How Wall Street’s Compensation-Defined Culture Fueled its Demise
By Shah Gilani
Contributing Editor
Money Morning/The Money Map Report
On the subject of executive compensation, the question addressed here is straightforward: Are Wall Street executives worth what they are paid?
As a successful former Wall Street executive, who was quite well paid, it’s a question I am qualified to answer.
And the answer is “No.”
The prevailing school of thought as espoused by those who pull down these hefty compensation packages, those who are paid to do the bidding of the well-heeled and greedy, and those that aspire to achieve the so-called “Master of the Universe” mantle, is that “we want the smartest people running these firms and in order to get them you have to compensate them or they will go elsewhere.”
In an arena where salesmanship is Job No. 1, this is the biggest sales job of all. No one is that smart.
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Here’s the truth about working on a trading desk: It’s not that hard to be mentored by professionals who teach you how to take huge risks with other people’s money and cash in when the going is good.
It’s about the culture. Which is why it is easy to now see why Wall Street’s star is falling as Washington’s is on the rise.
A Culture Defined by Deals and Compensation
Those mentors are your bosses and they take a piece of your profits. If you lose money, it doesn’t mean they lose, and if they lose money and you make money, there’s a better-than-even chance that because they’re senior to you in the pecking order, they’ll still make a lot more than you do.
So everyone tries to make as much money as they can and rise up the ladder as fast as they can. The higher you go, the more you get paid and the more secure your compensation becomes. There are always traders trying to get onto trading desks, or working to maneuver their way on to competing desks to make bigger bonuses.
There’s an underlying rule-of-thumb in the trading universe: If you’re going to fail, fail BIG. After all, it’s not your money, but it is your reputation.
In the 1980s, I was trading for an investment banking firm that applied to become a primary dealer, meaning our government desk wanted the privilege of trading directly with the New York Federal Reserve Bank, when the Fed bought and sold Treasuries on the Street.
The head government trader was “stripping” Treasuries and trading the “coupons” and “corpuses” separately. He had a great end-of-year quarter and made a lot of money in his trading account. He got a seven-figure bonus.
But there was a problem.
Half of his trades were losers and he hid those tickets in his desk. It was discovered he had lost twice as much as he had claimed to make.
He was fired. He kept his bonus. The firm withdrew its application to be a primary dealer and had to shore up its capital immediately. What happened to the trader?
He got a job within a week at The Bear Stearns Cos.
He was celebrated as being a big risk-taker. In the culture of Wall Street, it didn’t matter that he didn’t make money – or, in fact, that he’d lost money. He had the guts to trade big. That’s how perverted Wall Street can be.
The (Truly) Good Old Days
Goldman Sachs Group Inc. (GS) is a great example of how superb firms used to be run. Before it went public, Goldman was operated as a partnership. The risks that bankers and traders took were with their own money and the hard-earned capital of all the other partners.
Partners didn’t take their capital out, they weren’t allowed to. Even when you retired, you couldn’t just take all your marbles and go home. You had to leave capital in so the next generation of partners had capital, which was good for the firm. Not anymore. In the public company bank, investment bank or trading-firm model, it’s the public’s money. It’s the shareholders that get burned, not partners or employees. The pursuit of profit becomes primary to preservation of capital.
Typically, 40% to 50% of the revenue of the firms on the Street goes to the discretionary bonus pools. That’s a lot of potentially productive capital just going out the door, never to return.
That amounts to a heads-I-win/tails-you-lose business model for employees. It works well for awhile; but what happens is that as firms grow, in order to keep paying out big bonuses to keep the big rainmakers at the firm, in order to increase earnings per share, the volume of capital applied toward profit-making gets heavily leveraged.
And, as I’ve demonstrated in past columns, leverage cuts both ways. The net result of what just happened is that too much leverage was applied to insufficient capital in order to pay out big bonuses and keep the traders and bankers in their seats. If greed and compensation wasn’t such a big part of the game, more reasonable compensation packages would have left more money in the firms, where it would be available as capital. And that would have meant that there was a much greater margin of safety in the firms.
When High Pay Doesn’t Pay
When it comes to the economy itself, most of Wall Street’s highest-paid bankers and traders add very little actual value. The discernable value these folks add is actually limited to the value of their compensation, as it becomes an element of gross domestic product (GDP).
Let’s face it: That same money would better serve the economy if a large portion of it was channeled back to directly create shareholder value, to pay dividends, or even to sit on a bank’s balance sheet as “accumulated capital,” enabling that bank to to fund cheaper, lower-cost loans.
Now that’s an idea whose time has come – once again.
News and Related Story Links:
- Money Morning Deregulation Series:
How Deregulation Eviscerated the Banking Sector Safety Net and Spawned the U.S. Financial Crisis. - TheFreeDictionary.com:
Corpus. - TheFreeDictionary.com:
Accumulated Capital. - Wikipedia:
Systemic Risk. - Money Morning Week Ahead Column:
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