Levels Matter: Cry Me a River Edition

Bloomberg reports:

Wall Street traders, who typically receive the fattest year-end bonuses among bank employees, are poised to suffer the biggest pay cuts as revenue at their divisions dropped an average of 12 percent so far this year.

Goldman Sachs Group Inc., the New York-based bank that makes most of its money from trading and set a Wall Street pay record in 2007, slashed average compensation 26 percent in the first nine months. By contrast, Charlotte, North Carolina-based Bank of America Corp., which employs branch managers and brokers as well as bankers and traders, raised average pay 10 percent.

Perspective people...



Source: Bloomberg

Mortimer... We're Back!

After a few years of financial service worker salaries moving closely with the broader market (it is important to note that the level remained about 30% higher), the financial services sector has seen a spike in recent months.



That didn't take long...

Source: BLS

Oligopolistic Banking System and Compensation

At this stage, most of us are familiar with the idea that compensation within the financial services industry has grown much faster than compensation outside the system. As can be seen below, this trend has largely gone uninterrupted throughout the crisis.



And while this level of compensation remains exorbitantly high across all of financial services, the lack of competition among the largest banks has caused compensation within the industry to become even more concentrated.

Before specifically detailing those firms, lets go to Wall Street Pit:

The Journal reported that based on its analysis — which includes banking giants J.P. Morgan, Bank of America and Citigroup, securities firms such as Goldman Sachs and Morgan Stanley, and exchange operators CME Group Inc. and NYSE Euronext Inc. — executives, traders and money managers at 38 top financial firms can expect to earn nearly 18% more than they did last year, and slightly more than they did in the record year of 2007.

While 18% seems like a massive jump (it is) from a level that was already too high (in my opinion), it ignores the broader issue of what has resulted from a government (i.e. taxpayer) guarantee on the downside risks of those banks deemed too big to fail... a MASSIVE increase in compensation (the joys of a "too big to fail" title for the select few).

The chart below details the compensation for all of those 38 firms, grouped here by JP Morgan, Morgan Stanley, Goldman Sachs, Bank of America, Citigroup, and "Other" (all others). BUT, slice off Citi and "other" and we can see that the remaining four make up more than 100% of that 18% jump (let it be known that the data below is not an apples to apples comparison - as Felix points out these charts don't account for the fact that JP Morgan and Bank of America have swallowed up smaller counterparts).



That said, my point is that the increase in compensation (and risk) is now concentrated among only these top banks. Bonuses at these "big four" banks are up a whopping 25% since 2007 (all other firms are down 18% since that time) and 40% since 2006 (whereas all other firms are down 2%).



For all the talk and supposed intervention, nothing has changed (actually, with these banks even more "too big too fail", things may actually be worse).

Source: WSJ / BLS

"Japanese Wages in Record Plunge"

Business Day (hat tip Credit Writedowns) with the details:

Japan's wages fell at the fastest pace on record in June as companies cut bonuses to protect dwindling profits, adding to evidence that consumers are unlikely to contribute to an economic recovery.

Monthly wages including overtime and bonuses dropped 7.1 per cent from a year earlier to 430,620 yen ($5400), the sharpest decline since the survey began in 1990, the Labor Ministry said today in Tokyo. Bonuses shrank 14.5 percent.

Source: MHLW

Deflation Alert: Wages Show Biggest Drop Since 1950's

Source: BEA

"Equal Pay Day" Still Hasn't Arrived

Yesterday, April 28th marked 'Equal Pay Day'. Imperial Valley News with the details:

“Forty-six years have passed since President John F. Kennedy signed the Equal Pay Act into law in 1963,” pointed out Congressman Filner. “And yet, in many cases, there is still not equal pay for equal work in this country.”

In 1963, when the Equal Pay Act was signed, women who worked full-time, year-round made 59 cents on average for every dollar earned by men. In 2007, women earned 78 cents for every dollar earned by men. That is progress - but it is slow progress. It means that the wage gap has narrowed by less than half a cent per year.

Men vs. Women Pay by Industry


Source: BLS

Just One of the Guys

Matt Stafford, a "pretty solid" college quarterback based solely on stats (yes, not all college stats are fluffed, so it is possible he is better than those stats) just signed a new contract IN DETROIT FOR 6 YEARS.... 72 MILLION F&CKIN' DOLLARS.

According to the AP:

Detroit desperately needs a quarterback to help turn around the NFL's first 0-16 team, which has had the worst eight-year stretch in the league since World War II, and is turning to Stafford after he was a starter in each of his three seasons at Georgia.

Looking at Matt's new salary compared to the median wage for a variety of industries in the Detroit Metropolitan area, it looks like he'll fit right into the Detroit community.



Ah... the Detroit Lions... one of the only teams (I'll throw Cincinatti and Cleveland in there) that make my J-E-T-S look good. From 0-16 to.... 2-14? At only 175x the salary of the Detroit team doctor, he is WELL worth the money!



But lets looks at the positives... maybe he can throw some of that cash GM or Chrysler's way.

Source: BLS

Merrill $3.6 Billion Bonus Breakdown

Andrew Cuomo writes Barney Frank (hat tip Paul):

Merrill Lynch's decision to secretly and prematurely award approximately $3.6 billion in bonuses, and Bank of America's apparent complicity in it, raise serious and disturbing questions.

In the letter there are details regarding the breakdown of that $3.6 billion, which I've attempted to breakout further (there is some rounding and assumptions involved, but in general it is what it is).

Total Breakdown

Average by Tier (not sure how clear this is... I couldn't think of a better way to show it)

Source: NY State

Game Theory: Why Giving the "Option" to Limit Pay Won't Work

The AP reports:

The Obama administration plans to limit pay to $500,000 a year for executives of government-assisted financial institutions in a new get-tough approach to bankers and Wall Street, a senior administration official said Tuesday.

Back in September I used the below chart to show why giving banks the option to accepting TARP money with the caveat that they must limit pay will fail (they key is the option). My guess... if this passes, many banks will simply give the bailout money back (hey, maybe that's what the Whitehouse is hoping for).

Originally posted September 26th, 2008:

Lets assume for the time being that there are only two banks; Bank A and Bank B.

The media / political pundits would have you believe the likely outcome of the bailout is the top-left box in which both Bank A and B sell risk assets to the Treasury. In this case, the result is a more regulated banking industry, with imposed limits to salary, but importantly markets clear.

Click for larger table:



HOWEVER, it is in BOTH banks interest to deviate from that.

Why? Simple. If Bank A (or B) believe the other is selling their risk assets to the Treasury; they will each be better off holding on to theirs.

Why? If the other bank sells and they hold, markets will still clear (in theory) and the bank that holds onto their risk assets can sell at the new market prices. This results in increased market share as they:

• Can pay more for talent
• Are less regulated
• Don’t have the stigma of selling to the Treasury (think of what selling portrays to the market)

This is even worse in the “real world” as all banks have the incentive to wait for other banks to sell risk assets to the Treasury to clear markets.

The likely result? The bottom right box in which no bank sells voluntarily and markets remain frozen. While there were many problems with the initial plan, at least there was a 100% incentive to sell the assets.

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.

Investment Banking Heads Made $1 Billion+

Twelve of the highest paid executives of the investment banking world that helped create the current disaster made over $1 Billion from 2003-2007.

The top paid.... Dick Fuld from Lehman Brothers who (in a leaked email) responded to an internal suggestion that he and other senior bankers forgo their bonus this year:

Don't worry -- they are only people who think about their pockets.

I guess when you rake in more than $250 million over a five year stretch, you no longer have to worry about your pockets...

Source: NY Times

The Downfall of the Investment Banking Model

Niels Jensen and Jan Wilhelmsen, of Absolute Return Partners via Infectious Greed.

What is truly disgraceful is that investment banks could only manage returns on equity of 15-25% with a balance sheet that was often leveraged to the sky.

Using Lehman as an example, below is a quick and dirty explanation as to why investment banks were "only" able to achieve 15-25% return on equity and why it wasn't necessarily "disgraceful" (on an individual bank by bank basis), but rather a function of how these banks functioned in a framework that should not have been allowed. In fact, I argue that these aggressive return targets played an integral role in the downfall of the investment banking model.

Net Income:
While Lehman's net income did in fact rise dramatically from 2003-2007, it pales in comparison to what Lehman Brothers (and others) paid their employees. In 2007, Lehman paid their employees well in excess of $300,000 per year ON AVERAGE. To see how large this was in comparison to the net income of the firm, if salaries in 2007 were at 2003 levels per employee (still $260,000+), return on equity would have been 30% instead of the 20% level reported.


Leverage:
To pay for these increased salaries and still reach their 15-25% return on equity (from a growing equity base), Lehman increasingly turned to leverage (when a firm needs to return almost $4B rather than $2B to reach their target, strategies that previously would have been turned down, are now accepted. These lower returning strategies are then amplified through leverage).

As can be seen below, this is exactly what happened. From 2003-2007 average salaries skyrocketed as banks outbid one another for new talent (more projects requires more employees), leverage increased dramatically as Lehman's went from less than 24x to 31x (and remember this is more leverage off of a larger base number), all the while return on equity wasn't able to keep up with both the increase in salary or leverage.

So do I think 15-25% is "disgraceful"? On an individual bank by bank level, I don't think so. Lehman (and other banks) had to act in this manner to survive as ALL banks acted in this low-risk (for the most part it's not their money) / high-reward environment.

The thing I find "disgraceful" is that this was was allowed to happen, as it was never really beneficial for anyone besides the bankers and was in fact detrimental to our people, economy, and country.

Fuld Will be Just Fine...

Dealbook:

Between 1993 and 2007, Mr. Fuld took home about $466 million in compensation, including base salary, bonuses, long-term incentive plan payouts and the value of stock options he exercised. That’s according to calculations from Equilar, an executive compensation research firm.

Hollywood's Most Overpaid Movie Stars

Per Forbes:

To calculate our payback figures, we took half of each film's worldwide box office (to roughly approximate the studio's cut of each ticket). Then we added the first three months of DVD revenues and subtracted the budget to derive the film's gross income. After that, the actor's total compensation (upfront pay plus any money earned from sharing in the film's profits) was divided into the gross income to get the actor's payback figure for the film. The payback for the last three movies for each actor was averaged to calculate ultimate payback. We deliberately used gross income rather than net income in our analysis because the latter figure is so easily manipulated by studio accountants, with marketing expenses treated differently for almost every film.

I just took their payback figure and inverted it to create a "salary as a percent of gross income". Not Nicole's year...

When 50 Cent is Worth $150 Million

While we're waiting for July's Producer Price Index to be released in about an hour, lets turn it over to Forbes: Hip-Hop's Cash Kings 2008 for an update on how the recession is effecting our favorite Hip Hop stars:

The new king of hip-hop wealth banked $100 million after taxes on one deal alone when his stake in VitaminWater's parent, Glacéau, was bought by Coca-Cola as part of a $4.1 billion deal. 50's portfolio also includes the popular G-Unit clothing line and record label, plus films, videogames and a slew of platinum albums, including last year's Curtis. Also in the works: a mining partnership with South African billionaire Partrice Motsepe (see "The 50 Cent Machine").

Of the top 20 Hip Hop earners, 50 Cent / Jay-Z / and P-Diddy pulled in more than half the group's combined $550mm+...

Minimum Wage

Salary by Degree

Source: Wall$treetFighter