Wall Street Comp

Sorry everyone for the hiatus. I am back on the job!

There has been a lot of discussion of Wall Street compensation over the past two weeks. Compensation that equaled 2004 levels, when the "street" had a then record year for profits, strikes many on Main Street as problematic when these firms received over $250 billion in TARP (bailout) funds because they were unable to meet the minimum required capital ratios.

Often Main Street is wrong - this time they are not. At a time when the street should be shoring up its balance sheet, and using its capital to make markets and make loans, the street paid out $18.4 billion in bonuses - or roughly 8% of its TARP funds. The firms claim that they didnt use any TARP funds to pay bonuses, but that flies in the face of a common street expression: "Money is fungible." Translation: A dollar is a dollar, and if you put money in one pocket and spend it from the other, it still has the same effect - you still are down those dollars.

The firms' answer is that if they didn't pay out these bonuses they would experience a significant defection of top talent - the dreaded "brain drain." But aren't these the same brains that got the firms into trouble in the first place?

I for one think that the "brain drain" would be a good thing. Where will they go - to other big firms? No, because they won't be able to pay up either. No, they will start new boutique investment banking firms.

Wall Street was a much better place when much of the better talent resided at these smaller, private partnerships with limited capital. In those days, firms relied on their wits instead of their balance sheets (or more rightly, their shareholders' balance sheets). In those days care of clients was paramount, not short term trading profits. And in those days, you "ate what you killed;" i.e. if you brought in business - based on your intellectual capital - you got paid well. If you didn't, well you didn't.

In recent years Wall Street has made its money by maker larger and more complex bets using the balance sheet. This is not the same thing, and quite frankly does not deserve the same level of compensation. For example, in the past, a department might get paid out 40%-60% of the profits, with the balance being paid to the partners or retained as capital. However, if you are using risk capital, it is not appropriate to get paid that way. Unfortunately, the Universal banking model has meshed the pay practices of the private partnerships with the brute force capital approach of the traditional money center banks.

In a competitive moving market, with lots of participants, the only way to make more money risking capital is to take larger & riskier bets. If you are going to get paid the same ratio for risking shareholder capital as not, then the law of large numbers kicks in and you have incentive to risk larger and larger amounts. This is in fact what happened over the last decade or so.

I really do not care what someone makes - provided he earns his living either risking little capital or his own. If he is risking shareholder capital, then compensation needs to be reigned in. The same applies to corporate CEOs. You are playing with shareholder money - you are an employee - act like it and get paid accordingly!

Andrew Ross Sorkin of the New York Times has, in a recent article, proposed that instead of decreasing Wall Street compensation, we simply pay the regulators Wall Street-like wages. That way we attract the "best and the brightest" to the regulatory side. Andy, Andy, Andy. Consider who is feeding you this nonsense - Wall Street and Private Equity houses.

Look, having the best and the brightest didn't keep Wall Street from making disastrous bets on mortgages, CDOs, and credit derivatives, and it didn't keep Rumsfeld and Wolfowitz (very smart guys) from making idiotic decisions on Iraq. Best and brightest is not the issue - the aura of being beyond reproach is the issue.

Pay bankers for performance? - sure. Pay them for risking shareholder capital ? - not so much. If bankers got paid less for risking capital than for not, believe me they would spend more time on non-capital intensive strategies.