John Whitehead is being proven right.
The former Goldman co-chairman took the unheard of step of excoriating Lloyd Blankfein for Goldman’s “shocking” pay levels of 2006. As anyone who has been following Wall Street knows, compensation levels were even higher in 2007, 2009, 2010 and last year. Per an interview with Bloomberg:
“I’m appalled at the salaries,” the retired co-chairman of the securities industry’s most profitable firm said in an interview this week. At Goldman, which paid Chairman and Chief Executive Officer Lloyd Blankfein $54 million last year, compensation levels are “shocking,” Whitehead said. “They’re the leaders in this outrageous increase.”
Whitehead went even further, recommending the unthinkable, that Goldman cut pay:
Whitehead, who left the firm in 1984 and now chairs its charitable foundation, said Goldman should be courageous enough to curb bonuses, even if the effort to return a sense of restraint to Wall Street costs it some valued employees. No securities firm can match the pay available in a good year at the top hedge funds.
“I would take the chance of losing a lot of them and let them see what happens when the hedge fund bubble, as I see it, ends,” Whitehead, 85, said….
The Galtian traders who carry on as if they are solely responsible for their profits are being shown to be more dependent on the franchise, in particular, the concentrated information flows from dealing with lots of customers and counterparties, than they had persuaded themselves and management. Bloomberg today tells us that the prop traders who have decamped from Goldman, convinced that they’d be able to rack up stellar returns, are floundering. It isn’t just that they aren’t racking up huge wins; they are losing money and falling short of hitting the average for their trading strategy. As the report notes:
Ex-Goldman Sachs (GS) Group Inc. traders led by Pierre-Henri Flamand and Morgan Sze raised more than $4.5 billion for their own hedge funds..
So far, none of them has made money for clients.
The two are among at least six traders who have left Goldman Sachs’s biggest proprietary-trading group in the past two years, which the New York-based bank shuttered in response to new U.S. regulations. All, including Daniele Benatoff and Ariel Roskis, trailed this year’s stock market rally after losing money in 2011, investors said…
Flamand, 41, who was the global chief of Goldman Sachs’s principal strategies group before he quit two years ago to start Edoma Capital Partners LLP in London, has lost about 2.4 percent through February since his $1.8 billion hedge fund started in November 2010, according to investors.
Edoma is an event-driven fund, which invests in companies undergoing events such as mergers, spinoffs and bankruptcies. Such funds returned an average 3.9 percent in the same 16-month period…
Sze, 46, who ran Goldman Sachs’s principal strategies team in Asia before briefly replacing Flamand as global head, left the bank in 2010 to start Azentus Capital Management Ltd. in Hong Kong, hiring 13 former Goldman Sachs traders. His event- driven fund lost about 4.8 percent through February since its April 2011 inception, said a person with knowledge of its returns.
Event-driven funds declined 2.4 percent in the same period…
We’ve long been skeptical of the idea that big firm traders are worth their outsized pay packages. Of course, it nevertheless make sense for management to play along, since higher pay levels for traders justify robust pay for everyone senior to them in the hierarchy (yes, a top trader will often be paid more than the top brass, but it’s an anchoring issue. And pay in banks at the senior levels has become more hierarchical than it was in the 1980s and 1990s).
Long standing readers may recall the 2009 row over the pay level of Andrew Hall, the head of a Citigroup oil trading unit. He had made $100 million in 2008 on a long-standing pay arrangement that gave him a pay deal for his team that was just below 30% of profits, a level unheard of since Mike Milken at Drexel (and we all know how well that turned out). Kenneth Feinberg, Obama’s pay czar, refused to back down, leading to the predictable hue and cry as to how terrible it would be to break Hall’s contract (we pointed out that there were likely ways to do just that, that big producers like Hall were often guilty of expense abuses that would allow for termination for cause).
Consistent with the notion that Hall needed Citi more than he’d pretended earlier, he started negotiating with the bank (if he really was such a hot item, one would think he’d be able to decamp and raise money). As we pointed out at the time:
A LOT of Hall’s performance was due to cheap funding from Citi, and probably massive leverage too, conditions he could not replicate anywhere else. A risky, highly geared operation should pay an interest rate appropriate to the hazards it is taking, not the borrowing costs of its parent (this basic premise is widespread in financial firms, embodied in approaches like RAROC (Risk Adjusted Return on Capital), the Basel I and II rules, and Economic Value Added models.
And the denouement, from ECONNED:
Phibro, along with its richly paid chief, Andrew Hall, is leaving Citigroup for Occidental Petroleum. The price Oxy paid for Phibro was only the current value of its trading positions–liquidation value and not a brass razoo more. There was NO premium for the earning potential of Hall and his supposed money machine. It’s not hard to see why. Hall’s returns were heavily dependent on high leverage, cheap funding, and market intelligence from other trading desks, all huge subsidies from Citigroup. In turn, these concentrated capital and information flows do not come about naturally, but are the product of industry-favoring policies.
His example illustrates that the widely proclaimed view that highly profitable traders are worth their exorbitant pay is often a fiction. The fact that no other buyers, not a financial firm, commodities trader, or consortium, stepped forward when Citi was looking for a graceful exit shows that the business was worth very little on a stand-alone basis.
Instead of seeing the Hall episode as further evidence that industry pay practices are extractive, the media focused instead on “government interference” or how Citi would be harmed by losing the revenues from taxpayer-supported commodities speculation.
The problem, of course is that given how much traders and investors who appear to generate outsized returns (query at what risk and with what information advantages) are celebrated in their circles almost as much as sports stars. Their allure is fading bit by bit, but it will be quite a while before the ascendancy of traders is reversed.