The 1% Solution

I caught a round of discussion on Market Hype TV Monday (AKA CNBC or NewsCorp Lite) about the estimated $144 billion that will be paid out as individual compensation on Wall Street this year.

That’s 1% of our GDP…

Several talking heads said the I-bankers were being paid too much (32% of gross revenues), but also said that people should be free to get paid whatever the market will bear.

I used to talk to my television when referees made really bad calls, hence my support for the video tape review in NFL games and tennis matches.  Others try to warn ingenues in flimsy nightgowns with backlighting.  I don’t talk to the TV to warn gore flick victims not to open the cellar door, but couldn’t resist pointing out that backlit nightgowns are about as stupid a directors’ trick as oil drums with burning planks.

Still,when I saw these “experts” saying that investment bankers were paid too much, but that they should be free to get paid as much as employers were willing to pay them, I was tempted to say to the television

“Huh?  Can you really be that confused?”

Having been a player in that compensation game, albeit before it took a whopping 1% of GDP to employ those people, I have some insight about all this. I know how people make their cases to get paid as much as they can.

What it comes down to is that every person involved in any profitable transaction comes to bonus time convinced that their essential contribution is worthy of net compensation equal to 10% or more of the gross profit.  And that’s before paying the equity capital anything.  But the unspoken (or sometimes angrily shouted) threat is that the star I-banker or trader will leave to join a hedge fund, where they will get 20% of the profits and effectively none of the losses.  With that as your benchmark, 10% is “reasonable.”

Naturally, when the transaction volumes in the trading world can equal a full year of the real world’s GDP every day, the numbers get really big really quickly, even if margins are tiny.  But margins aren’t that tiny in derivatives, or in leveraged loans, or in tax-advantaged structured trades, or in private equity deals, or in leveraged leases, or a number of other activities that all those Masters of the 21st Century execute in their glass-and-granite towers.

You might think that paychecks would decrease when half the companies in a business disappear, and nearly half the people with a given skill set are laid off.  For most kinds of work, that would be true.

But Wall Street is different.  It operates with monopoly pricing, so fewer investment banks translates into higher profit margins for those who remain.  There is also the fact that bosses tend to get paid more than their underlings, so it’s easy for bosses to want to pay a lot to those underlings.  That goes all the way to the top.

I’m sure I wasn’t the only one shocked to hear that the head of the New York Stock Exchange was getting a 9-figure parting gift.  But look who was on the Board of Directors and its compensation committee.  Investment bank CEO’s.  Guys who thought they were being shortchanged if they only made $25 or $30 million in a year.  For them, Dick Grasso’s $10 million or so, compounded along the way, was just normal for a member of the CEO club in their business.  After all, his operation was an essential part of the business, albeit not a capital risking part.  Hence the paychecks that were “only” half the pay for the other members of the club.

It’s the same right down the line inside these firms.  And there’s always the hedge fund paydays to make the compensation inside the big investment banks seem reasonable.

It all reached its absurd zenith when taxpayers forked over “retention” bonuses averaging well over a million apiece to the AIG Financial Products crew, in addition to their healthy six-figure salaries.  It’s not as if they had done a good job.  They had engineered the biggest derivative losses, ever.  It’s not as if there weren’t others who knew the specialty available.  JP Morgan Chase had a full complement of derivative traders, risk managers, accountants and analysts before they absorbed Bear Stearns, the outfit with the fourth largest portfolio.  Lehman had a full load of CDS professionals, too.  In short, there were tons of people who had been taking home more than a million apiece per year in that specialty that were out of a job.  Normal economics might suggest that everyone who kept their job was about to take a whopping large pay cut.

That’s not what happened.  The pie grew, even though the number of forks dipping into it shrank.  It’s as if the derivatives traders were part of some secret union that could do to America everything the most rabid anti-union shriekers believe of the UAW, SEIU or NEA.

In short, the most powerful union in America isn’t even a union.  It manages to cost our country 1% of GDP even though the number of people in the union is far less than a million members.  Those other unions are just pathetic in comparison.  I bet the airline pilots never thought they could get higher personal compensation when airlines were going out of business and pilots were losing their jobs.  They really should have been taking lessons from the investment bankers that were advising their employers on how to restructure.

My question is this:  If we wanted Wall Street to take less risk after needing taxpayer and Fed bailouts, credit lines and guarantees that added up to trillions of dollars, why are those companies now paying more money to their employees than before the meltdown?  I thought the reason investment banks paid their people was that those employees took risk to make profits, and managed that risk prudently.  Now that they are supposedly taking less risk, why are they being paid more?  Now that there are two qualified people for every position, why aren’t pay packages declining?  Would it even make a difference if the owners of those companies stage a shareholder strike?

Something to think about here in bank earnings season, especially if you’re a shareholder.  Or if you’re a taxpayer still stinging from being on the hook to bail out these banks.

hh

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9 Responses to The 1% Solution

  1. David Ericson says:

    Howard- If any of these I-Banks end up on the hook for fraudulent securitized R and C mortgages, why won’t the payouts be considered looting in advance of the coming liabilities?

    David

    • hhill51 says:

      Salary and bonus payments are legally protected in bankruptcy cases from claims by creditors, so the principle is well-established that employees aren’t held financially responsible for their employers’ transgressions. Sad, but true. It doesn’t seem to matter whether you’re a $10 an hour checkout clerk, or a $10 million a year hot shot trader, even if you are the trader or banker that arranged the deals that failed.
      \\
      The Justice Department did try to get the guys that managed those two Bear Stearns funds that more or less started the train wreck, but they couldn’ t make the charges stick, even on them.

  2. Steve Meyer says:

    There is a contradiction in the high pay for finance pattern that
    I have never understood. If finance managers want underlings to
    get high pay then why are technology mangers doing the opposite.
    Managers are paid higher for cutting engineer and programmer
    pay (there are some blogs of layed off IBM engineers on this)
    while finance is the opposite. Even within finance, I think
    managers are paid higher for cutting even quant pay. Can you
    explain the contradiction? No wonder the US no longer makes
    anything.

  3. cg says:

    too depressing to comment on. I was hoping for Madame Defarge to come with her knitting and the pitchfork crowd to wall street but the wall street cads cleverly changed the street signs to all point to Washington DC. clever oh so clever. sigh…..

  4. Rocketman says:

    A brilliant insightful address of one of the biggest problems today that extends into every serious problem that this country has. It’s obvious that the higher ups in government now think of themselves in the same way as those CEO’s. We as a people either need to solve this problem and soon or before much longer it will be unsolveable, if it already isn’t, or it will destroy us all.

  5. dave says:

    These guys (banksters) have done way more damage to the US than AlQuaeda could ever have done in its fondest dreams – and still they get paid for wrecking the place! Amazing – they should be treated as terrorists, but… if you have money… you have friends.

  6. Fake Name says:

    I cannot risk telling you who I am but would say that the overpayment of CEO’s and Wall Street is nothing new (I have no historical reference point, however). I believe this is a good old boy network, you sit on my corporate board and I sit on yours. It has its tentacles in most of corporate America. In effect, it would be a case of skimming the cream off the top. There is likely to be some organized criminal power behind this don’t you think? Don’t you think the beneficiaries of these salaries are likely to be in collusion with one another?

    My awareness of this began in 199X, as a graduate student in a prominent university. My conversation with spooky: If I played the game I would have likely been a beneficiary of this system which was explained to me by a high level “spook.” Yes, security agency(s) are a part of all this, its not about national security however, is it? Too bad i sought something more honorable, something worthy of the name.

  7. hardrock says:

    More debt – far better to make high risk investment banks carry their own load and not dump it on the people; far better to eliminate “creative financial instruments” which trade OTC with no supervision and little hope of re-payment; far better to separate reserve banks, investment banks and insurance companies; regulation must be brought back – human beings are simply not yet evolved to the point at which they can be allowed to run free; socialized debt needs to be repatriated to from the investment houses in question; the debt is so high now, it can never be re-paid, and the real economy has been trashed to the point of non-viability. It’s time to start over – abandon world reserve currency status – bring in a new asset-backed currency; accept globalization as non-viable for now; put everything off-book on-book and pass the necessary new law to allow property rights to be restored at market value (not the bubble prices). That would mean making the people who did the securitizations responsible, for the fraud – confiscating assets and imposing jail sentences and fines – and eliminating the Fed for a typical Central Bank (under government) to re-establish US credibility in the world – short of that, Ben, shut the hell up!]

  8. Larry says:

    Your Question: ” If we wanted Wall Street to take less risk after needing taxpayer and Fed bailouts, credit lines and guarantees that added up to trillions of dollars, why are those companies now paying more money to their employees than before the meltdown?”

    Because they did not EARN the money.

    It got collected from the serfs and handed to them, basically because they said so. And since then, interest rates have been so low that the money that they are privileged to fart into existence is virtually “free” as well.

    They have been functioning in this position of privilege SO long that they actually BELIEVE that they somehow DESERVE to have lives of extravagance while the peasants around them suffer.

    Let them eat cake.

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