Is Wall Street Pay Falling Far Enough?

The New York Times, writing from the industry town, in “Wall Street’s Pay Is Expected to Plummet,” tries to make the case that the calls for scalps deeper pay cuts are overdone:

The first clues are emerging that Wall Street pay will plummet this year — but perhaps not enough to satisfy the financial industry’s critics.

Bonuses, which soared to record heights in recent years, could drop by 20 to 35 percent across the industry, according to a private study to be released on Thursday. Bonuses for top executives could plunge by 70 percent.

But to some, those figures, from the consulting firm Johnson Associates, demand the question: Why should Wall Street executives get any bonuses at all? Banks’ profits have plunged, and the government is spending hundreds of billions of dollars to shore up the industry and prevent its problems from dragging down the economy.

A report on Wednesday from the New York State Assembly said Wall Street bonuses could tumble 41.3 percent next year, which could further widen a budget deficit….

In an interview on Wednesday, Mr. Cuomo suggested that even 70 percent declines for top executives might not be enough, given a financial blowup that culminated in a $700 billion federal rescue for the industry. Many critics, Mr. Cuomo among them, contend that outsize pay encouraged bankers to take outsize risks in the first place. The crisis that followed led to the bankruptcy of Lehman Brothers, the emergency sales of Bear Stearns and Washington Mutual and federal rescues for the insurance giant American International Group and the mortgage companies Fannie Mae and Freddie Mac.

“Given this economic situation, how do you justify any performance bonus at all, is my initial point,” Mr. Cuomo said.

Bankers and traders have been rewarded for taking risks that Wall Street clearly failed to manage. “When you incentivize that type of behavior, you shouldn’t be surprised when you find very risky, overly creative, short-term, highly leveraged products,” he said.

Mr. Cuomo added that he would closely examine the books of the nation’s biggest banks to ensure that no government money went into bonus pools. Henry A. Waxman, the California Democrat who heads the House Committee on Oversight and Government Reform, has asked for similar pay information from banks….

Among different areas of banking, the study suggests that fixed-income traders will see bonuses decline 40 to 45 percent.

Investment banks typically pay out about 50 percent of revenue as compensation, and year-end bonuses can account for a large percentage of employees’ pay. In the past, fat bonuses led to big spending on lavish apartments and other luxuries, and leaner times are expected to hurt New York’s economy.

In previous lean years, Wall Street banks justified large payouts by arguing that top employees would flee for higher-paying jobs. But with tens of thousands of Wall Street jobs disappearing, that argument may no longer hold. “Where are people going to go?” one senior banking executive asked.

I will grant that New York is a horrifically expensive place to live, unless you bought your apartment a long time ago (then it is just expensive). But cost of living has never been a rationale for pay (at least in the US), otherwise artists and writers who live here would be better compensated.

20% to 35% bonus cuts versus the extraordinarily rich payout of 2006-2007 is a complete and utter joke. Let me give you two data points. The first comes from John Whitehead, former co-CEO of Goldman, and mind you, he was raging at the 2006 pay levels:

Nothing in John Whitehead’s 37-year career at Goldman Sachs Group Inc. prepared him for the excesses of today’s Wall Street.

“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.”

Pay packages for traders and investment bankers are soaring as Goldman and its rivals fight the lure of hedge funds, private pools of capital that offer managers a cut of profits on the money they invest. Last year, the five biggest Wall Street firms paid a record $36 billion of bonuses, more than $200,000 per employee.

New York-based Goldman set the pace. Blankfein out-earned all of his counterparts and Co-Presidents Gary Cohn and Jon Winkelried each received $53 million, including cash bonuses of $26.7 million. Goldman employees shared $16.5 billion of compensation and benefits, an average of $621,800 apiece. That’s up 20 percent from a year earlier and almost $300,000 more than the firm’s closest rival.

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…

Goldman partners in Whitehead’s day made salaries of $120,000, compared with $600,000 today. Their cut of the firm’s profit was plowed back into Goldman’s capital and remained mostly unavailable until retirement. When Goldman sold shares in an initial public offering in 1999, partners with a claim on the firm’s book value received five times as much in stock.

The second data point is what normally happens in a downturn, and 20% to 35% bonus cuts is well below normal for a bad industry contraction. Moreover, per Whitehead, past boom periods were no where as rich as the latest one, so one should expect even deeper reductions, rather than the comparatively shallow ones in the works.

Bonus cuts are normally much steeper for middle level and senior professionals than the rank and file. For instance, in the dot-bomb era, I know of investment banking MDs (well regarded, still in the saddle)whose bonuses fell by 70%. They knew they were appreciated because the MDs who weren’t were fired. I don’t have a sense of the level of the pay cuts, but in the 1990-1991 recession, three quarters of the M&A bankers were fired. The prospects for the industry looked so bad that in an unprecedented move, a record number of Goldman partners went limited (that meant their capital account was valued, and would earn interest at a pre-set rate, and they could gradually pull it out over a long period of time). Why did they do this? Because they expected that the firm was going to take such large losses that they thought their capital accounts (even with high Goldman earnings) would not return to their current levels in any reasonable time period (to my knowledge, the firm had never seen such “every man for himself” behavior in previous tough times)

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  1. Anonymous

    Goldman Sachs paid out 16 Billion last year. The mkt cap is 35 Billion. Stock is where it went public 11 years ago. They have looted the company. How about zero bonuses for the next decade? What a crew of ponzi schemers.

  2. nemo

    Isn’t a large part of the reason New York is so ridiculously expensive is BECAUSE people in finance, the major industry there, are so ridiculously overpaid?

    It’s the same phenomenon in any Gold Rush town — prices of everything are driven to ridiculous levels. Once the Gold Rush is over, prices of everything once again return to Planet Earth.

  3. Yves Smith

    The health care industry was the biggest employer in Manhattan through the early 1990s, and it was expensive to live here even then. But yes, it has gotten even worse.

  4. cent21

    Why would there be any bonuses on Wall Street this year?

    Aren’t bonuses linked to profitability? I mean, come on. I’ve gotten bonuses before, but never in any year when the company lost money.

  5. Independent Accountant

    The world of Wall Street is so far removed from the world of Pat Buchanan’s “peasants with pitchforks”, that it may as well be on the moon. Wall Streeter’s average 2007 pay “was $379,000–more than six times the average for all private sector jobs in [New York] state”, my 18 October 2008 post,
    Next, where will they go? Let the blood flow on Wall Street and Southern Connecticut, until both are knee-deep in it, my 29 October 2008 post, Wall Street compensation could drop 67% and still be double New York State’s average! It’s expensive to live in NYC, no doubt. I grew up there and can tell you its about 90% higher than the cost of living in Houston. Wall Street’s answer: move! Exxon moved its corporate headquarters to the Dallas metroplex and cost NY State and City billions a year in taxes. How much of “Wall Street” could leave NYC? Probably plenty. Do the major Wall Street houses have competant controller’s offices which should have made “relocation studies” decades ago and have them ready to roll? How well managed are these firms? Not very. Based on the vagaries of “multistate corporate income tax allocation”, there is virtually no trading what takes place electronically that should be done in NY. Go to Dallas. Heck, for a fee, I’ll bet Exxon could do the studies for a Wall Street house. Why pay $90 a foot for real estate? Even downtown Brooklyn is only about $30 a foot. Let the blood flow!

  6. a

    Here’s a paragraph in Bloomberg’s article on the same subject (“Wall Street’s Top Executives Face 70% Bonus Cuts, Study Says”):

    “However, thanks in part to the financial bailouts and mergers we’ve seen recently, the decline in incentive payments won’t be as drastic as first thought.”

    Thank you Uncle Sam! It makes one sick to the stomach.

  7. Anonymous

    "I don't have a sense of the level of the pay cuts, but in the 1990-1991 recession, three quarters of the M&A bankers were fired."

    About 3/4's of attorneys and accountants at big law or accounting firms, who'd been working on M&A, were also laid off. Firms ramped up hiring of law students in litigation and bankruptcy, and senior people with business or skills in those areas. But that was irrelevant to the M&A lawyers / accountants.

  8. Bob_in_MA

    Rather than micro-manage executive pay packages, wouldn’t is be easier and fairer to simply recreate the progressive income tax?

  9. a

    From Bloomberg:

    “UBS will have to get bonuses for 2008 approved by Switzerland’s banking regulator… The bank must get approval from the Swiss Federal Banking Commission, or EBK, for the amount, composition and distribution of this year’s bonus pool, under the rules of the aid package… The government said that UBS’s bonus payments should be reduced to what’s ‘absolutely necessary’…”

    Now there’s a country which negotiated when it put money into its banks, rather than just giving it away a la Paulson.

  10. Moopheus

    It doesn’t seem unreasonable to ask the question, of why, if Wall Street was so badly capitalized it needed a bailout, it can afford to set aside money for bonuses. And if it could afford to do so, why did it need a bailout? It has been reported that Paulson forced some banks to take money from the TARP. Why did Paulson feel the need to do this, if he knew that the banks were holding on to this bonus pool?

  11. Anonymous

    is there any other industry where shareholders money is paid out to ordinary workers in such high numbers? I don’t think so. This will not change until shareholders will demand that the bonus culture will be abolished. Or at least made in line with other industries. Banks claim they can’t do this, because traders will go to other banks. I do not belief this, there are plenty of talented people wanting to be traders. Moreover, if they would all abolish it, there is no place to run. Its only an excuse they use because they do not want to abolish their own bonus.

  12. tompain

    11:27, the essence of the problem is corporate governance. How exactly should shareholders “demand” that the bonus culture be abolished? It’s not like there are contested elections for the board seats. Shareholders have no power. The only reason even more money does not get paid out in compensation is that many of the senior employees own stock. If too much goes to comp, the stock will tank. The likelihood that the balance between comp and earnings will be optimal for a non-employee shareholder is zero. These companies really should not be publicly held companies. There are other companies that pay their employees an enormous share of revenue – law firms, for example. Medical practices. Accounting firms. Almost none are public. The only ones who went public are the finance guys who know best how to sell stock to suckers. Note that Buffett hasn’t bought any GS common stock yet. Bet he won’t.

  13. Anonymous

    @tompain: making them non public companies sounds like a solution. But are there no shareholders meetings where large shareholders can demand that the board abolishes the bonus culture? You make it sound like this is impossible, but the only difference between other public companies who pay their employees normal salaries (with maybe some stock or a modest bonus) and banks is the bonus culture at banks that developed in the past decade. This is not some kind of law of nature, this is a culture, and can therefore be changed if shareholders would demand it.

  14. ajw

    In other words, the same bankers who pushed and pushed corporate clients to value shareholders over their own employees do exactly the opposite in their own companies.

  15. bg

    Isn’t this moral hazard and tragedy of the commons game theory at play?

    1. Bank ‘A’ overpays talent – and knows it. So does ‘B’ and ‘C’.
    2. If Bank ‘A’ were to lower pay in an oligopoly, then it would be in ‘B’ and ‘C’s interest to gobble up the talent, as revenue follows talent.
    3. So Bank ‘A’ ceases to exist.
    4. Bank ‘B’ and Bank ‘C’ are now losing 1.1 gazzilion, instead of their previous 1.0 gazzilion.
    5. Bank ‘B’ and Bank ‘C’ now get more government bailouts, because ‘A’ is out of the picture, and ‘B’ and ‘C’s need is greater.

  16. tompain

    1:17, sorry, but it does not work that way. Who is it that you want to “show up” at the shareholder meeting? What do you want them to do there? The best solution for someone who thinks the companies are run poorly is not to own the stock. There are plenty of activist investors out there who could go after these companies if they thought it would make sense. Steel Partners tried to go after a money management firm with the intent of cutting comp. Guess what happened? All of the employees left, and the business went with them.

    You are wrong that the only difference between these companies and other public companies is a bonus culture. If that were true, some discount provider would have come to Wall Street and cleaned up the way Southwest Airlines did. It has to do instead with the nature of the business. The primary money-making assets of these companies can walk out the door. When they went to IPO themselves, investors should have just laughed and said what assurance do I have that you are not going to take all the profits for your employees? But they didn’t. Caveat emptor.

    This is why Buffet only wanted preferred stock. They have to pay his dividend. Even so he demanded constraints on the management team as part of his deal. Common stock investors should have done same, but the time to do that was at the IPO.

    Stay away from these stocks. That’s all there is to it. The employees are going to ream the shareholders every time. Don’t kid yourself that that is going to change. No one can make them change.

    If not for the government getting involved here, none of us should even care that a bunch of bankers are screwing over a bunch of stockholders who were dumb enough to buy the stock in the first place. Although, from a broader perspective, the same poor governance practices are at work everywhere else in our economy, with less drastic but still unfavorable effects. It ought to change. But there is no practical way for shareholders, however well-intentioned, to really make it happen.

  17. tompain

    4:57: Yes, exactly. Is there some reason why we should be surprised that this happens? Normal human behavior, is it not?

  18. Dave Raithel

    “But cost of living has never been a rationale for pay (at least in the US), otherwise artists and writers who live here would be better compensated.”

    Ya break my heart …

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