Tuesday, November 11, 2008

The End of Wall Street / Investment Banking Bonus Matrix

Michael Lewis has a great article titled 'The End' in Portfolio which inspired the investment banking bonus matrix below. I wrote back in September about the Downfall of the Investment Banking Model and he goes 1000 steps further, with details that are only possible from starting out in Wall Street's epicenter in the early 1980's. While I highlight some sections of the article, I highly recommend you go and read the whole thing. He doesn't take long to dive in:

To this day, the willingness of a Wall Street investment bank to pay me hundreds of thousands of dollars to dispense investment advice to grownups remains a mystery to me. I was 24 years old, with no experience of, or particular interest in, guessing which stocks and bonds would rise and which would fall. The essential function of Wall Street is to allocate capital—to decide who should get it and who should not. Believe me when I tell you that I hadn’t the first clue.
The amazing part is that after a while, the pure and absolute ego that drives Wall Street makes those that stay feel like they deserve all this money. Even after ALL that has happened over the past year and a half, they can look you in the eye and honestly say they DESERVE another round of massive bonuses. Does the fact that they have accepted hundreds of billions of taxpayer money stop them? Of course not... every situation can be explained by the Investment Banking Bonus Matrix...

Enough of a rant... back to the article. As Lewis points out in a later passage regarding the supposed "changes" that were made on Wall Street in the 1990's:
The changes were camouflage. They helped distract outsiders from the truly profane event: the growing misalignment of interests between the people who trafficked in financial risk and the wider culture.
And he traces this misalignment all the way back to John Gutfreund, the former CEO of Salomon and antagonist of his great book Liar's Poker. John Gutfrend changed the social order of Wall Street by transforming Salomon Brothers from a private partnership into Wall Street's first publicly traded corporation. Why? By doing so:
they transferred the ultimate financial risk from themselves to their shareholders. It didn’t, in the end, make a great deal of sense for the shareholders. (A share of Salomon Brothers purchased when I arrived on the trading floor, in 1986, at a then market price of $42, would be worth 2.26 shares of Citigroup today—market value: $27.) But it made fantastic sense for the investment bankers.
And in a statement that seals my opinion on Gutfrend once and for all, he delivers this doozy:
“When things go wrong, it’s their problem,” he said—and obviously not theirs alone. When a Wall Street investment bank screwed up badly enough, its risks became the problem of the U.S. government. “It’s laissez-faire until you get in deep shit,” he said, with a half chuckle.