According to President Obama, it is “the height of irresponsibility,” and “shameful” that Wall St paid bonsues for 2008 performance. Well, bonsues probably were too big in general, and there will certainly be some specific cases revealed (maybe Merrill) where people were paid lots for average performance as their firms went down. And I have no interest in defending the bonuses in total or at other firms as it is difficult to say what was deserved or not deserved. I happen to work for a firm that came near bankruptcy due to the actinos of few, and everyone has suffered as a result. I can sympathize with the outrage over the bonuses paid. However, I am a bit disappointed that President Obama has used such a broad brush to demonize all of “Wall St” in his remarks. It is not helpful for the American public to think that all bankers are bad or to blame, because clearly they are not, and these types of remarks lend fuel to the fire that an angry public already holds. The negative sentiment and scapegoating that this instigates is painful for those of us working in banking, but also is not healthy for our society. We ALL need to take responsobility for our actions, our expenditures, our words, etc. So I thought that I might lay out some points about what “Wall St” is and what it is not, about how people on “Wall St” get paid and a bit about how we got into the financial mess that we are in today.
- “Wall St” is made up of many different sub businesses that all are housed in these massive financial institutions (see here for a pretty good overview of investment banks). I think that when many people think of “Wall St”, they think about a Gordon Gecko type of character. Gecko was a lionized version of a deal maker who profited from buying and selling companies without regard for the social cost. There certainly may be some of these around today. For the most part, though, investment bankers that I know are people who advise companies on buying or selling assets, on raising money in the debt or equity capital markets and really on anything that falls under the purview of corporate finance. These people generally want to give their clients the best advice possible, and if things work out such that their advice is acted upon, the firm that they work for will be paid handsomely and so, in turn, will the banker be paid handsomely. For the most part, these investment bankers generated positive fee income for their employers in 2008 (actual cash flow coming into the firm). Not a lot different from a software salesperson, or car salesperson, or any type of salesperson who sold goods or services and was paid based on the income generated by those activities. A big difference with other sorts of salespeople, however, is that the majority of an investment bankers’ pay comes in the form of the end of year bonus….this is not some cherry on top, this is 70-95% of total compensation, and typically upwards of half of this amount in paid in company stock that vests over a 3-4 year period of time. This “bonus” is a 100% discretionary form of payment, i.e. not a commission based on sales targets, but there is a market for people and so bonuses have tended to be in a range across institutions. This market for people has its ups and downs, but generally the bonus is something to be counted on and therefore people plan their economic lives with the bonus in mind. This year, and certainly next, the bonus is under lots of attack. But remember, the large majority of people working on “Wall St” had absolutely nothing to do with the parts of the firm that lost lots of money. To be fair, the pay of investment bankers has likely been subsidized by profits made in other parts of the bank over the years, and some of these profits are now in question. Also, to be fair, investment bankers may have made too much money over the last 20-30 years for lots of reasons that have to do with how our economy works. But, again, like other salespeople, investment bankers have been paid based on the fact that they have generated big profits for their firms. As bankers make less money now (and almost zero money at the firm that I happen to work for), it is no different than other folks who have huge pay cuts or are let go…..houses have to be sold, expenses cut, lives rearranged. It stinks.
- The billions of losses that “Wall St” has experienced, and will continue to experience, are primarily due to securities that have home mortgages as their foundation (there are some other things, but let’s try to keep this somewhat focused). The securitization of mortgages meant that lots of money could be funneled into providing new loans to people who wanted to buy homes or for those who wanted to refinance or take equity out of their homes. This “cheap money” led to homes being bought for little or no money down and for lots of stretching to be done on the part of homebuyers and speculators (as well as for vacations getting paid out of home equity lines, and this sort of thing). This increased demand led to massive increases on the prices of homes. Everyone who bought a house that they really could not afford on their income level, or who took out a home equity line of credit to pay for a vacation or a car or some other non-capital related expense, or who sold in this period of inflated prices, has benefited from everything that is now being blamed on the banks. So we all have to take responsibility for it (and yes, I know that there were unfair and predatory lending practices, and like always those things are unethical/criminal and should be punished on both the lender/broker side and the borrower side). The point of this paragraph, however, is to suggest that the profits earned from the securitization of mortgages were created by relatively few people with the approval of management, and now same for the losses. Clearly, not all of “Wall St” was involved in making this mess. The business of advising companies on M&A and on originating loans and capital markets issuances is what lots of people on “Wall St” are involved in, and this business has been profitable to the investment banks. There are other people beyond the investment bankers advising companies as well, like sales people, research analaysts, and whole groups of traders, who all have had nothing to do with the mess that we are in today.
- The government must fess up to its role in all of this. It has been well documented that Congressional leaders like Barney Frank (with support of Senator Barack Obama and lots of others) made home ownership in this country a policy objective. The regulation / lack of regulation that made this mortgage mess possible was explicitly the result of this policy belief in home ownership for more Americans. To go along with this, the government, via the SEC, allowed investment banks to massively increase their leverage beginning in 2004 from approximately 12 to 1 up to levarage of greater than 30 to 1 (see Alan Blinder article referenced in blog entry below Summary of What Went Wrong). This meant that as asset values have come under scrutiny, the investment banks that are at the center of so much of our financial system did not have the capital available to sustain the losses. So, all of this securitization and money funneling into the home market as discussed above was instigated by governnment policy initiatives and regulatory bodies. And today, this is why TARP exists, to replenish the capital of the banks, and maybe soon to buy the bad assets from the banks to get the toxic stuff off of the banks’ balance sheets. Without the explicit approval to run investment banks at such high levels of leverage, the banks may have been able to sustain the losses that we are seeing. And banks acted irresponsibly and greedily as well, so clearly lots of blame to go around.
- For all of the homeowners out there who are throwing darts at everything and everyone around them, but looking little at themselves, I think that we all bear some of the blame as well (see a couple of references to explain this point, an article from Seeking Alpha and a nice long term Case Schiller chart). I will use my parents as the example to make a point. My Dad sells fork lift trucks and my Mom is a teacher and now principal of an elementary school. They bought their first house in about 1973 for I think $50K, a nice home outside of Hartford, CT. They traded this up once in the town, then again in 1978 on a move to the Boston suburbs and then again in 1995, and finally sold the last house in 2002 for approx. $1.1 million. That is nearly 12% annual return, pretty good compared to 8.6% annual return in the market even excluding the 2001 crash (and also does not count the benefit of tax savings, just the annualized return on what they paid to what they sold for). They were able to generate huge absolute returns on real estate and this made them wealthier. They have not retired yet, and recent losses in their retirement accounts like many people have suffered are giving them lots of anxiety about retiring. But, to be fair, they did not save that much money during most of their working lives either, like lots of other Americans, and this has contributed to their situation. They did not really make enough money to save and also provide a good experience, education, etc for their children or for themselves. So, the real estate wealth that they have is really material to their current economic situation. If not for the massive run up in home values, now viewed as unsustainable, they would be in worse shape on retirement….much worse, I think. As a banker, I had to take out a huge mortgage to afford a house like the one they sold in 2002. Even on an income that was more than double-triple their combined income, I was not even close to being able to afford the real estate that they had. How is that? Well, home prices got way ahead of the natural economy. Lots of people benefited, and not just the mortgage brokers and banks that securitized the mortgages and made profits, but people like my parents and probably lots of other Americans out there.
So, my conclusion from all of this, is really a pretty simple one. The solutions to all of our problems starts with each one of us. Maybe that sounds hokey? Maybe it is. Sure, the lack of regulation, the greed, and maybe even the very structure of our particular brand of capitalism all need to be examined and modified. But none of what we have to do is helped by mudslinging or by dodging of our own level of responsibility in this mess. Our country runs fiscal and trade deficits that enables our citizens to consume more than we produce….this is probably coming to an end or to a serious modification. So, we are all going to have to make some tough choices and maybe carve out slightly, or even massively, different lives. This is not so bad, and may even be good, though the transition could be stressful and painful. What I would hope from our new President, someone that I am proud to have voted for, is that he delivers on the promise of a new kind of political leadership. A leadership that discussus issues with the American people in the nuance that the complex topics deserve and drives us all towards constructive solutions as one nation.