The CEO cult is a general problem throughout US business, but the (former) financial powerhouses took it to the worst extremes. A couple nice little articles from the current Economist; the first one has some astonishing numbers about the current year's bonuses versus the market cap for these POS operations; the second is mostly notable for this remarkable quote: It is telling that fully 79% of Wall Street workers who responded to a poll by eFinancialCareers.com said they received a bonus for 2008, despite the carnage. Almost half said they were dissatisfied with the amount received.
The bonus racket economist.com
Jan 29th 2009
From The Economist print edition
Bank incentives are all wrong
“ISN’T it funny/How they never make any money/When everyone in the racket/Cleans up such a packet.” That Basil Boothroyd poem was originally written about the movies, but it could just as well apply to banking.
In its last three years, Bear Stearns paid $11.3 billion in employee compensation and benefits. According to its 2007 annual report, Lehman Brothers shelled out $21.6 billion in the three years before, while Merrill Lynch paid staff over $45 billion during the three years to 2007.
And what have shareholders got from all this? Lehman’s got nothing (the company went bust). Investors in Bear Stearns received around $1.4 billion of JPMorgan Chase stock, now worth just half that after the fall in the acquirer’s share price. Merrill Lynch’s shareholders got shares in Bank of America (BofA) which are now worth just $9.6 billion, less than a fifth of the original offer value. Meanwhile, Citigroup paid $34.4 billion to its employees in 2007 and is now valued by the stockmarket at just $18.1 billion.
All this has reinforced the idea that banking is simply a gravy train for employees. The row over the early payment of bonuses at Merrill Lynch shows yet again that insiders’ interests come first (those to BofA staff, however, are likely to shrivel).
The case against banks goes something like this. Over the past 25 years, the cost of finance has been low and asset prices have generally been rising. That has encouraged banks to use more leverage in order to earn high returns on equity. The process of lending money against the security of assets, or trading assets with the banks’ capital, helped to push asset prices even higher. A sizeable proportion of the profits that resulted from all this activity was then handed out to employees in the form of wages and bonuses.
But when asset prices started to fall, the whole system unravelled. Banks were forced to cut the amounts that they had borrowed, putting further downward pressure on prices. The “shadow banking system”, which relied on bank finance, started to default. The result was losses that outweighed the profits built up in the good years; Merrill Lynch lost $15.3 billion in the fourth quarter of 2008 alone, compared with the $12.6 billion of post-tax profits it earned in 2005 and 2006 combined.
In effect, executives and employees were given a call option on the markets by the banking system. They took most of the profits when the market was booming and shareholders bore the bulk of the losses during the bust.
What about the efforts made to align the incentives of employees, executives and shareholders? Employees were often paid in restricted stock and thus suffered heavily when their firms collapsed; Dick Fuld, the boss of Lehman Brothers, was a prominent example. Why then were bankers not more cautious, given the risks to their own wealth?
There were two main reasons. First, their base packages (pay and cash bonuses) were sufficiently large to make them feel financially secure. That gave bankers a licence to gamble in the hope of earning the humungous payouts that would take them into the ranks of the über-wealthy. The second reason was that the bankers simply did not recognise the risks they were taking. Like most commentators (including central bankers), they thought that the economic outlook was stable and that the financial system was doing a good job of spreading risk.
Henceforth two things need to be done. The first is that the trigger for incentives (as well as the payments themselves) need to be longer-term in nature. Bonuses could still be paid annually but based on the average performance over several years; if bankers are rewarded for increasing the size of the loan book, their pay-off should be delayed until the borrower has established a sound payment record. The effect would be to claw back profits earned by excessive risk-taking.
The second is that the banks’ capital has to be properly allocated. If traders are given licence to use leverage to buy into rising asset markets, then the trading division should be charged a cost of capital high enough to reflect the risks involved.
Impossible, the banks might say: our star employees will never tolerate such restrictions. But if there is ever going to be a time to reorganise the incentive structure now must be it. A threat to quit will be pretty hollow, given the state of investment banking. And few traders will have the clout to set up their own hedge funds in today’s market conditions. In any case, the greediest employees may be the ones most likely to usher in the next banking crisis. Better to wave them goodbye and wish good luck to their next employer.
Looting stars economist.com
Jan 29th 2009 | NEW YORK
From The Economist print edition
What will it take for bankers to show a little remorse?
Reuters
Reuters
They were only little bonuses
“THE road of excess leads to the palace of wisdom,” wrote William Blake. Not on Wall Street. At a time when its erstwhile titans could do with displaying contrition, signs of hubris abound. The most glaring is the sacking by Bank of America of John Thain (pictured), Merrill Lynch’s former boss, after he rushed through generous bonus payments for his investment bankers despite disastrous losses (see Buttonwood), and the revelation he spent $1.2m refurbishing his office. Citigroup, meanwhile, has cancelled an order for a $50m executive jet, though only after flying into flak from the media and the Treasury. And, as he fights off lawsuits from angry investors, Dick Fuld, one-time leader of the now defunct Lehman Brothers, has sold his three-acre Florida estate for a princely $100—to his wife.
The recriminations over Mr Thain’s departure suggest that Wall Street’s finest were busy elsewhere when Barack Obama exhorted Americans to “set aside childish things”. While apologising for his opulent office refit, he defended the bonuses as necessary to retain talent (in this market?) and reward those unconnected to mortgage losses (whatever happened to collective responsibility?). For his part, Bank of America’s head, Ken Lewis, by now consumed with buyer’s remorse, may have known more about the handouts than he let on. His hold on his job looks fragile. Mr Thain’s role is being looked into by New York’s ever-vigilant attorney-general.
The affair could be “the last nail in the coffin” of public trust in bankers, sighs one investment-bank boss, adding that “We can now add moral bankruptcy to the financial sort.” To some, Citi’s aeroplane fiasco is equally confidence-sapping. How can a bank that owes its survival to the taxpayer think it acceptable to procure a jet that boasts “uncompromising cabin comfort” and to hold on to several others (plus a helicopter)?
The explanation may be that finance’s most recent golden age created a culture of entitlement so deep that it survives, for a while at least, even when boom turns spectacularly to bust. It is telling that fully 79% of Wall Street workers who responded to a poll by eFinancialCareers.com said they received a bonus for 2008, despite the carnage. Almost half said they were dissatisfied with the amount received.
This lack of humility could cost moneymen dear as it whips politicians and the press into an increasingly hostile alliance. The new treasury secretary, Tim Geithner, has already promised closer oversight of banks that receive public funds. Meanwhile, unearthing venality is the latest journalistic pursuit.
The loss of confidence in bankers can now be tracked. According to a financial-trust index launched this week by academics at the Kellogg School of Management and the University of Chicago, only 22% of Americans have faith in the financial system. Intriguingly, however, even fewer approve of the government’s handling of the crisis. As much as Wall Street’s erstwhile masters of the universe have helped to sully their own reputations, they remain less frowned upon than their handlers in Washington, DC. |
