Sunday, August 9, 2009

A Tale Of Two (Wall Street) Compensation Plans

For those that believe that the Wall Street banks that borrowed billions from the government have been chastened enough to abandon their reckless behavior AND forfeit their outlandish pay packages, you should read the NY Times article linked to below.

"Rewarding Bad Actors" by Paul Krugman explains that not only are firms like Goldman Sachs preparing to pay out billions in bonuses for 2009, but also, that the profits may be coming from marginally legal activities such as high-frequency trading. With this maneuver, Wall Street banks employ powerful computers to execute trades exponentially faster than any human could possibly manage to, thereby capturing tiny spreads on millions of trades. This technique is certainly responsible, in large part, for the profits that Goldman will post.

Over at Citigroup, a small commodities trading team led by Andrew Hall has been speculating successfully enough that Mr. Hall may earn more that $100 million for 2009.

Now I'm not a communist, and I think that people who do well should be rewarded well, but what is it that these organizations are doing so well?

On the high-frequency trading side, Goldman is making an artificial market that crowds out other trades and distorts the real market dynamics. The Citigroup traders are creating similar effects in oil markets and the like, driving up prices because the oil they are trading is being warehoused in tankers, and is not getting to market until prices improve. Of course, Citigroup's machinations are directly aimed at creating that improvement.

Mr. Krugman makes a very strong argument that these activities harm America because they are pointless beyond the fact that they make money for their respective firms. Each tactic corrupts the markets' fundamental purpose. For example, the stock exchanges are intended to allocate capital to companies so that the firms can function effectively. On the commodities side, what was supposed to be a hedging vehicle for things like corn, oil and such, with the intention being to stabilize prices, Mr. Hall and others are grotesquely manipulating things so as to produce a precisely converse result.

I suppose both Goldman and Citigroup are proud that they have such smart people who can devise clever strategies to steal money. After all, I've often opined that America has become a kleptocracy, and if so, the top kleptocrats are those whom we should admire the most. Right?

I suspect that neither organization is particularly proud. Consider that Lloyd Blankfein, Goldman's CEO, sent out a company wide voicemail (who has ever heard of such a thing these days) admonishing employees to avoid spending their bonus money extravagantly (Ferraris I suppose) lest Goldman incur federal government wrath (and maybe Andrew Cuomo's too) and general public vilification. Come to think of it, why did Blankfein use archaic voicemail rather than email? It couldn't possibly be that he wanted to avoid having the press scrutinize his message, could it? Well Lloyd, they got it anyway.

The notoriously press-averse Mr. Hall is working a different plan. Apparently, he wants to get out from under Citigroup's very visible umbrella, and create a separate firm that simply pays Citigroup a hefty (49%) tithe in the future. Undoubtedly under this arrangement, Mr. Hall will make even more money with even less transparency. Nice work if you can get it!

Are these the actions exhibited by people who are proud of what they are doing? As the old gangster adage explains, "if you are going to make money, it's best if you make it in the dark."

Here's the link and I recommend that you read Mr. Krugman's analysis and draw your own conclusions.

Credit Suisse is trying (at least temporarily) a different approach. They too expect to earn sizable profits this year, but they're not paying their traders and bankers bonuses entirely in cash and/or company stock. Rather, they have established a $5B fund that holds toxic mortgages and bonds that those traders and bankers managed to accumulate.

The Credit Suisse folks eligible for bonuses, for the most part, don't like this one bit. That alone convinces me that this is the right way to go and if the responsible individuals manage to profit from the toxicity they created, more power to them. I certainly hope this sets an example for other Wall Street banks; if you create a problem then that problem is yours to fix.

Will Credit Suisse continue to use creative compensation plans in the future? I hope so, but I wouldn't bet on it. Here's the link that caught my eye:

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