Why Wall Street Bonuses Are Fair Game

Good news for Wall Street employees, compensation will likely be higher for the "fat cats." Considering the economic crisis, investment banks are doing fairly well, not like 2007 by any means, but better.

How is Wall Street pulling this rabbit out of the hat? You must recognize that investment banks’ largest expense is compensation. So, when times are lean, the Street lays off legions of workers . Then, a smaller bonus pool can be spread over fewer employees.

But, there are other forces at work. Washington democrat/liberals, who loathe capitalism, want to artificially reduce compensation on the Street because they think it is unfair. To whom is it unfair? At this point, the old “income gap” rhetoric rears its ugly head. It's as if there is a commandment or a law of nature that speaks against out-sized compensation.

What most critics of high Wall Street compensation fail to recognize is that it is based upon profitability. If a firm earns large profits, it rewards its employees with bonuses. There is nothing sinister or conspiratorial about the system. In the lean years, comp is drastically reduced to correspond to lower earnings. You can look back at salaries and bonuses of the heads of securities firms to see just how much compensation has been cut back in recent years reflecting the times.

The more fundamental question that no one seems to be interested in is how do Wall Street firms earn so much money? Several months ago, I wrote a piece that outlined the businesses of a major investment bank. Its activities cover a huge swath of finance, from stock brokerage to securities underwriting to investment management. And, all of these businesses have the potential to earn large profits.

The fact is that the services provided by Wall Street are extraordinarily valuable to its clients. Commerce and economic growth would be stymied without them. And, institutional clients of Wall Street firms are the most sophisticated in the world. They include the chief executive and chief financial officers of all the large multinational companies, hedge funds that control trillions of dollars, sovereign nations, college endowments, pension funds and private equity investors. This group is not duped by bankers into overpaying for services.

The importance of conducting a successful stock offering cannot be overstated. Very bad things can happen when the securities process breaks down. The Facebook initial public offering is a prime example of this. The missteps by the bankers in pricing the deal and distributing stock were a large contributor to the serious decline in FB stock since it went public. FB paid for quality advice and execution and did not receive them.

Similarly, clients depend upon bankers for their expertise in analyzing mergers, underwriting debt and a myriad of other services.

The bottom line is that clients pay bankers huge fees, they enable banks to earn large profits and those profits are shared with the employees for superior performance.

And yet, outsiders, liberals, say it is unfair. It is not a zero sum game. There is not a finite amount of money at stake. If bankers earn high comp, it is not at the expense of lower and middle-income people.

The latest intrusion into the free market is to limit cash payments to bankers by deferring bonuses for a very long period of time. Or more specifically, pay bankers in stock and not allow them to cash in for a five to seven year period of time.

The concept is not new; bankers have received restricted stock for years (usually it was restricted from sale for three years). It is used as a retention technique to discourage bankers from taking jobs with competitors. But now, this stock can be “clawed back” by employers if an employee does things that cause the firm to lose money or take undue risk.

The reality is that this tactic is not effective. Bankers are not motivated in this manner. If they are criminals, they should and will be prosecuted. But, bankers do not do bad deals purposefully thinking they will beat the system.

It should be noted that deferred comp resulted in huge personal losses for bankers in the years after 2007. In fact, restricted stock grants that might have represented 40-100 percent of compensation in 2007 that could not be sold for several years, were priced at near the highpoint of  the stockmarket. Since then, the stocks of all banks declined significantly. This technique did, in fact, align the interests of the employees with the stockholders. But, the 2007 compensation figures often quoted by critics of the industry are significantly overstated.

Please understand, I have no issues with banks being restricted when they are in debt to the federal government. When they are not, they should be treated like any other free enterprise and be able to determine their own compensation packages. Regulators are important to the securities business, but their focus should be on bank leverage and other financial standards to ensure that banks are safe.