Posts Tagged ‘risk’

Bonuses

April 9, 2010

People misunderstand bonuses. They resent them, too, but there again I resent Ant and Dec, I don’t think they should be banned (although perhaps taxed out of existence?)

I think the best way to tackle this subject is with some numbers, since facts always seem to be a bit lacking in the bonus debate. My salary is just under £75,000 per year. As long as I stay employed I can count on that, and that is the number I would be appraised on for credit-worthiness and so on. It is, I think, very high and is almost £30,000 higher than the average London salary for someone of my age and qualifications. I am always flabbergasted when I see it written down. I have never really overcome my childhood sense of money, when £1,000 seemed unimaginable. Given that when I grew up my parents were poor, money has become something which is both special and yet strangely unreal. Money, most of all, means freedom from worry.

One of the bizarre ironies of the credit crunch is that my salary was a lot less a year ago. Yup, you got it, banking is one of the few (perhaps only) industry to increase salaries in the face of the global downturn. There are a number of reasons for this.

First, some banks have been trying to take advantage of the situation and have been hiring aggressively. Barclays Capital and Nomura are the most commonly mentioned names here, but there are others. Meanwhile, organisations such as RBS and UBS have been desperately been trying to keep hold of their staff.

This has forced those organisations on the defence to increase salaries in order to keep people, and those who are poaching to offer above-market salaries. This doesn’t just apply to the superstars, but to everyone. Need a good replacement for that person who has just departed from your team? Try RBS. In turn, those organisations that are losing people will probably do a salary review and decide they need to increase salaries across the board. Those that have been poaching people will need to do the same thing – it’s not good to poach someone and then have them paid more than their peers.

Second, banks have pre-empted bonus taxes by increasing base salary. The idea is they will pay less bonus but keep people’s total compensation at the same level. So bonus taxes may well decrease bonuses, but they do cause wage inflation.

Combined, some people have done very nicely from the credit crunch; and in the light of honesty I have to number myself amongst them. Others, though, have lost their jobs (employment within the industry is still much lower) or been largely unaffected, so the love has not been shared as equally as some may indicate.

Finally, people have grown much more wary of stock options (typically forming a large portion of the bonus) since stock options in Bear Stearns and Lehman turned to dust.

On top of that base salary, my employer may choose to pay me a bonus. While no doubt I am extremely loveable, this is not a present. Nor is it a performance bonus in the traditional sense, i.e. something which is correlated to pre-agreed targets. If I do well, my department does well, my division does well and the entire business does well, then the bonus will be at its maximum. However, the employer also has a certain amount of discretion: they may not pay a bonus at all if the organisation needs to conserve cash, or they may prefer one person if their individual performance demands it, or if it is felt they may leave. There is no strict formula. Plus, the firm pays by accumulating a bonus pot over the course of the year (i.e. stashing away money from their revenue), so the pot is shared – one person gets more, then logically another gets less. Typically a zero (a donut) is a polite indication that you are no longer welcome and should consider employment elsewhere, unless the firm is doing badly, in which case everyone gets a zero.

My bonus is in the 20% to 30% of my base salary. For senior people, their bonuses will be many times their base salary.

Base+bonus = total compensation. Banks never speak in terms of the two separately. Nor does the taxman. An increase in base may even mean a decrease in bonus in order to prevent the total compensation increasing too sharply.

Put it this way: bonuses allow my employer to cut my salary. One year I may be paid one amount, the next that could be cut dramatically, the year after it may increase dramatically. The more senior the individual, the greater the proportion of their salary is in the form of a bonus, which in turn means more flexibility an employer has to trim their compensation down to the minimum.

Amongst junior employees (i.e. the vast majority) bonuses are typically viewed with some mistrust. Not that people turn them down, but no mortgage lender or credit rating agency looks at your bonus. Plus, banks will avoid increasing base salary unless they’re forced to and prefer to give salary increases within the bonus – typically so they have the option of taking it away again next year. Anyone who is smart stashes their bonus away until they have saved enough to live without a job for a few months … redundancy is a pretty sure thing in this industry. My own base salary once stayed fixed for three years in a row, although my bonus suggested very real pay rises. The fourth year my employer did badly and I got zero bonus, and the fifth, so after five years of employment I was essentially on a graduate’s salary.

This explains why RBS was so defensive of handing out bonuses to its over-performing investment bank division. To hand out a zero was both an open invitation to leave, but also would have been seen by its employees as a salary cut.

I would never argue that bankers are worth what they are paid (“worth” is such a difficult term to pin down), in the same way I wouldn’t argue about footballers’ salaries. What I would say is that the bonus is part of an unspoken deal: when times are bad we take pay cuts, when times are good then pay increases compensate for the flexibility and the previous down times. It is, in effect, an open agreement to accept unilateral compensation cuts. Perhaps we need a union?

On the other hand, perhaps it just further reflects the risk-and-reward culture of the city?

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High rolling risk and low rolling reality

March 8, 2010

Two important news stories, both of which were largely ignored:

» Hedge funds do not pose systemic risk, concludes FSA

» FSA plays down prop trading impact

Two well known villains of the finance world – hedge funds and prop traders – seem a lot less, well, villainous after the FSA did some investigation of them.

That Mr Obama seemed like such a nice man (and not a crack whore in sight)

January 29, 2010

Mr Obama seems not to like the banks. You can hardly blame him. Banks’ reaction to news that they will be prevented from trading speculatively (prop trading), cut down in size, not allowed to be too big to fail, and be forcibly separated from their retail banking arms was strangely muted. Perhaps they are in shock. Perhaps they think it’s not going to happen.

This all goes back to the concept of “casino” banks. Banks lost stackloads of money because they gambled it all away like a crack whore with a misappropriated suitcase of laundered drug money.

In reality, the casino analogy is quite neat (not so sure about the crack whore comparison though), not because investment banks are gamblers, but because they are the casino. Banks put up capital and risk money, but like any casino they should always end up on top (back to the crack whore again?) as long they keep an eye on the numbers, are careful about the risk and don’t get over-excited … which they unambiguously failed to do. In that sense investment banks and retail banks are not that different: don’t be stupid and it’s a guaranteed money-earner, get stupid and, well, credit crunch all around. Much is said of their complexity, but banks are no more complicated than, say, a hospital – an institution most people feel more than qualified to comment on.

The separation of investment bank and retail bank is a red herring. In the UK it was the retail banks (Northern Rock, HBOS, RBS) which lost devastating amounts of money, on retail business! Follow this technical detail carefully: they loaned money to people who could not pay it back. Oops! But, strangely, the massive shift in regulation could actually be good for banks. By forcing a true political conflict and getting into the detail, the banks may force some people to be on their side and, even, win an occasional debate. It could be even better for London; most US banks have a huge London presence, and it should not take much to move there. Alistair Darling will be pleased. There is even speculation that some of the banks will turn themselves into hedge funds and so side-step the regulation.

Is this a good thing? After all, banks can be destructive, but then  so can hedge funds – anyone remember LTCM?* – but then so can building societies, and car companies, and pension funds, and tulip bulb markets, and … and crack whores? Well, they’re strictly a bilateral transaction, when it comes to getting fucked on a big scale, you need larger institutions.

* Long Term Capital Management, a hedge fund that went spectacularly wrong, losing almost $5bn in 1998. There were significant fears its bankruptcy would cause a chain reaction in the markets, and so the Fed organised a bail-out, funded by, errrr, investment banks.

Goldman staff have the last laugh on bonuses

January 27, 2010

» Goldman staff have the last laugh on bonuses

They’ve called it the $30bn speech – that’s the value wiped off shares in top US companies in the minutes after President Obama announced on Thursday that he was to introduce measures to reduce the size of financial institutions and limit their ability to take on risk.

Almost without exception, big bank shares headed south on the news, with stock in Goldman falling some 8% Thursday and Friday. But Goldman staff are doubtless delighted at the effect Obama’s statement had on the firm’s shares, as the award price used for calculating the number of shares that go into individual bonus packages (as deferred equity) is thought to have been based on Friday’s close. In other words, thanks to the President’s obsession with bankers and their bonuses, Goldman staff will actually receive around 8% more stock in their bonus sacks than they would have before he opened his mouth. Such is The Law of Unintended Consequences.

It seems too neat to be true – which probably means that it isn’t. It’s a sign of our obsession with Goldman that a speech which implies the end of its business model, has its stock fall significantly and put its very future in doubt is seen as being in its favour.

Goldman says reports of CEO testimony improper

January 17, 2010

» Goldman says reports of CEO testimony improper

There are two ways to interpret Goldman Sachs’ activity here:

  • They ruthlessly and unpleasantly sold products they knew were going south
  • They hedged their position

Personally, I believe the latter. Mostly because, as a broker, Goldman’s main job is to help its clients buy or sell the assets the client wishes to buy and sell. Deciding an investment strategy is the client’s job (or their adviser, or asset manager, or whatever). Judging the quality of the assets is the job of a credit ratings agency. Obtaining the assets is Goldman’s job.

If you go to a fishmonger and want to buy salmon – and the fishmonger tells you he thinks salmon is disgusting and you’d be better off going for cod – then you may be wondering when you invited the fishmonger to lunch or asked him for advice on your menu (you may do many other things, from follow his advice or, if you are a serial killer, batter him to death [batter – food pun, ha ha] with a lump of fish, but you get my point). You want salmon, he sells you salmon. He then buys more salmon from his supplier to restock – and his activities of buying and then selling at the same time are unlikely to lead to him being denounced by, well, everybody.

The fact is, investment banking is not a commune. Some hedge fund wants to go long CDOs or the latest cool stocks? Let them. Just don’t expect the broker to do the same thing. We don’t expect our doctors to get our illness, lawyers to become a party to our contracts, estate agents to move in with us. Brokers are risk averse. They’re not going to pin their entire profits on their clients’ investment strategies or even ask them what they are. Many businesses are the same – they are there to help you buy and sell, they are not there to share your tastes. It is when those riskless businesses screw-up, like Lehman, that things get very fishy indeed.