules will soon outnumber the bankers.

There is no longer any doubt that remuneration in the financial services industry will be lower.

The only question is whether we are talking about a 10 percent to 20 percent reduction - the kind of blip that causes you to trade your Bentley for an Aston Martin. Or are we looking at a total wipeout, the sort of industrywide catastrophe from which there is no recovery?

In other words, is banking now like the typewriter business in the 1980s, or the horse-and-carriage industry in the 1890s? Here's my estimate. Over the next five years, average pay at banks around the world will drop 50 percent.

First, there is too much capacity in the industry. There were simply too many bankers out there doing too much banking. Adair Turner, the chairman of the UK's Financial Services Authority, said as much in a lecture just last month.

"Wholesale financial services - and in particular that element devoted to securitised credit intermediation and to the trading of securitised credit instruments - grew to a size unjustified by the value of its service to the real economy, and is now going through a downsizing, part of which is cyclical, but part a permanent one-off adjustment to a more economically efficient size," he said.

It is now obvious that a lot of the financial innovation of the last decade was a waste of everyone's time and energy. We didn't need all that complexity. It certainly didn't make the world economy run any more smoothly. The net result is that the industry will shrink, wages will decline and there will be more people around than jobs. Just ask a UK coal miner from the 1980s, or a Detroit auto worker today.

Next, history is about to reassert itself. Thomas Philippon, an assistant professor at the Stern School of Business at New York University, has studied wages in banking and finance compared with other professions of the last century.

In the 1920s and early 1930s, pay reached record highs, he says. Then it collapsed after the Wall Street crash. Through the 1950s and 1960s, bankers didn't earn much more than peers in similar professional jobs. Then in the 1980s, pay started to soar again. By 2006, it was running at 40 percent more than its long-term average. Relative earnings even outstripped the previous peak in the early 1930s.

This past decade was the best time to be a banker. Yet the one thing we know for certain is that markets get back to normal over time. If oil is trading at $140 a barrel, it's probably going to fall in price. If gold is trading at $200 an ounce, it will probably rise. And if bankers are paid 40 percent more than their long-term average, then - well, you get the idea.

Lastly, regulation. From the middle of the 1980s until this year, financial markets have been steadily liberalised. That has led to a huge burst of innovation and experimentation, which caused rising pay.

Some of that has worked out well, though much of it hasn't.

The era of light-touch regulation is over. State-run banks will be tightly controlled by their new shareholders. Even the banks that need no taxpayer bailout will find the authorities keeping an eye on them. We are only at the start of that process.

In all likelihood, the regulations will get heavier and heavier, leaving little room for innovation because the last thing anyone wants right now is an elaborate piece of financial engineering. Yet if bankers are just doing dull familiar things in a dull familiar way, they can't expect to be paid very well.

Investment banking won't disappear. But the compliance officer and the corporate social responsibility executive are suddenly the most important people in the office. And that will make it a quieter, less dynamic and less profitable profession.

To get back to their sustainable long-term level, salaries will need to fall 40 percent. But, as any trader will tell you, markets always overshoot, both on the way up and the way down.

So, in reality, a 50 percent drop seems more likely. And the stark truth is, if you want to earn more than anyone else, which no doubt many people in banking do, then it is time to think about taking up some other career.

We could be well into the 2050s before banking is booming again.

Matthew Lynn is a Bloomberg News columnist. The opinions expressed are his own.

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