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News & ArtsTuesday, January 27, 2009
Economy How Wall Street Bonuses Select for Bubbles
Posted by Jonathan Golob on Tue, Jan 27, 2009 at 3:09 PM
I'm not the only one finding this report quite telling:
More Wall Street employees received bonuses for 2008 than were expecting to in October, though many remained unhappy with them, according to an online poll.EFinancialCareers.Com said about 79 percent of workers who responded to an online poll this month said they received a bonus for 2008, more than the 66 percent of respondents who expected to get a reward in October. Still, 46 percent said they were dissatisfied with their bonus.
“What it shows is the bonus culture is very deep-set in the securities industry,” said John Benson, founder and chief executive officer of the Web site, a unit of Dice Holdings Inc. “There’s an entitlement culture amongst a number of people in the industry, which I think in the current environment is very misplaced.”
Or, as Naked Capitalism cynically quipped:
In the stone ages on Wall Street, most everyone understood it was better to lodge a C performance in an A year than an A performance in a C year. Clearly, the clock is being rolled back.
The justification of the bonus culture is to promote merit. Do a better job, as measured by some metric based on short-term gain, and you are lavishly rewarded.
Let's think through the consequence of this. You're a smart and responsible trader, circa 2005. You recognize the coming collapse in the mortgage-backed securities market, and thus stop trading in them. In retrospect, this is A performance. Sadly, you're too smart. The bubble is still going. Your colleagues pouring money into the froth do way better in 2005 than you do. They get a bonus. You don't.
Fast forward to today, if you still have a job. You made the right choices, but the market has sunk into the bursting bubble. Nobody does well. It's a C year, and you don't get a bonus again. You leave finance.
Rather than thinking of the proposed restrictions on Wall Street bonuses as intentionally punitive, I'm starting to think of a ban as intrinsically beneficial, stopping a powerful incentive to follow with the crowd up the steep slope of bubbles.
1
"More or Less," the BBC's statistics show, had a recent story supposedly proving a trader would get a better bonus for imitating his C-level colleague's trades than for doing A-level trades himself.
http://news.bbc.co.uk/2/hi/programmes/mo…
http://news.bbc.co.uk/2/hi/programmes/mo…
2
One thing to consider, fair or not, is that the bonus structure is included in the salary package. You agree to take the job with the understanding that if you meet the basic job requirements, you will receive the rest of your salary as a bonus. In a bad year, though, you can discover that the money you expected is not being given to you. Among the traders and top executives, this number is enormous, especially to anyone not in that salary bracket. In the back office, both the salary and the bonus is significantly smaller, but these are both considered part of "total compensation". The bonuses, like stock option packages, are used to lure employees where the base salaries are not sufficiently competitive or are unlikely to move.
In this economy, where anyone with a job should be grateful, the complaints about bonuses are more about a perceived pay cut.
In this economy, where anyone with a job should be grateful, the complaints about bonuses are more about a perceived pay cut.
3
I'm really tired of hearing the justification "but the good people will find jobs elsewhere if we don't pay bonuses", when these "good people" have run the system into the ground. I'd love to see a ban. I'd love to see some semblance of fairness applied to compensation in general.
4
LegalDeptGirl makes a good point - it's misleading to treat bonuses as purely rewards for extraordinary performance. For whatever reason, a lot of bankers get fairly small "salaries" and fairly large "bonuses." Maybe those bonuses should be smaller, maybe there are issues with public money going to subsidize them - but cutting bonuses entirely would be arbitrary and counterproductive. If the government bailed out a restaurant, we wouldn't demand that the staff stop getting tips, because we recognize that tips are functionally part of income. Similarly with bonuses - just because they bear the label "bonus" doesn't make them something that should be slashed to zero.
5
Originally, bankers used to make maybe $40K, with an $8K bonus.
Engineers made far more.
Bankers had better learn to adjust, because non-productive uses of expensive talent (e.g. finance) should be downsized in favor of more productive uses.
The end of the Banker Boom is nigh.
Engineers made far more.
Bankers had better learn to adjust, because non-productive uses of expensive talent (e.g. finance) should be downsized in favor of more productive uses.
The end of the Banker Boom is nigh.
7
The bonuses, as currently structured, reward short term performance. Now we see that the short term performance has come with a long-term loss. Not surprising. American corporate structure in general is focused strongly on quarterly reports rather than long-term performance.
Instead of doing away with bonuses entirely, another idea would be to make bonuses based on long-term performance, rather than short term. Say, make the bonus based on an average of the last 5 year's performance, for example. That would give incentive to a longer term outlook, and would cut down on churning of employees, and would reward long-time employees over new-hires.
Instead of doing away with bonuses entirely, another idea would be to make bonuses based on long-term performance, rather than short term. Say, make the bonus based on an average of the last 5 year's performance, for example. That would give incentive to a longer term outlook, and would cut down on churning of employees, and would reward long-time employees over new-hires.
8
@2 and 4:
This is the precise problem I'm considering. If bonuses are restricted, then base salaries will go up. Great!
It's the tying of a bonus to a particular metric that causes the problem. Salaries are tied to a person, and therefore can consider things like overall competence rather than "by what percentage did his or her trades go up this fiscal year."
This is the precise problem I'm considering. If bonuses are restricted, then base salaries will go up. Great!
It's the tying of a bonus to a particular metric that causes the problem. Salaries are tied to a person, and therefore can consider things like overall competence rather than "by what percentage did his or her trades go up this fiscal year."
9
This is a problem inherent with any form of job that has a large portion of income derived from resultant work. To lash out at Wall Street is transparently an emotional reaction.
10
How's about slashing these Wall St CEOs' salaries from approximately 1,575% of their employees' annual salaries down to something a little bit lower that (I am sure) they can all still live quite well on?
11
This operates in Liberal Science as well.
If you go around shouting "Global Warming" you get a lot of funding (bonus).
If you say "well, the evidence isn't solid" you become a bottle washer.
If you go around shouting "Global Warming" you get a lot of funding (bonus).
If you say "well, the evidence isn't solid" you become a bottle washer.
12
@4 I doubt the salaries are actually small, but they are smaller, or more stagnant, than these traders would have wanted. They are used to a very high standard of living, even if most of the pay it comes as a yearly windfall. Anyone earning that much isn't living paycheck to paycheck. These are people who have room to scale back their personal finances. They should see a drop in bonus, especially if they worked in a risky business area.
I agree that the pay structure needs to change overall, though. Just like we learned not to accept stock options after the dot-com bubble burst, employees need to negotiate for base salary, and not promised bonus.
I agree that the pay structure needs to change overall, though. Just like we learned not to accept stock options after the dot-com bubble burst, employees need to negotiate for base salary, and not promised bonus.
13
@11,
No, if you say the evidence isn't solid, you get oodles of cash from right-wing think tanks, and, unlike in real science, you don't have to provide any results with that cash -- it can go directly towards lining your pockets.
No, if you say the evidence isn't solid, you get oodles of cash from right-wing think tanks, and, unlike in real science, you don't have to provide any results with that cash -- it can go directly towards lining your pockets.
14
Jonathan, thank you for referencing Naked Capitalism. I started reading it several months ago after seeing it on Slog's blog roll, and now it's one of my first sources for economic information. I don't understand a lot of the technicalities, but Yves Smith & Co. definitely know where the bodies are buried, and they don't shy away from pointing them out. The comments are as intelligent as the posts themselves and well worth reading. Thanks for pointing me towards this.
16
Bonuses should be taxed separately from income at about 85%. 99% of the people do not get bonuses (a lot of them don't even get Holiday parties).
17
Or to put it another way, imagine two banks. One pays its employees $100,000 a year, and the bonuses range from $300,000 to $500,000. The other bank pays its employees $400,000, and the bonuses range from $0 to $200,000.
Now we enact the Golob ban on bonuses, because it's obviously unfair to pay bonuses to employees of poorly-run companies. As a result of the new fairness on Wall Street, some bankers now earn $100,000 and other bankers earn $400,000, based on the happenstance of what their employers decided to call their income.
And in reality, bankers earn very little in base salary. I know of no one who would work for a bank without a significant bonus or the prospect of significant bonuses in the future. Which is fine, as long as you don't think we'll need banks in the future.
So anyway, by all means salaries should be smaller than they were previously, and maybe the entire system needs to be rethought (so that, for instance, bonuses can be clawed back if they were based on bad deals in the first place). But banning bonuses is either cosmetic (relabel them as salary) or disastrous.
Now we enact the Golob ban on bonuses, because it's obviously unfair to pay bonuses to employees of poorly-run companies. As a result of the new fairness on Wall Street, some bankers now earn $100,000 and other bankers earn $400,000, based on the happenstance of what their employers decided to call their income.
And in reality, bankers earn very little in base salary. I know of no one who would work for a bank without a significant bonus or the prospect of significant bonuses in the future. Which is fine, as long as you don't think we'll need banks in the future.
So anyway, by all means salaries should be smaller than they were previously, and maybe the entire system needs to be rethought (so that, for instance, bonuses can be clawed back if they were based on bad deals in the first place). But banning bonuses is either cosmetic (relabel them as salary) or disastrous.
18
@8 (Golob): Who cares what you call the income? There's no law that says that "bonuses" have to be short-sighted but "salary" can be based on overall competence.
@12: I'm not a banker, so I don't really know, but I think most bankers earn mid-to-high 5 figures in base salary. That's decent, but it's not great on an hourly basis, and bankers tend to live in very expensive cities where $50,000 is not even middle class (it would be very difficult to raise a family on $50,000 in NYC, for instance). There is no fucking way anyone with a college degree would work the hours they work if the only compensation were the base salary.
@12: I'm not a banker, so I don't really know, but I think most bankers earn mid-to-high 5 figures in base salary. That's decent, but it's not great on an hourly basis, and bankers tend to live in very expensive cities where $50,000 is not even middle class (it would be very difficult to raise a family on $50,000 in NYC, for instance). There is no fucking way anyone with a college degree would work the hours they work if the only compensation were the base salary.
19
Don't ban bonuses - just make them non-deductible for the banks, declared on the public forms in large print, and tax them heavily on receipt.
Say about 70 percent, which is what people paid when we last fought two wars if they made a lot.
Say about 70 percent, which is what people paid when we last fought two wars if they made a lot.
20
@8 - Employers like bonuses because it gives them a hedge to avoid paying out a full salary if they have a bad year. With a higher base salary, the employer has no wiggle room and might be less willing to risk hiring someone.
I think @2 and @4 are correct. Often, "bonus" is basically code for "deferred salary", and it's deferred until the employer makes sure they can afford it at the end of the year. In this case, the metric that it's tied to is "how much money is left over at the end of the year?"
Rather than focus on bonuses, isn't the problem the direction that management leads these investment firms? If the boss says "Jump!", the employee that jumps the highest will get the biggest bonus. If jumping was a bad idea, then blame the boss, not the employee who performed as directed.
I think @2 and @4 are correct. Often, "bonus" is basically code for "deferred salary", and it's deferred until the employer makes sure they can afford it at the end of the year. In this case, the metric that it's tied to is "how much money is left over at the end of the year?"
Rather than focus on bonuses, isn't the problem the direction that management leads these investment firms? If the boss says "Jump!", the employee that jumps the highest will get the biggest bonus. If jumping was a bad idea, then blame the boss, not the employee who performed as directed.
21
I'm on furlough this month (unpaid), following an earlier salary reduction. A lawyer-friend of mine was relating that a colleague of his was (horrors!) deprived of both a bonus AND an expected pay raise. No sympathy from me - I'd rather go to work and get money than sit at home unpaid.
22
#16 - Bonuses are taxed at a higher rate than income, more than half is directly deducted by the feds, and could still count as income, despite having only seen half of it. There's also fairly low caps on how much you can divert into tax-exempt retirement accounts (I've learned to put 100% in 401k, despite a losing portfolio, I'm coming out way ahead this way). Even though my bonuses are about 15% of my salary, it's not the kind of salary that forgives this scenario. (what's always killed me is that Fed flat tax on bonuses is supposed to be 25%, CA takes another 9.3%, yet you'll never see as much as 45% of your bonus. It's somehow an accepted fact - can someone enlighten me on the math here?)
Of course, I'm not making $150,000 bonuses. Which is what some 2nd year Analysts make on top of their $50,000 salaries (in a decent year - which was every year until 2008 - some bonuses will ONLY be in the $50k range). Those kids will be just fine, even though half of them will be/have been laid off, or not replaced at the end of their program. I still can't sympathize too much, it's people in the middle that get screwed the most, and people at the bottom that hurt the most. I think a better solutions is to tax bonuses with a bracketed solution similar to income, but with a higher take.
Ahhh... to be "middle class", and about 300% below the income for home (or condo, or TIC, or box, or plot of grass) ownership. What am I blabbing about? Ah, whatever, at least the weather here is pretty decent, and I can afford to eat out once in a while, things ain't so bad.
Of course, I'm not making $150,000 bonuses. Which is what some 2nd year Analysts make on top of their $50,000 salaries (in a decent year - which was every year until 2008 - some bonuses will ONLY be in the $50k range). Those kids will be just fine, even though half of them will be/have been laid off, or not replaced at the end of their program. I still can't sympathize too much, it's people in the middle that get screwed the most, and people at the bottom that hurt the most. I think a better solutions is to tax bonuses with a bracketed solution similar to income, but with a higher take.
Ahhh... to be "middle class", and about 300% below the income for home (or condo, or TIC, or box, or plot of grass) ownership. What am I blabbing about? Ah, whatever, at least the weather here is pretty decent, and I can afford to eat out once in a while, things ain't so bad.
23
#18 - you touched on another point a lot of people might not be aware of. 100 hours a week is the minimum for anyone less than executive level in banking. Without an obscene bonus, there isn't much motivation for this. The price of business school is practically built in to this scenario.
Still, the industry probably needs big changes, from the top, down.
Still, the industry probably needs big changes, from the top, down.
24
@22: I don't know about California, but for federal purposes bonuses are simply taxed as income. (In the voice of George Bluth: "I have the worst fucking accountants...")
25
#24 - actually, asking this question out loud had me looking this stuff up, and actually answered some of the mysteries for me, but for the life of me couldn't explain to someone asking me the same question.
http://www.thestreet.com/funds/taxforum/…
http://www.thestreet.com/funds/taxforum/…
26
@25- Bonus = Income.
It's withheld (not taxed) at a higher rate because it's as if you made that much money on each paycheck, and a large bonus check most likely bumps you up a few tax brackets (for that week anyway).
However, at the end of the year, it's all lumped together, and you have one income figure. This is what you are taxed on. If too much was withheld, then you will get it back as a tax refund when you file your return. If your bonus is at the end of the year, then you won't have to wait long.
It's withheld (not taxed) at a higher rate because it's as if you made that much money on each paycheck, and a large bonus check most likely bumps you up a few tax brackets (for that week anyway).
However, at the end of the year, it's all lumped together, and you have one income figure. This is what you are taxed on. If too much was withheld, then you will get it back as a tax refund when you file your return. If your bonus is at the end of the year, then you won't have to wait long.
27
Back to Golob's point... which is that if you set up a structure that appears to reward people for short-term performance, you get crap in the long-term. Any system that changes that has the potential to reduce the chances of a bubble.
29
Golob! Why don't you post more?? Slog needs more scientific thought to balance all the art/philosophy BS that gets flung around all the time.
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