The Plight of the Overpaid Banker

Gabe Sherman has put together an astonishing concentration of moans and whines from New York’s monied classes, and it makes for enlightening reading. You thought that New Yorkers were all liberal Obamaphiles? Well, they were — until their seven-figure bonuses started coming under attack.

The most interesting part of the piece, to me, is the way in which these professionals consider what they do to be much more valuable than what other people do:

“No offense to Middle America, but if someone went to Columbia or Wharton, [even if] their company is a fumbling, mismanaged bank, why should they all of a sudden be paid the same as the guy down the block who delivers restaurant supplies for Sysco out of a huge, shiny truck?” e-mails an irate Citigroup executive to a colleague.

As Sherman says, bankers are the last Americans to Get It: they don’t think that the excesses of Wall Street were responsible for wealth destruction rather than wealth creation, and they still think that a degree from Wharton is, in and of itself, a Good Thing. One financier essentially tells Sherman that the going rate for any job which involves being woken up in the middle of the night should be roughly $2 million a year — which is not the kind of attitude guaranteed to make you friends among, say, the farming community.

Most people outside Wall Street have come to the conclusion that excess pay was a direct cause of the current meltdown, but the highly-paid symbolic analysts at our biggest investment banks somehow have a massive blind spot when it comes to that fact. Just check out the cognitive dissonance here:

“One of my relatives is a doctor, we’re both well-educated, hardworking people. And he certainly didn’t make the amount of money I made,” a former Bear Stearns senior managing director tells me. “I would be the first person to tell you his value to society, to humanity, is far greater than anything that went on in the Bear Stearns building.”

That said, he continues, “We’re in a hypercapitalistic society. No one complains when Julia Roberts pulls down $25 million per movie or A-Rod has a $300 million guarantee… you can pick on Wall Street all you want, I don’t think it’s fair. It’s fair to say you ran your companies into the ground, your risk management is flawed—that is perfectly legitimate. You can lay criticism on GM or others. But I don’t think it’s fair to say Wall Street is paid too much.”

Of course Wall Street’s compensation structures were doubly responsible for its flawed risk management. Firstly, they created excess risks: they encouraged investment bankers to put on what I call the Rubin Trade, where you make massive bets that something with a 95% probability of happening will indeed happen. And secondly, they contributed to the marginalization of the risk-management function in investment banks: since risk managers were paid so much less than star traders and top management, they tended to get overruled a lot, and in any case be discouraged from spending too much time looking at the really important big-picture views of systemic risk.

The bankers’ belief in their own ability to make money is so unshakeable that you still hear things like this:

The most aggressive employees, those who took the greatest risks, thought of themselves less as members of a firm and more as independent contractors entitled to their share of the profits. In this system, institutions tended to be hostage to their best employees. “The feeling is, if people don’t get compensated adequately, they’re going to go out and do this on their own,” says Alan Patricof, who founded the private-equity firm Apax Partners.

Well, I hope they do. So long as they’re not gambling away trillions of dollars of other people’s money at systemically-important institutions, they’re welcome to do as they like. But if they do work at a systemically-important institution — one where the government and the economy as a whole will pay dearly if they blow up — then they shouldn’t be paid the kind of money which encourages putting on outsize risks. And the sooner they wake up to that fact, the better.

Comments

[Adam O.:]

"But I don’t think it’s fair to say Wall Street is paid too much."

I would just love to hear that guy's definition of fair.

Apr 20 12:30 PM

[just folks:]

How did these Wall Street people convince themselves of their innate superiority, and more importantly, what in their culture kept them believing it? Is it the case that Wall Street attracts only the narcissistic, or does Wall Street convert them into the Marie Antoinettes they channel? To the degree I had any sympathy for these folks before, after hearing their tantrums and threats, I have none now.

All the shrieks we're hearing from bankers is just a time-delayed echo of the shrieks from the rest of us lesser persons. Join the club, oh exalted ones.

Apr 20 01:01 PM

[Echo To All:]

the current compensation model can still work, so long as the proper regulations are in place to supress systemic risk. The domino effect will take place...

w/ proper regulation, specifically designed to supress systemic risk, an attempt toward ill gotten gains will be thwarded.

So the banker will only make 'Z' amount instead of 'Z x 33'. Then the banker can keep his/her money.

(its just that going forward it will not be multiplied due to crazy leverage... they can bitch all they want about this very important fact. Then stop working as bankers, and start working at Sysco)

Apr 20 01:31 PM

[Alan Young:]

Today's cartoon says it well (sorry I can't figure out how to post the graphic or to preserve access after today)

www.sfgate.com/cgi-bin...

Apr 20 02:37 PM

[Lilguy:]

Not banks, but pretty much the same story:

Chrysler rejected a $750 million US loan because of the limits put on executive compensation although Chrysler denies it.

Quote:

"Top officials at Chrysler Financial turned away a $750 million government loan because executives didn't want to abide by new federal limits on pay, sources familiar with the matter say.

The government had been offering the loan earlier this month as part of its efforts to prop up the ailing auto industry, including Chrysler, which is racing to avoid bankruptcy. Chrysler Financial is a vital lender to Chrysler dealerships and customers.

In forgoing the loan, Chrysler Financial opted to use more expensive financing from private banks, adding to the burdens of the already fragile automaker and its financing company.

Chrysler Financial denied in a statement that its executives had refused to accept new limits on their pay."


Here's the link: www.washingtonpost.com...

Talk about an FU!

Apr 20 08:37 PM

[D. McHattie:]

You know why these people think they're important? Because we, via our government, treat them like they're important.

Both the Bush and Obama administrations, Congress, the Senate and the Federal Reserve all act as though it would be the end of the world if a few banks went into conservatorship.

Honestly, I think a majority of the American public also has the misguided notion that the economy would grind to screaching halt if a few banks were taken over and sold to other banks.

When will we recover our self-respect?

Apr 20 09:09 PM

[JudeJin:]

it is fair until they take the risks equally! right now, it's called privatising profits and socializing losses. it is definitely not fair!

if a doctor mispractices,he'll lose his license and his income for a very long time. bankers?

Apr 20 09:48 PM

[John Lounsbury:]

We can stop worrying about big government freezing out entreprenurial growth in the real economy. The big banks have already done the job.

Apr 21 09:32 AM

[Wildhawk:]

I'm a former financial planner and investment consultant who is now a compensation consultant, so I have at least a passing familiarity with the debate. The issue at hand is one of incentive. The folks on Wall Street have the incentive to take gigantic risks on huge, one-sided bets because they have an asymetric risk-reward profile- if they pay off, they take home ungodly amounts of money, and if they crash and burn, they either face no conequences from their current firm, or worst case, leave the firm and pick up with another firm shortly thereafter, making exactly the same bets for the new firm.

While I can't speak to the apparent hubris that comes from working on Wall Street, I do think there is a very simple way to take the systemic risk out of Wall Street: change the compensation structure to tie compensation to attainment of multi-year goals, paying that compensation out over longer timeframes (e.g. 3-5 year payout at 25%-33% per year for attainment of 3 year rolling profit targets), and pay it as a mix of cash and stock. That would serve to incent longer viewpoints on trading, and keep "skin in the game" over multiple years, rather than resetting the compensation clock every year.

Couple this with an early comment I've made about making everyone who handles financial transactions fiduciaries, and you get a longer term viewpoint joined at the hip with stiff incentives for avoiding fraud and malfeasance (i.e. huge fines and jail time for those people who ignore their responsibility to comport themselves in a prudent manner).

Putting these two things together allows Congress/regulators to not have to put hard compensation limits on Wall Street (which are doomed to fail, if ever seriously considered), and creates a very simple and straightforward regulatory framework without it being overbearing, complicated and heavy-handed, and still incentivizes risk-taking and capital investment, but in a more prudent and thoughtful way.

Apr 23 09:46 AM