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18 Responses to “The Wall Street bonus culture”

1. J Murray Says:
   February 8th, 2009 at 3:09 pm

   For a counterpoint to this article, read “Greed is Good” in the weekend Wall Street Journal. This article accurately depicts the origins and rationale for Wall Street’s bonus culture, which is that top performers command top pay in a competitive market. Please note that a dozen Wall Street CEOs have lost their jobs, and thousands of workers have, too. And that Wall Street is heavily organized around paying for performance.

   In contrast, Congressmen like Barney Frank and Chris Dodd, whose support for Fannie Mae and Freddie Mac contributed mightily to the current financial crisis, sit ensconced in Washington, earning nice salaries, with better benefits and pensions than most of the rest of us will ever see. Where’s the culture of accountability there?

2. Ed Morrison Says:
   February 9th, 2009 at 9:27 am

   Jonathan:

   Your point is laughable.

   Congressional Salary: $174,000

   My guess is that your paycheck is larger.

   Ed

   =======

   * Lehman Brothers Chairman and CEO Richard Fuld Jr. made $34 million in 2007.

   * Goldman Sachs paid its chairman and CEO, Lloyd Blankfein, $70 million last year. Co-Chief Operating Officers Gary Cohn and Jon Winkereid were paid $72.5 million and $71 million, respectively.

   * American International Group’s chief executive, Martin Sullivan, got a $14 million compensation package in 2007.

   * Morgan Stanley Chairman John Mack earned $1.6 million. Chief Financial Officer Colin Kelleher got a $21 million paycheck in 2007.

   * Former Merrill Lynch CEO John Thain was paid $17 million in salary, bonuses and stock options in 2007. BofA CEO Kenneth Lewis earned $25 million in 2007.

   * JP Morgan Chase & Co. Chairman and CEO James Dimon earned $28 million in 2007.

   * Wachovia Corp. Chairman and CEO G. Kennedy Thompson received $21 million in 2007.

   Source

3. J Murray Says:
   February 9th, 2009 at 10:43 am

   Ed, actually, not. You seem to misunderstand how compensation works for most VCs, probably because the media typically focuses on the exceptions, not the norm.

   My compensation is risk-based, wrapped up in the success of my investments, and taken sporadically as capital gains. My performance directly determines my current and future compensation, and I invested 10 years of my career in this job without knowing what the outcome would be. I have no fat, taxpayer subsidized pension or healthcare for life, as Congress does.

   You must not have read the WSJ article carefully, because it focused more on non-CEO compensation than on CEOs. Your focus on CEOs, which I understand is the focus of Democratic attacks on private markets, reduces a complex issue to a political slogan.

   The employees who generate profits for Wall Street companies are highly at risk; many come and go in the industry without making much money, after investing years of their careers. Kind of like my situation. They typically have employment contracts, which even the federal government is not empowered to breach under the “takings” clause of the Constitution. These employees take a high percentage of their compensation, often three-quarters, as bonus. If one company doesn’t meet market rates, another will and uncompetitive companies end up being staffed by mediocrities. You could have learned all that by reading the article instead of reflexively falling back on the tired political sloganeering attacking CEOs.

   Like you, I would wish for CEOs to be paid less. My argument would be that for that to occur, we need a greater supply of qualified people, because the pay these CEO’s received reflects market rates. What it would take to hire a replacement is one factor. The high risk of these jobs is another; there was a lengthy article in the Wall Street Journal last week showing that a fired CEO is unlikely to ever find a job again.

   I sit on boards and hire CEOs, and I can assure you that we don’t pay them a nickel more than it takes to get them to work at the company.

4. Ed Morrison Says:
   February 10th, 2009 at 10:05 am

   Jonaathan:

   You are confusing two issues: the level of compensation versus the composition of pay packages.

   If your pay is as low as you imply, though, perhaps you should apply to lead GCP, JumpStart or NorTech. You’d be far better off. These executives, as the PD pointed out some time ago, are paid well over $200,000. (An absurdity in its own right based on Cleveland’s relatively pathetic economic performance over the past decade, but that’s another matter.)

   The executive pay issue for most Americans is two fold. First, the escalation of executive pay has vastly outstripped underlying growth in the economy. This has led to an increasingly inequitable distribution of income in the economy.

   This question of the growing inequality seems to both only people on the far left end of the political spectrum.

   A second issue is more troubling and cuts across political lines. That is the lack of financial consequences for the wealth destruction that the financial sector’s management practices have triggered.

   Take the case of David Daberko an his management team at NCB. According to the PD, Daberko took down $46 million in compensation over his last three years.

   http://snurl.com/bmk19

   At the same time, his management failures wiped out 95% of the stockholder value in his bank. Now NCB is inflicting heavy damage on PNC. PNC has lost about half of its value since the NCB takeover.

   http://snurl.com/bmko4

   But, before you jump, I am not advocating any government regulation of executive pay.

   I prefer ritual humiliation for these self-absorbed boneheads.

   Put a mug shot of Daberko in every Post Office in Cleveland.

5. J Murray Says:
   February 10th, 2009 at 3:45 pm

   Ed, I agree that executives should be held accountable for their actions. However, the destruction in value that has recently occurred is fundamentally a result of government action, specifically three activities: 1. The Community Reinvestment Act, passed by Congress and enforced through political pressure on banks to make uneconomic loans for social policy reasons; 2. The vast expansion of Fannie Mae and Freddie Mac, which created incentives for bad mortgage lending practices; and 3. An easy money policy by the Fed. Read John Taylor’s article on the Wall Street Journal Web site on this subject; it’s the clearest description of what happened that I have seen.

   Now, to be sure, not every bank and investment bank responded to the incentives by overexposing itself in bad mortgages. Those that did are seeing a tremendous destruction of shareholder value, deservedly so. That’s accountability: CEOs fired, boards replaced, shareholder value destroyed. Where is the comparable accountability on Capitol Hill?

   For my taste, I would have loved to see a bank CEO, five or so years ago, stand up in front of Barney Frank and Chris Dodd and say, “No, Congressman (or Senator). My bank won’t make mortgage loans to people with poor credit in neighborhoods where homes are not appreciating in value, no matter how low the Fed holds interest rates, nor how large Fannie Mae and Freddie Mac become, because that’s bad for our shareholders.” Of course, that CEO would have been roundly castigated for insensitivity to minorities and the “working poor” in the press and fired by gun-shy boards.

   I think it’s also a bit shallow to blame everything that happens on CEOs. Their compensation structure is set by the board, which must recruit and retain people in a competitive market. For sure, many CEO pay packages are incorrectly structured, but that’s the fault of the Board, not the CEO.

   CEOs, particularly of public companies, also are under great pressure to be responsive to analysts and quarterly earnings reports. When one bank rides the gravy train of cheap credit and securitized mortgages to enhanced profitability, it’s awfully hard for its competitors to accept lower earnings. Not impossible, but hard. It would take a courageous CEO to stand up to that pressure. I’m certain there are CEOs like that out there, but since what they did was prudent and not newsworthy, we’re not hearing about them.

   As to the distinction between the level of compensation and its composition, compensation is a market-based phenomenon. I don’t hear you complaining that LeBron James makes $20 million a year, the average NBA player makes $$3,000,000, the employee who runs the marketing department makes $150,000, and the tickettaker makes $30,000. LeBron is a scarce commodity and can command that salary. CEOs, too.

6. Ed Morrison Says:
   February 11th, 2009 at 7:37 am

   Jonathan:

   I do not complain about levels of compensation. These are market decisions.

   I do question the lack of connection in our prevailing CEO culture between pay and performance.

   Your issue about the regulatory climate does not obscure the fact that accountability is largely lacking from financial service CEOs, especially in cases like Daberko.

   NCB was very poorly managed under his leadership, and Daberko paid no consequence for his destruction of a bank.

   You also mistake my point about CEOs. The CEO culture — the executive mindset fostered by both CEOs and corporate boards — has run amok in financial services.

   Let me turn to the regulatory climate. The idea that conservatives are pushing that government was responsible for this mess is simply stunning. Did government ineptitude contribute? Certainly.

   But government officials did not come up with the idea of hot wiring bad loans from inner city neighborhoods to international capital markets with opaque financial derivatives to create toxic assets that no one can now value.

   Who in government could be so ingenious?

7. J Murray Says:
   February 11th, 2009 at 10:46 am

   Ed, I’m willing to bet that Dave Daberko lost more money on National City Bank stock that any other individual. If that isn’t accountability, I don’t know what is.

   Whether the bank was poorly managed or not is still an open question. In its Q4 earnings report, PNC reported that National City’s assets were not as bad as PNC thought when it bought National City. PNC consequently reported higher earnings than expected. From what I have seen, there may have been a component of political arbitrariness in the government’s decision to abandon National City while supporting other banks. The history on this story is not closed.

   There is no question that the vehicle that brought the financial system to its knees was mortgage-backed securities invented by Wall Street. However, the systematic risk that was introduced into the system was provided by Fannie Mae and Freddie Mac and the implicit assumption–moral hazard–that the U.S. government would back those securities–which it is now doing, making the implicit assumption correct and explicit. If Fannie and Freddie had not grown so grossly, the crisis would not have happened.

   Further, the Fed put easy money into the market for so long that investors of all types–not just on Wall Street–were incented to borrow cheaply and buy hard assets like homes, land, and commercial real estate. No easy money, no asset bubble, no excess. Government caused this crisis.

8. John Ettorre Says:
   February 11th, 2009 at 11:40 am

   Whether NCB was poorly managed may still be an open question to you, J, but I can’t imagine that’s true for too many people. All kinds of intelligent people and businesses knew enough to stay the hell away from derivatives, or what the bard of capitalism (Warren Buffet) once called financial weapons of mass destruction. Only the impossibly greedy and foolish got caught up in the frenzy, and rightly got wiped out in the process.

9. Rick Pollack Says:
   February 12th, 2009 at 1:18 pm

   1) CRA was responsible for less than 10% of subprime loans.
   2) The problem with the GSEs (Fannie and Freddie) was their reckless pursuit of profit in the late 90s. They greatly expanded their captive portfolios and that is what introduced the systematic risk. They did not pile into subprime until ‘02/’03. As such, they did not create the problem but they certainly amplified it.
   3) There was an easy money policy throughout the 90s called credit cards. In the mid 90s I did contract work for the credit card unit GE Consumer Credit. One of their managers submitted a credit card application on behalf of his dog to prove the point that it was ridiculously easy to get credit. His dog was issued a card.

   Between 1993 and 1998 subprime lending increased 760 percent for home purchases and 890 percent for refinance mortgages (refis). During the same period the prime market grew at 38 and 3% for refis. A major reason for the huge number of subprime refis was credit card debt yet I don’t see you blaming the credit card industry for their easy money policy. Factor out all that credit card debt and who knows where we’d be.

   Freddie and Fannie did not “drive” the bad lending practices, they piled on the subprime wagon post 2000 just like Citi and many other well known financial institutions. If, five years ago, the CEO of Citi had said to Barney Frank we are not going to make these loans, as you suggest, he would have been sacked by his Board. Citi purchased The Associates specifically to be in that market. The vast majority of subprime lending was not a function of social policy it was done in the pursuit of profit.

10. J Murray Says:
    February 12th, 2009 at 4:13 pm

    Rick, with a bank typically leveraged 10-1–and some more than that–it only takes a small percentage of loans to go sour for its capital base to be eroded. Even today, 95% of mortgages are performing. I would be you that of the 10% from CRA, that half or so are non-performing.

    I agree with your points 2 & 3, although when people talk about “easy money” they are generally referring to Federal Reserve policy, not private credit issuers. One reason the credit card industry expanded so dramatically in the 1990’s was because enhanced credit profile modeling helped credit card issuers more accurately understand and price risk. And yes, many people rolled their credit card debt into mortgages, fuelling the housing asset bubble.

    However, Freddie and Fannie absolutely did “drive” bad lending practices. Mortgage issuers knew that the F’s would buy any junk they packaged, using any underwriting standards.

11. Mark W. "Some Guy on Bridge" Schumann Says:
    February 12th, 2009 at 4:42 pm

    Even today, 95% of mortgages are performing. I would be you that of the 10% from CRA, that half or so are non-performing.

    Once again Jonathan proves his ignorance of mathematics.

    If 10% of all loans were CRA-related–which is what Jonathan’s going with here even though that’s not the statistic Rick Pollack actually provided–and half of them were non-performing, that would be 5% of all loans.

    If that’s true, then every other loan is performing just fine for there to be 95% performance overall.

    I hope that’s not Jonathan’s argument.

    Although I suspect it’s less of a math problem than a reading comprehension issue. The actual statistic provided by Rick Pollack is that 10% of bad loans are CRA-related. I’ve found information elsewhere indicating that loans from institutions regulated by CRA have been less likely to default than those from other institutions. Now rummaging through my bookmarks to find that…

12. Rick Pollack Says:
    February 12th, 2009 at 8:47 pm

    J – Here is a recent CRA document prepared by staff at the Fed:

    “As the financial crisis has unfolded, an argument that the Community Reinvestment Act (CRA) is at its root has gained a foothold. This argument draws on the fact that the CRA encourages commercial banks and savings institutions (banking institutions) to help meet the credit needs of lower-income borrowers and borrowers in lower-income neighborhoods. Critics of the CRA contend that the law pushed banking institutions to undertake high risk mortgage lending.

    In this memorandum, we discuss key features of the CRA and present results from our analysis of several data sources regarding the volume and performance of CRA-related mortgage lending. In the end, our analysis on balance runs counter to the contention that the CRA contributed in any substantive way to the current crisis.”

    http://www.federalreserve.gov/newsevents/speech/20081203_analysis.pdf

    Does this data support or validate your assertions about CRA?

13. Mark W. "Some Guy on Bridge" Schumann Says:
    February 13th, 2009 at 8:23 am

    Jeez, Rick, there you go with facts again. You’re ruining a perfectly good emotional argument.

14. Ed Morrison Says:
    February 14th, 2009 at 8:58 am

    Interesting article in this week’s New Yorker: The Myth of Moral Hazard”.

    Compensation might explain why the theory of moral hazard matters less than its proponents suggest.

    The moral-hazard argument also assumes that the most important factor shaping corporate decisions is the interest of the company as a whole. But, more often, what’s shaping those decisions is the interest of individuals, and on Wall Street those interests are often only loosely connected to the long-term health of companies. The fact that people can reap enormous rewards for decisions that are beneficial in the short term but costly in the long term is likely to lead to reckless behavior, regardless of whether companies are bailed out or not. Even if we allow Citigroup to fail, after all, Chuck Prince, the former C.E.O., will still have walked away with a package reportedly worth more than seventy million dollars.

    http://snurl.com/bvh8l

15. J Murray Says:
    February 14th, 2009 at 9:45 pm

    Rick, as I read this study, CRA loans have performed slightly better than the worst subprime and alt-A junk–liar’s loans–put out by non-bank mortgage originators. That’s a convenient reference point if you want to advocate on behalf of the CRA program. But it’s kind of like saying that CRA junk is slightly better than other junk.

    I would like to see a comparison between CRA junk and better credit risks and mortgages by more traditional measures. I’m willing to be that CRA loans have performed signifantly worse–but of course it wouldn’t be politically correct to point that out.

    Erosion of bank capital is erosion of bank capital and to the extent that CRA loans perform more poorly than traditional loans, they erode bank capital.

    Mark, I wasn’t creating or solving a math problem, just making a point. My numbers weren’t related to Rick’s numbers except that they both use Arabic numerals.

    Ed, there’s no question that individuals operate in their self-interest. Adam Smith pointed that out three centuries ago. Well designed compensation systems–economic systems in general–should align individual incentives with shareholder gain. That clearly didn’t happen in many Wall Street companies, and in non-Wall Street companies, too. And in Congress, and unions…

16. Ed Morrison Says:
    February 15th, 2009 at 4:19 am

    Jonathan:

    I agree with you. But what should be the intervention, if any, when this misalignment creates costly consequences that must be paid by others?

17. J Murray Says:
    February 15th, 2009 at 1:15 pm

    Ed, the companies should go bankrupt and their officers, managers, and directors should be subject to shareholder and other civil lawsuits and, if criminal behavior occurred, criminal prosecution. However, if the businesses failed just because of market forces outside of their control, so be it.

    What we’re doing is funneling vast sums of taxpayer money to prop up companies that are deemed, by some career bureaucrats and elected legislators to be “too big to fail.” How do we know? We have never let them fail. This approach is artifically propping up the value of assets on bank balance sheets, and making uncertainty a center of the investment world.

    My preferred solution would be a forward-looking regulatory schema, but I fear that is an impossible goal to achieve, since legislation and the resulting regulatory agency practices are usually based on the last crisis.

    One of the clearest things I have observed in the business world is that as soon as any regulations are put in place, businesses immediately being figuring out how to maximize outcomes for themselves within the regulatory schema, and how to innovate around regulations. There are those out there (some on this forum) who will immediately be shocked and outraged by that and cry for business leaders to operate with the same intent that the legislators and regulators had when they implemented the schema. But that’s unrealistic. Businesses today are living (trying to live) inside a huge, complex regulatory house of cards that is poorly designed and serves businesses, government, and the public poorly.

18. Rick Pollack Says:
    February 15th, 2009 at 11:10 pm

    J – what the report actually says:

    “For this exercise, we focused only on zip codes right above and right below the CRA eligibility threshold (median neighborhood income of 80 percent of broader area median). As such, the only major difference between these two sets of neighborhoods should be that the CRA focuses on one group and not the other. This analysis indicates that subprime loans in zip codes that are the focus of the CRA (those just below the threshold) have performed slightly better and alt A loans in these areas slightly worse than those that are not (table 6)”

    They performed a straight subprime comparison across zip codes. It does not say, as you stated, that CRA loans performed only slightly better than the worst subprime junk. It says that in zip codes with CRA activity the subprime loans, overall, performed slightly better than subprime loans in other zip codes. You don’t know how many of the loans in a given zip code were CRA (bank) and how many were subprime (other). If the CRA loans only made up a small percentage of the overall subprime loans in those zip codes then it could mean those loans performed well.