AskDong

I ask this question not because I have the answer.  I don’t, just some thoughts.  Given the current financial crisis, salaries and bonuses for financial workers seem awfully inflated.  Believers in efficient economic markets would argue that the high salaries in the financial world are just the product of supply and demand, and that the best and brightest are paid what the market will bear.   I don’t believe the labor market is as efficient as it could be, and I definitely do not believe the best and brightest have all become financial wizards on Wall Street.

While I think most wages are efficient.  Retail workers at one store do not differ greatly in pay from a worker at a another competing store, or differ too much even from and entry level clerical worker.  The market efficiencies breakdown higher up the income ladder, and especially in the financial world.

Those who believe that the titans of Wall Street are paid what they deserved will argue that these titans bring in the revenue.  They are not paid from money conjured from thin air.   They are paid because they make money trading, or bringing in deals.   This is true, the money is coming directly from individuals and corporations.  The problem lies with large numbers that are spread across even in larger numbers.  Individual investors hardly object to a few extra dollars a year that add up to millions for a fund and some its employees.  Nor do shareholders object when millions are turned over to the investment bank in the form underwriting fees.  The stock and bond issues are magnitudes larger.  What is a few million when we’re talking billions?  This ability to spread costs to many and funnel them to a few is at the heart of what allows Wall Street to pay itself so well.

Also if it’s truly talent that’s paid then why is that every head of Goldman Sachs has managed to do so well?  Wouldn’t we expect that they may have at some point promoted a dud?  In baseball, the top paid players are not necessarily the one’s who’ve stuck around a long time, but players who are at the top of their game.  Lloyd Blankenfein seems like a nice enough of a guy, but I do not believe he is at the top of the game.

What’s really happening at the top of the pecking order in finances and elsewhere is the operation of a micro ogliarchy.  At every level there are rtificial barriers to entry that prevent the optimal number of people from actually getting a job at that level.  Didn’t go to the right school?  Too bad, the analyst program is probably off limits.  Want to become a Managing Director?  Too bad you don’t have the right experience from bulge bracket bank.

While I believe it’s possible to overcome any of these individual obstacles to land a great a job with great pay, in total it creates aartificial limits on supply.  Of course this begs the question why any efficiently run bank would want to do this?  Wouldn’t they want to hire as cheaply possible from an over-sized pool of applicants?  Sure if they were run efficiently and without regard to precedent.   However, they are run by employees who consciencely or unconsciencely want to justify their own credentials.

Many finance people may be paid too much, but this does not mean I believe they should not be paid well.  It’s true many of the best and brightest are working in the financial industry.    And most of them have worked tirelessly to make sure that our capital markets are amongst the best in the world, and moneyis funneled into the right places. (obviously this has not worked too well in the past few years, but better days will come.)  I encourage our socieity to reward them handsomely -  as handsomely as we reward good doctors, engineers and scientists.   The problem today is that money that accrue to middling wall streeters far outstrip the financial rewards that go to even the best scientists and engineers in the world.

I feared the worst last week as Congress worked on legislation to tax not only all the AIG bonuses, but potentially all bonuses due any firm receiving government.   I was absolutely disgusted by both the bonuses, and the solution.  One week later, I find myself surprisingly pleased with the turn of events.

Cooler heads seem to be prevailing.  The tax measure was both clumsy, legally questionable, angry, and retributive rather than forward looking.   I’ve grown optimistic that this tax will not see the light of law.   The president has voiced concern, and the Senate seems to be having cold feet.

Was this the game plan all along?  I doubt it, but I do think if it were it’s actually been a worthwhile excercise.   Why?  The bonuses pail in comparison the larger bailout.   I agree with the criticism of the media for not putting the bonus to scale with the bailout.  165 million is not even close to the same as 175 billion even though they sound read awfully similar.  I would like to think Congress and the President have more important things to do than being “outraged” about what effectively is rounding error for the real problem.

As things are playing out, the outcome hasn’t been so bad.  Over 50 million has already been given back by “choice.”  I imagine more will be given back at the end of the day.  The media coverage and public shaming has more importantly served a greater purpose.   There’s no question that some “innocent” babies have been thrown out with the bathwater.  AIG financial product group consisted of more than just the shysters who sold financially disastrous CDS.  Hopefully the next time, a well paid finance person has the opportunity to negotiate of big retention because they screwed up, they’ll think again.   With any luck, the whole financial world might start asking questions on compensation and risk.

I’m not against people paid well.  I want to be paid well.  I believe in capitalism, I think those who risk their money deserve to be paid well.  I believe entrepreneurs deserve the riches they make.  I believe many good CEOs have very much earned a share of the riches that they have made.  What I don’t believe is that people should paid handsomely just because they work with large sums of money.  Effectively what’s what many people on Wall Street are paid for, to know the difference between a million and a billion.   They definitely should not be paid for taking huge risk, none of it personal.  Yet, they are.  Do some deserve to make a lot of money?  Certainly, but most do not.  Anyone can bet the bank to reap large rewards with somebody else’s money.   The scrupulous treat the money as their own and take appropriate levels of risk, but too many like the guilty at AIG bet thinking of it as the house’s money.  In AIG’s case the house has effectively been the American taxpayer.

I’ll be the first to admit I supported the federal bailout of the banks, the TARP.  I still support the bailout, but share with others concerns on oversight.   The money needs to be used wisely.  What has me aghast today however is the decision to pay hefty bonuses on the part Morgan Stanley and Goldman Sachs’ which reserved 10.9 billion for it’s bonus pool.  The total bonus pool has been cut 25-40% compared to last year.   To me that’s not enough.  I supported the bailout because I believed that the injection was necessary to keep the banks solvent, not to feed the fat cats.  If the banks are truly strapped as I believe them to be, it seems irresponsible to pay out such bonuses.   Banks to my knowledge are refusing to lend because they feel they are not capitalized enough.  If this is truly the case then all extra monies should be going to shore up the capital base.

At the same time I’m sympathetic to the position the banks are in.  There are a number of good reasons why the banks should be paying bonuses.

1. Many employees have had profitable years and have nothing to do with subprime.  Traders are acutely aware of the exact profit they make for the firm.  
2. Banks want to retain top employees.
3. Bankers are paid dispproptiantely via bonuses.  Anywhere between 1/2 and 99% of a banker’s compensation is derived from the year end bonus. 
4. Some banks did not want federal funds, but were forced to take them anyways. 

I believe in all the above to varying degrees.  Bonuses should be paid, but at fraction of the levels that are being handed out currently.   I cannot think of any other industry that would have the gall to require a federal bailout and then pay it’s employees hefty bonuses.  Up to this point I have not shared the public outrage towards the bank bailout.  I firmly believed that the bailout was necessary for the good of the global economy.  A strong banking system underpins a health economy. 

I’m not angry yet, but I have become a little irate.  Again, while I believe in all the reasons to pay bonuses, there are some solid counterpoints.

1. Yes, some employees did have a very profitable year. However, had the government allowed the bank to go insolvent, bonuses would not have been paid.  Bankers can’t always socialize the risk and privatize the profit.  
2. Given the job market, I have a hard time believing employee retention is as much of a problem RIGHT NOW as it has been in the past.  It’s not like hedge funds are having a banner year.  Some employees will leave, but I also believe that great companies succeed not purely by catering to people’s greed.  I may be naive but I believe great companies instill loyalty by doing the right thing.  The right thing now is scaling back bonuses, and compensating loyalty later when the the ship has been righted.
3. Bankers despite earning most of their compensation via bonuses still receive very healthy salaries.   Would it be the end of the day for banker making $150k a year to receive “only” a $50k bonus?
4. The last point is trickier as there are some banks who did not require federal assistance.  I doubt Goldman or Morgan Stanley to be such a bank.   Regardless given that these banks are paying out bonuses in excess of profits, it would give to reason that they might want to scale back. 

Like many other personal finance bloggers, I am curious if others are feeling the pinch of economic downturn. Almost everyone I know has had an “all hands” meeting at work.  Many of these meetings has been to calm the nerves of uneasy employees.  Still, many others have been to announce that layoffs are coming or that have come.   In my limited career of 10 years, I have witnessed my fair share of layoffs.   I saw the tech bubble crash around me.   I also experienced the ripples of the Enron collapse cascade through the energy industry.   This downturn, however, has had an auspicious start.  Few industries seem safe.  Not banking, not manufacturing, not technology, maybe health care.

So what any of us to do in these uncertain times?  There is always one investment that is always worthwhile, and that is the investment in yourself.

• Learn New Skills - these could be related to your job making you more valuable, but it could also completely unrelated.   A hobby can sometimes turn into a new career.
• Get reaquainted with a forgotten colleagues.    You might not be looking for a new job, but networking is best started when you’re not looking.
• Start working on plan B.   Doesn’t matter where you are or how you’re doing, everyone should have a plan B.
• Be optimistic.  I firmly believe that economic downturns offer unique opportunities for those who are willing to persevere.   Down markets offer great opportunity for investment.   This is when the chafe gets separated from the wheat.

Last week, I was shamelessly reading People Magazine. The Pitt-Jolie twins were the featured topic. While I may at times slavishly follow the no holds barred divorce of Christine Brinkley and Peter Cook. The twins interest me, not so much. I’m not much of a baby person in print or in the flesh.

While my interest in twins was little too non existent, my interest in how much Angelina and Brad were paid was quite a bit. Apparently they were paid $16 million for the the first pictures. I don’t think I could I pay someone to look at my baby pictures. While Jolie and Pitt are set to donate their booty to charity, this is still another example of how the haves are in the position to have more.

I’m not making a political or social comment or at least I’m not trying to, but rather attempting to emphasize how success, financial and otherwise, is a function of success. To become rich, it’s easier if you’re rich already. In the blogging world, this is apparent in the way the more popular blogs are the blogs that most easily gain readership. This is an example of the Network Effect. More generally speaking there is something like the network effect in all aspects of life. If you ask Bill Gates, I’m sure he’ll tell you that making the first billion was much harder than making the 2nd. I say this not discourage anyone, but rather to give hope.