My comments on today's Bank Compensation article in the Journal:
Wall Street Pursues Pay Loopholes
Compensation Caps Drive Some Firms to Weigh Options; Higher Salaries?
Some Wall Street firms are looking for ways to sidestep tough new federal caps on compensation.
In response to expected bonus restrictions, officials at Citigroup Inc., Morgan Stanley and other financial institutions that got government aid are discussing increasing base salaries for some executives and other top-producing employees, people familiar with the situation said.
The crackdown, part of the economic-stimulus package passed by Congress and signed into law by President Obama last month, limits bonus pay for the top five executives of any recipient of taxpayer capital through the Troubled Asset Relief Program, plus the 20 next-highest-compensated employees.
...The talks also are proceeding cautiously because of the political volatility of pay, bonuses and perks on Wall Street, including outrage over American International Group Inc.'s promise to pay $450 million in bonuses to employees in the insurer's financial-products unit. What has gotten into the management of US insurers lately. This was one of the most bone-headed moves I have seen come from management since the CEO of MBIA fired Fitch because it didn't like the rating he thought Fitch was going to give it, which of course caused everybody to distrust (even more) the ratings of all the other companies that MBIA engaged. Boneheaded! Did the management of AIG not see this coming? Was there nothing they could do to smooth things over with employees until the storm blew by. Did they forget that they are roughly 80% or so owned by the government? Not many bureaucrat CPAs can pull down $3 to $6 million bonuses!
Most traders and bankers on Wall Street get a base salary of anywhere from $200,000 for managing directors to $1.5 million for a chief executive. But the lion's share of their pay comes in the form of a bonus, a tradition that began when most firms were private partnerships and partners shared directly in the annual income of the firm. And herein lies both the problem and the solution. The banks are no longer partnerships, but the employees are still getting the economic perks of partnership status (majority sharing in the [not so excess] booty) while the economic risks of the partnership status are being forced upon the shareholder (liability, longer tailed risk of trading and investment operations, etc.). For example, in trading and warehousing the leveraged MBS, CDS and CDO products, a partnership will be wielding its own capital (which is probably why these products weren't traded and warehoused back when these companies were private), hence the risk profile that was willing accepted was most likely much, much more conservative given the expected return for said unit of risk taken. Now that they companies are flush with outside shareholder capital, the AMM mentality creeps in. For those that don't know, AMM (Ain't My Money) is the Street version of OPM (Other People's Money). Now, the firm (which is actually now a company) is willing to take risks it would never have dreamed of as a private partnership funded solely by the partners. You know like 30 to one leverage (twice that if you factor in off balance sheet vehicles) on products that not only have not be tested in a downturn but also have opaque pricing and liquidation terms. The Firm (now turned Company) also is able to pay out of revenue, instead of risk adjusted profit, since,,, well,,, it Ain't Their Monies!. As an efficient, succesful private firm, the bonuses should have and did in some cases, and currently should even as a public Firm (versus a Public Company), have a string attached to it at one end that led to the revenue generated. Once the revenue became risk adjusted final profit that string was cut and belonged to the earner. Until then, that money was a ward of the firm. In this fashion, revenue that came from CDO trading should be viewed with a X year tail (where x= the average duration of the CDO), at the end of the duration the full bonus will be paid out, or would have been finished being paid out in risk adjusted pro-rata increments. That way, whenever anything blows up, the revenue generating employe takes the first hit, then corporate retained capital, then shareholders and bond holders directly - in that order. Notice how I didn't include taxpayers nor government in that hierarchy. The reason is that I believe the revenue generator will have a different set of goals in mind when generating said revenue that will protect corporate retained earnings, investor capital, and tax payer subsidies. You see, now everybody is on the same side. The revenue generator now becomes the risk adjusted profit generator. Sales people stop churning for maximum commissions and start churning for maximum satisfied client ratings. Traders stop trying to max out quarterly revenue and start looking for 5 year maximum risk adjusted returns. Shareholders gladly payout hefty bonuses, for that means they made more clean money. Basically, the I banks are now run like I run my financial operations. They are run like they are privately owned again. There is really no need to move on, I have just solved the entire compensation dilemma. Hey, Obama! I'm not even going to charge y'all for my services. Consider it my contribution to the cause, bro! That's my 60 cents worth. It was my 2 cents, but I levered up 30x!
"The trend is to increase the base pay in light of the reduced bonuses," said Scott Talbott, senior vice president of government affairs at the Financial Services Roundtable. "Without the revenue" that top performers provide, he adds, "these companies can't survive." Yeah, but the problem is and has been ever since the banks went public from private partnerships is that management has been focuse on raw revenue instead of what really counts for the OWNERS of the firm - risk adjusted profits. You can get away with not adjusting profits for risk for a few years, but over 10 or 20, you will receive some bite marks in your ass. Believe it!
Under the forthcoming rules, bonuses could come to no more than one-third of the total annual compensation paid to employees covered by the restrictions. Some compensation experts view the bonus limits as a mistake that turns the notion of pay for performance on its head, despite Wall Street's culpability for the recession and credit crisis.
"These are not bureaucratic positions where you're paying individuals high salaries," said Michael Karp, chief executive of Options Group. "How can you pay a banker a really high salary without knowing what kind of revenue that person generates?" Taken a step further, "How can you pay a banker a high revenue bonus without knowing what kind of risk adusted profit, that banker makes?" You can take the risk adjusted part out, for time will review hidden risks. You just have to amortize and defer profit based bonuses based upon the duration of the risk tail that accompanies the revenue generated. It is ludicrous to pay a trader 100% of the revenue based bonus of a CDO that is full of untested, unpriceable, murky clearing assets with a 5 year duration - UPFRONT!
Still, critics are ready to pounce on any potential maneuver around the federal limits. Raising base salaries would play into "a long and dishonorable tradition of responding to any attempt to curb pay excess by just putting it in a different pocket and calling it something else," said Nell Minow, editor of the Corporate Library, a research firm focusing on corporate-governance issues. Any attempt to get around bonus curbs "can expect pushback from shareholders," she predicted. If only shareholders knew how to pushback effectively. These are the same shareholders who for decades allowed there hard earned capital to flow into excessive revenue based bonuses in lieu of common and preferred dividends. I find the prowess of these shareholders somewhat suspect!
At Morgan Stanley, discussions about raising base pay levels are preliminary, and the New York company hasn't fleshed out a formal strategy, according to people familiar with the matter. Oh, I'd love to hear what they are coming out with. Cuomo probably has the subpeonas signed already!
Citigroup officials have considered designating which 25 executives will be subject to bonus limits, people familiar with the discussions said. In that scenario, the new rules might not apply to lower-ranking yet still highly lucrative traders and investment bankers, these people said. "We will comply with the restrictions, in addition to the substantial changes we have already made to our compensation structure," said a Citigroup spokeswoman. Yeah, but we will ignore fixing the haphazard compensation problem which got us into this mess in the first place. More revenue! How do you spell profit???!!! What's risk????
Citigroup has received $45 billion in taxpayer-funded capital do far, while Morgan Stanley has received $10 billion. The latest U.S. rescue of Citigroup will leave the federal government holding as much as 36% of the company's common stock. Now, only if some of our elected officials take heed to the BoomBustBlog, we can have some really effective shareholder activism to bring back the type of prudence that private owners enforced over their operations. If, and only if...
Inside banks and Wall Street firms, some executives are hopeful that the Treasury Department will water down the curbs on bonuses, inserted into the stimulus bill by Sen. Christopher Dodd (D., Conn.), during the department's rule-making process.
One possibility that banks would applaud is that the pay restrictions apply to top executives and other managers, instead of less-senior but crucial rainmakers... Be less concerned about those who make rain and cater to those who cultivate fertiile soil! It is this shortsightedness that engendered the Asset Securitization Crisis (see Global Debt - A Closer Look).
The Dodd provision sent shockwaves across Wall Street. Some bankers and compensation experts contend that top revenue-producers could bolt to non-U.S. banks or hedge funds that aren't subject to TARP-related restrictions. "It's possible we will lose some people," J.P. Morgan Chase & Co. Chairman and Chief Executive James Dimon said in a recent speech. "I'll be very sorry if that happens." It remains to be seen if this is for the better or not. After all, there are many industries and companies in the US that are best of breed and top in their game, and have achieved such without paying out 50% of their net revenues in compensation costs. Don't drink you own Kool-Aid. Bankers, money managers and traders are not smarter than everybody else. If that was the case, then I could anoint myself the smartest person on Wall Street for 2 consecutive years running (see Updated 2008 performance), but I know better - and so should you!
Raising base pay at J.P. Morgan isn't being discussed, people familiar with the matter said.
Wells Fargo & Co., the San Francisco bank that got $25 billion in government capital, disclosed last week that it increased the base salaries of CEO John Stumpf and two other executives.
A bank spokeswoman declined to comment on the raises. A person familiar with the matter said the increases were decided at about the same time that the new curbs were signed into law. Yeah, business as usual. How about a performance draw and salary clawback provision based upon a rolling 5 year risk adjusted profit pool for the CEO. That would set things aright!