Money in (and from) the Bank
February 1st, 2010 | 
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Stanley Bing, an often insightful contributor to Fortune Magazine, wrote a very interesting blog post last week in regards to banking compensation. He cites an article in the NY Times that said, “Roughly 90 cents out of every dollar that these banks earned in 2009 — and sometimes more — is going toward employee salaries, bonuses and benefits, according to company filings.” The paper also notes that Citigroup “paid its employees so much in 2009 –$24.9 billion — that the company more than wiped out every penny of profit.” There has been a lot of outrage over banking institutions who took TARP money paying such exorbitant salaries and bonuses…but is it really a bad thing?
Bing goes on to suggest that the dichotomy between actual compensation and opinion on it (aside from know-nothing middle America who is just jealous) has to do with a battle between shareholders vs. employees. He goes on to talk about why salaries, benefits and bonuses are structured the way they are, and therefore, why we shouldn’t be so upset about it. But I’d like to take one particular phrase he mentions and run with it:
“In fact, as much as shareholders like to see the value of their investments grow, we like to see our salaries do the same…..Nobody gets all outraged if investors garner huge rewards on securities of companies that are otherwise doing a lousy job, or for that matter make a killing enterprises by shorting them”
The people who complain about TARP recipients overcompensating their employees with “our” (i.e. taxpayer) money miss the point completely. If they didn’t compensate those employees (who as Bing correctly points out expect bonus money as part of their overall compensation structure…and have since they signed on with the firm, unlike corporate America’s bonus recipients who just hope and pray for one each year) with significant bonuses, those talented employees would elect to work for a competing bank or firm who was willing to compensate them for their efforts. Without such talent, the same TARP-recipients would suffer even more. Their losses would likely be greater, shareholders would lose even more money, and we the taxpayer would likely have a much larger bailout request from the bank!
Let me give you a real estate investment banker analogy. We typically make money as a percentage of the capital we raise for a client. We are typically compensated at closing (as opposed to our client having to come out of pocket). As a result, technically the lender on any given deal is the one paying us (our client pays us, but they use loan proceeds to do so). So whining about employee compensation would be tantamount to the bank complaining about having to pay us as investment bankers on the transaction. But what they would fail to understand is that without our effort, such a transaction would have never come to fruition. They wouldn’t have had this opportunity to lend money presented to them, and our client wouldn’t have sourced the capital they needed for their asset.
Likewise, without properly compensating their employees (which may seem egregious on the surface to many folks), banks wouldn’t be able to do what they do. And if they weren’t able to do what they do, this would impact the capital markets, the taxpayers, and everybody else a lot more negatively than they have thus far.
I am sure there are those of you out there who completely diagree with me regardless of my cogent argument above. I welcome you to tell me why I am wrong with a comment. Bring it on!
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I respectfully disagree. Almost every one of these banks is benefitting even still from free (to them) government guarantees on their debt. This even includes Goldman Sachs. That’s on top of TARP money that most of them received, including all the large banks. And most of them benefitted from 100 cents on the dollar payouts from AIG (cost to taxpayer over $150 billion to date) and Fannie and Freddie (cost to taxpayer now up to $400 billion) and others.
I believe that financial institutions that benefit from government subsidies, including FDIC guarantees, should have a very large equity base. Bear and Lehman were debt-funded 30 to 1. I think it should be more like 3 to 1 – that’s still 75% debt to asset value, a ratio all commercial real estate owners would love to see today. Until a financial institution has that large an equity base, the compensation decision is not just between its shareholders and employees as you’ve stated. The third party in the room is the US government (you, me and the rest of the taxpayers). Until that equity base is there, the risk that one of these institutions could fail is too great to permit unfettered 7, 8 and even 9 figure compensation figures (6 figures is fine with me). The only fetter I ask is that any compensation over $1,000,000 be paid in stock. Some would have that be restricted shares. I’d say, maybe for some of it, but I’m not really concerned if it’s sold. Sold or not, it’s deleveraging the institution and that’s what matters to the taxpayer. I’d also add that until an institution is de-levered to the 3 to 1 ratio, it should be prohibited from paying dividends or buying back shares. Neither the owners nor the employees should extract any cash from the entity until the 3 to 1 leverage ratio is obtained.
Bill…great insights. Part of me wants to say “touche” and leave it at that. From a policy perspective, I think you might be on the right track. The issue of course is, last year, and even now, what would happen if you told banks who were leveraged 7, 10 or 20 to 1 that they had to be 3 to 1 before they could pay dividends? Would you invest, short term in a company that was given that mandate? Wouldn’t their stock price get creamed as a result, causing further turmoil short-term? How do you propose staving off such a scenario, or do you feel that such a fate is deserving no matter what the consequences?