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Investment bankers are overpaid
That comes straight from the mouth of Morgan Stanley Chairman John Mack. Mack is proposing an "open discussion" on compensation at investment banks.
"I still don't think the industry gets it," Mack said yesterday during an appearance in Charlotte, North Carolina. "The issue is not structure, it is amount."
Mack, who retired as CEO of the world's biggest brokerage in December, cited a 28-year-old Morgan Stanley trader whose unit had earned $300 million to $400 million for the firm. After Morgan Stanley offered $11 million in compensation, the trader jumped to a hedge fund that paid him $25 million, Mack said.
Naked Capitalism has an excellent column from Edward Harrison of Credit Writedowns on this. He explains why investment banking is so different from just about any other business:
In a normal corporate environment, there is a strict hierarchy in which those at the top earn more than those at the bottom. In order to rise to the top (and earn the salary and huge bonus - I might add), one needs to be considered successful. And that means putting in years of effort for which one receives performance reviews...
So the whole hierarchical apparatus is designed to align high achievement with other external signs of success: good evaluations, promotions, more money, more responsibility, more underlings, larger budgets, awards, and accolades and so on...
And by the way, this is how it works in commercial banking as well.
But, that's not how it works in investment banking at all. When one deal or a series of trades can mean billions in profit, even a relatively junior person can have influence on the bottom line far beyond what her title suggests. This is certainly true in the advisory business, but it is even more true in trading - especially proprietary trading, a major reason that proprietary trading is inherently risky and would be restricted under the Volcker Rule...
A slovenly 32-year old junior trader with terrible social skills, zero management ability and no one reporting to him can make millions of dollars a year. He's the guy you read about in the newspaper making three times the CEO's salary. He's the guy that all the other firms are trying to poach. And he's the guy that used to be referred to admiringly as a "big swinging dick." You don't see that at Acme Incorporated. That's what I mean when I say it's all about the money. You learn very quickly in investment banking that status is not all about the titles, it's more about the money.
But I disagree with Morgan Stanley's chairman that it's the amount of money. I believe it's the connection between the investment bank, the commercial bank, the government and the taxpayer. If investment bankers want to go play on an exchange somewhere and make piles of money gambling for or against each other, that's fine. Make all the money you want. Pay each other whatever you want.
But there should be zero connection between that activity and the commercial banks where the public keeps its money. And there should be zero connection between that activity and the taxpayer's money.
Mack is smart to propose an open discussion. Even though it may not seem like this issue will ever be resolved or disappear, I'm fairly confident that the people will eventually take their pound of flesh from the investment banks.
And it won't be pretty.
<i>But I disagree with Morgan Stanley’s chairman that it’s the amount of money. I believe it’s the connection between the investment bank, the commercial bank, the government and the taxpayer. If investment bankers want to go play on an exchange somewhere and make piles of money gambling for or against each other, that’s fine. Make all the money you want. Pay each other whatever you want.
But there should be zero connection between that activity and the commercial banks where the public keeps its money. And there should be zero connection between that activity and the taxpayer’s money. </i>
Very well said
Right. If the investment banking or any other financial activity that involves inordinate leverage more than say, 8 to then it must be hermetic like the players in a game of Monopoly. But of course the racket that has been constructed with derivatives involves wagering or arbitraging billions and leverage ratios of up to 50 to 1. Excessive leverage was at the root of the collapse of Long Term Capital Management, and is at the root of all financial crises along with excess liquidity (see Manias, Panics and Crashes by Kindleberger). As the saying goes, leverage can work for you and against you.
Investment banks tried to cope with this by inventing the notion of value at risk. As I understand it that involved calculating the worst case losses for a given day. We know how well that worked.
Neither investment bankers or anyone else should be allowed preposterously high pay especially when it does not benefit the broader economy and may well bring it down. The absurdity of the deals is that traders et al were paid as if the deals made the notional amount of money, yet whether the deals were even profitable could not be known for years. Indeed, Buffett, who characterized derivatives as weapons of mass financial destruction ended up dabbling but whether this bet will pay off won’t be known for several years.
For 2009 Goldman Sachs reportedly handed themselves $16 billion in bonuses alone for an average of $500,000 per employee. The average female worker in America makes about $34,000 annually. Since Goldman was saved by taxpayers and as a financial holding company is collecting nearly free money from the Fed’s lending discount window to finance its gambling shouldn’t the government confiscate the bonuses and use them to supplement the inadequate fiscal stimulus?
