Which is more important: Bonuses or people?
On Wall Street, the answer is easy. No matter what the leaders of the securities industry say about cutting bonuses to the quick, it's likely to be lip service: when it comes right down to it, generous pay is what keeps Wall Street running -- and if the Street has to lay off people to pay others better, that's what it will do.
The latest evidence of this is the annual bonus report provided by the New York State Comptroller, Thomas DiNapoli. DiNapoli's report shows that the profits of the securities industry fell by half in 2011- while bonus payments dropped by a relatively modest 14 percent.***
This seems like an odd contradiction. Wall Street profits fell sharply, and we know that there were significant batches of layoffs at nearly every major bank.
So why didn't bonuses take a dive like profits did? There are two potential explanations for this apparent contradiction.
DiNapoli suggests one of them: deferred bonus payments. On Wall Street, bonuses aren't really "bonuses" -- they're salary that's based on performance, and determined at the end of the year. Banks don't pay all that money in cash; they'd go broke fast. Instead, they give out a cash salary of anywhere between $200,000 and $600,000 for the most senior people; the rest of the "bonus" is paid in stock that vests in chunks over three years.
DiNapoli suggests that this year, bonuses were cushioned by the fact that the industry paid out part of the stock they owed their people from three years ago.
Three years ago was...2009. The bonus pool that year was a lot stronger than it was in 2008, when the banking industry was on its knees, surviving on bailouts from the government and still fighting rumors about its extinction. In fact, according to DiNapoli's calculations at the time, the cash bonus pool was up 17 percent from 2008. (The 2008 bonus pool was down 44 percent from 2007). But DiNapoli's
But another explanation for the relatively modest drop in bonuses is that banks chose to spread their money among fewer people.
This seems a more likely explanation considering the scale of the numbers and the Wall Street culture.
First, the numbers. DiNapoli suggests that 2009 bonuses provided a buffer against the brutal 2011 drop in bank profits. This seems hard to support. In 2009, he estimated that cash bonuses were up about 28 percent. That was a good kick, but this year, many people would see only about one-third of those bonuses paid out. That's still not much of a financial cushion for individuals against a sweeping 50 percent drop in bank profits this year. Take into account, too, that the securities industry's profits also fell 50% between 2010 and 2011, according to DiNapoli -- that's two straight years of drops. That's a lot of financial salvation to ask of one-third of a bonus from three years ago.
On the other hand, we do know two things: The first is that Wall Street has been laying off a lot of people, and will continue to. DiNapoli's office estimated in October that Wall Street layoffs between 2008 and 2012 would number around 30,000 people, with more to come.
The other thing we know is that the linchpin of the Wall Street culture is that "your best assets leave in the elevator every night." This essential and long-held wisdom holds that the securities industry will do everything it can to pay generously the people who are perceived to bring in the most profits. The idea of limiting the pay of someone who is a good "producer" does not compute to the CEO of most financial firms. Jamie Dimon, the brash CEO of JPMorgan Chase, encapsulated this chain of thought at the bank's Investor Day yesterday. Here are Dimon's comments according to the New York Times' DealBook:
We are going to pay competitively,” Mr. Dimon told a roomful of analysts and investors at the conference. “We need top talent. You cannot run these businesses with second-rate talent.”
The translation: second-rate people get paid second-rate bonuses. High bonuses mean you're rewarding good people. There is a 1 percent within Wall Street -- the successful bankers, traders and CEOs are seen as legends who should not be subjected to the pay limits of people who are merely good, or even average.
This 1 percent -- this perceived meritocracy of the highly paid -- is the single most key concept to understanding Wall Street's incentives. On Wall Street, you're not just highly paid if you're good -- you're good if you're highly paid. There is a halo effect from a big bonus, and the securities industry is not ready to remove that aura of godliness from some of its top people.
Now, whether this idea is actually true or not is another question. Even after four years of criticism of its more rapacious methods, and changes to its structures, Wall Street has not yet reached the level of soul-searching necessary to ask whether its people are actually, really all that good. Numerous studies have shown that Wall Streeters mistake luck -- or ego -- for talent. A lot of mergers and acquisitions, struck in a blaze of glory and back-slapping, go on to be failures later. Many mutual funds barely do better than indexes of the market. It's impossible to get an idea of how many trades fail to make money -- and more likely, lose money -- because firms just don't reveal it. Wall Street pay czar Kenneth Feinberg shrugged his shoulders in 2009 and suggested that Wall Street talent isn't actually talented, and that firms should let their "talent" walk.
Even a cursory examination of the data suggests that in these challenging economic times, compensation for bank employees has become unmoored from the banks' financial performance.
But within banks, this idea is still heresy. And while it is, bonuses will stay cushioned even as profits -- and payrolls -- drop.
***A little note about methodology: DiNapoli bases his math on the personal income-tax receipts that the state collects from New York City. He tracks the entire securities industry, which includes firms that are members of the New York Stock Exchange. He does not, however, track commercial/retail banking or insurance companies or real estate. So you might see many discrepancies between his estimates and other estimates about "Wall Street" bonuses. "Wall Street" is a giant, vague concept, and although it started out describing investment banks and trading firms, it can now include everything from commercial banks to trading firms to mutual-fund managers and private-equity firms, depending on who you ask.