Wall Street Bonus Madness
I know times are tough on Wall Street, and some posters on this blog have empathy for the people who’ve lost jobs or seen their paychecks slashed. I have some empathy, too, for the painfulness of this whole experience, but, at a macro-level, this is ridiculous:
What Red Ink? Wall St. Paid Fat Bonuses
Despite crippling losses, multibillion-dollar bailouts and the passing of some of the most prominent names in the business, employees at financial companies in New York, the now-diminished world capital of capital, collected an estimated $18.4 billion in bonuses for the year.
That was the sixth-largest haul on record, according to a report released Wednesday by the New York State comptroller.
(Yes, it’s inflation-adjusted.) I know bonuses are an essential part of the compensation package, but the fact that there’s a good chance this was made possible by TARP money is unacceptable. As an investor I had my dividends from these banks cut because of government investment. That made sense; I accepted it. I don’t see how there can be bonuses right now if companies are trying to conserve cash.
Compared to previous years, sure, workers are making much less. But 1) they already cashed in on the bubble that shareholders are taking the hit on, 2) they are still not making that much less (sixth highest bonus take on record), and 3) the alternative their firms faced was bankruptcy prior to government intervention, so job with no bonus should considered a victory in this economy. Okay, ex-Wall Streeter, flame away.
Hilarious back-and-forth on Slate:
Ledbetter is my hero:
Give Back the Bonuses
I think part of the $18.4 billion is not current discretionary compensation, (i.e., vesting portions of previous years’ bonuses that have to be paid, contractual amounts negotiated before the current economic environment). I know that at my former bank a certain percentage of bonuses above X amount was subject to a deferred payment schedule that vested over 3 years contingent upon the employee not leaving for a competitor. Also, I think it is not uncommon for recruited Managing Directors to have a guaranteed minimum compensation as part of their contract. Basically, I think there was nothing anyone can do now about some of the $18.4bn. It sucks, but it’s not like people are going “Woo hoo! $25 billion in cash! Let’s give ourselves $18.4 billion of it,” which is what the articles make it sound like. There is a lot of dumb stuff out there (AIG executive retreat costs), and there is probably some bad 2008 bonus decisions in that $18.4 billion, but there is another chunk that is bound by contract. They just signed some really bad contracts.
And, believe it or not, a few departments still made money this year. If it weren’t for their profits, the banks would need even more capital. Though I don’t know if paying them cash bonuses right now makes the most sense, I think they deserve something.
That said, $18.4 billion is a ridiculous number, and many people have been and continue to be overpaid. Even though there’s not much you can do about it, it’s shameful to pay people vested money on work for deals/trades that are now losing the firm money, as are guarantees for someone who has lost the firm money. I would want to see proposals that future bonuses for Managing Directors have a clawback clause (i.e., your bonus vests after X years, and if your deal ends up losing us money during that time, you don’t get it) or require MDs to hold larger stock positions in the company for longer durations of time so that they feel more of the pain (as well as help build the capital base). (I have more sympathy to non-profit centers of the bank and lower ranking employees who don’t really have a say, hence the cut off at the MD level. It’ll cost 20 analysts or more to save the cost of 1 MD)
Much of the mess results from Wall Street moving from a partnership to a corporation model. No one has any skin left in the game. The counter argument of that would be that a large % of BS was owned by employees, yet they still blew up. But 30% ownership is different than 100%. And a position in a partnership is a much longer position. 30% stock ownership goes through a lot more churn than MDs who are also partners. And that 70% of outside ownership tends to be impatient for profits today.
Re: Ledbetter’s article, I agree with most of his points, but his example of AIG is misguided. Much of AIG’s business was and is still good. The collapse came because they gave a small team in London too much power to play with CDS’s. I can’t find the exact numbers, but something like 200 employees within the 116,000 person company made up over 40% of the profits in good years. But when things came crashing down, they accounted for almost all of the losses, wiping out so much capital so fast that they undid what the other 115,800 people were doing. So in Ledbetter’s example, unless his 50% employee cut included Joe Cassano’s CDS team in London, it wouldn’t have made a difference.
As a current Wall Streeter who received a drastically reduced bonus this year, I can’t read this post without taking it personally. So I won’t comment.
I lost a lot of intellectual respect for Ledbetter after reading the Slate exchange and his subsequent article. He may be creeping into Daniel Gross territory for me — always skip without reading.
Don’t mean to offend anyone still on Wall Street with this post. And I agree that Ledbetter is being silly with his AIG example. But he’s expressing a sentiment that many people feel has been insufficiently voiced — which is that incentives are totally misaligned. I do feel bad for non-senior people who do everything asked of them and more, but are getting their compensation slashed. But there’s no accountability for senior execs who oversaw excess risk. What is fair compensation for these cats now that their bets have turned out net negative?
The arguments going around for deferred stock compensation seem pretty reasonable to me.
On these compensation contracts: what’s happening in this economy now to all that bad contracts that people signed? They’re renegotiating them. So if a bank is willing to renegotiate a mortgage, why wouldn’t it be willing to renegotiate an employment contract?
I’m actually not so bothered by the sales junkets. Those are to reward salespeople for the fulfillment of their tasks. For AIG, I assume it was for selling traditional AIG products. (I believe the media misconstrued the AIG retreat as an executive retreat.) Similarly, a big Wells Fargo sales celebration got canceled yesterday because of public furor. Of all the banks, Wells Fargo underwrote with the most integrity, so these sales people should be rewarded.
I’m with Beefcake on this one: Ledbetter is an idiot. First of all, rather than supporting your opinions with false assumptions and made-up numbers, why not do a little reporting and get some real data? It’s funny that he “suspects” AIG is still overpaying, considering my AIG friends got ZERO bonuses this year. What else you got?
Did you see Gross’s recent Slate column? Ever the contrarian, he’s saying that maybe Citi should keep it’s $400 million naming-rights contract with the Mets’ stadium, essentially because A) it could be a good value (zero data to support this), B) future dollars are worth less present dollars (really!),and C) the firm needs to continuing investing in the long-term in order to turn the ship around.
Has anyone considered that bonuses are also an investment in future success? If Citi were to pay zero bonuses, most people wouldn’t quit. But we all know who would: the very best talent, since they have the most opportunities and they were paid most unjustly. If you’re CEO of Citi and your job is to reduce the workforce, wouldn’t it be better to pay hugely-reduced bonuses (market rate, enough to keep talent), while laying off the bottom 15% of your talent? That makes more sense than paying no bonuses across the board and asking your best people to leave.
If the media really cares about cutting costs, why not complain about the severance packages everyone got? Most severance packages were bigger than bonuses, and they don’t have nearly as big an impact on retaining talent. Why don’t they cover this? Maybe because they’re dumb, or maybe because dumping on the now-unemployed doesn’t sing as well.
Finally, can someone please explain to me what people think is management’s incentive to overpay employees above what is necessary to retain talent? I don’t see it. These seniors are under tremendous pressure to keep their jobs and improve the stock price. They have an incentive to keep comp expense as low as possible. Why would they pay bonuses unless they thought that was the market price to keep talent?
Even in the extreme case of John Thain, it is possible that he rushed to pay bonuses because he knew that BofA would categorically not pay and lose all their best people before having the chance to learn who those best people are.
Okay, maybe he knew he was toast and pulled a “Shrewd Manager” a la Luke 16?
I’ve stopped reading Daniel Gross’s writing because in EVERY SINGLE ARTICLE he writes something of such staggering stupidity that I get really mad.
I basically agree with everything Look wrote. I also think that the $500,000 salary cap Obama proposed is a really bad idea. Sure, it sounds like a lot of money to ordinary Americans, but it’s pocket change for the small subset of people who are qualified to run these financial institutions. And given that this is not a fun time to be in the financial business, who would want to step up to the plate to be a whipping boy for little financial reward? Intrinsically pleasant jobs can get away with paying low salaries. Unpleasant jobs have to pay a compensating differential.
The salary cap also discourages financial institutions from accepting government money, when in fact a government recapitalization of the banking sector is exactly what is needed right now desperately.
Regarding AIG, I know somebody who has done a lot of high-level consulting for them. According to him, AIG stopped underwriting new subprime credit default swaps way back in 2005 or so because they saw that that market was headed for a downturn. So the only positions they had when this crisis unfolded were contracts they had written many years ago. They would have been fine with this exposure, except that the accounting rules got changed in 2007 to force companies to mark their CDS positions to market. With CDS short position market values plummeting, AIG suddenly had to put up a ton of collateral, which is what brought the company to its knees and forced it to be bailed out by the government. If the accounting rules had stayed unchanged, the company would have remained solvent. The underwriting models back in the early part of the decade hadn’t modeled the possibility of major margin calls on the CDS positions because the rules at that time (at least according to him) didn’t make that a danger.
Regarding renegotiation: Both parties have to agree to renegotiate. You can’t unilaterally renegotiate. The banks are renegotiating mortgages because there’s something to be gained by both sides: the borrower doesn’t lose his home, and the lender doesn’t bear the foreclosure costs and thus may ultimately get more money.
If I were an employee at a bank, what would I have to gain from renegotiating? Nothing. So I’m going to stand firm, even though my firm might desperately want to renegotiate my compensation down. Also, to the extent that firms show willingness to violate previous compensation contracts, they lose the ability to write long-term contracts with their employees because they’re no longer credible. In other words, the deferred compensation that Fifty-five and Cashback are advocating becomes much harder to implement!
Making compensation more sensitive to firm performance and locking it up accomplish the laudable goals of aligning incentives. (Although realize that for the typical employee, he is such a small fraction of the firm that his contribution to firm profitability is just a rounding error, so the actual incentive alignment accomplished by paying him in stock is nil.) But realize there’s a tradeoff. The riskier and further deferred you make somebody’s compensation, the higher an expected payout he’ll demand. So you can get try to reduce exorbitant salaries, or you can try to increase incentive alignment, but it’s hard to do both at the same time.
In general, optimal compensation theory trades off incentive alignment effects with the fact that it’s less costly for diversified stockholders to bear risk than an undiversified employee. That’s why optimal contracts typically will not reduce employee salaries one dollar for every dollar of firm value lost; it’s more efficient to provide employees some insurance. That’s why $18.4 billion in “bonus” money is not necessarily inefficient, to the extent that much of that bonus was implicitly part of the guaranteed base (regardless of the semantic label slapped onto it). Employees are effectively a semi-senior claimant on the firm’s cashflows. Nobody is complaining that these banks’ landlords — another class of senior claimant — are still getting their lease payments in full every month.
A lot of relevant articles in today’s WSJ. Their editors must be having the same discussions we’re having.
Link:”At UBS, Questions Over Bonuses”
Link: States’ Jobless Funds Run Low
On renegotiation again: we live in strange and desperate times. It’s crazy what people will agree to right now. In this economy, I’ve heard a number of stories of buyers unilaterally renegotiating and slashing their vendors’ invoices. On the other side, the vendors would rather have something rather than nothing. You would think that with the lack of credibility, then the vendors would not want to do business again. But they will because they want and need the business.
Employees across industries are accepting pay cuts, and they are willing because they get to keep their jobs.
There’s too much in the news about this topic not to post something. The interesting bits in this interview with Harvey Pitt are a) legally, AIG should have not paid bonuses and waited for the courts to force them, b) all the talk about taxing the bonuses is basically government seizure:
AIG bonuses seem ‘impossible to justify,’ Pitt says