Finance – Page 2 – 6 am pacific

Wall Street Bonuses are Not the Real Issue

This month the biggest Wall Street companies reported their quarterly earnings. JP Morgan Chase and Goldman Sachs reported bumper earnings, Citgroup and Bank of America, not so good. But if you leave out write downs on debt, everyone had a great quarter in their capital markets businesses. Billions have been budgeted for year end bonuses.

As could be expected, the issue of Wall Street compensation raised its head again. And this time there is the weight of the federal government behind it. Banks that have taken TARP money will see their executive compensation capped. And the Federal Reserve has suggested that all large banks that fall under its jurisdiction will be reviewed on on going basis to ensure that executive bonuses do not produce risk taking behavior that could put the banking system at risk.

There are several memes that get mixed up in any discussion about Wall Street compensation in the media. Add a lot of emotion from a distraught public and it becomes for a tangled mess where the media feeds the furore but there’s no real understanding of the underlying issues. Let’s see if we can parse the issues out.

Bonuses at AIG – Who Wrote that Compensation Plan?

It’s like everyone was waiting for this. The collective anger of a nation is spewing out. The media, the government and the average citizens are outraged. AIG Financial Products (AIGFP) employees have been getting hate mail. Bloggers are talking about forcing them to forgo their bonuses by threatening to make their names public. At the root of it – $165 million in bonuses to employees at AIGFP which was chiefly responsible for bringing down AIG which was then bailed out by the federal government with a whopping $170 B.

The political heat around this is intense. The one thing I’d like to get my hands, but probably won’t, is the contract that requires AIG to pay these bonuses out.

Banks and the Dreaded N-Word

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What is it about ‘Nationalization’ that makes it such a loaded word in the US? You can spot a politically loaded word if

The media gleefully uses [word] in its headlines, the opposition in Congress and interviews.
The government refuses to acknowledge that they have any plans to [substitute with loaded word] and come up with new words to describe what they are doing.
In all this, the public has only a vague idea about what is going on.

‘Bailout’ was one such word. Remember George Bush refusing to admit that what the federal government was doing amounted to a Bailout. Here’s an earlier post of mine on Bailouts.

Well, Nationalization is the latest politically loaded word.

Expected Bonuses on Wall Street

Bonuses paid to Wall Street were 44% down from last year but still, at $18.4B were the sixth highest in history [official release]. While the state of New York wrung its hands over the lower tax revenues, President Obama called it “shameful”. Practically everyone in the media roundly criticized the fallen Masters of the Universe for untramelled greed.

Yet, some people who know what bonuses on the Street are really about wrote in partial defense of the bonuses. Felix Salmon writes

Now there are good reasons for having a bonus system: it incentivizes profitable work, and it makes it easy for banks to pay less money in lean years. But as Bookstaber writes, there’s definitely an implicit minimum bonus at investment banks — a sticky level below which it’s hard to cut bonuses any further.

There are reasons to have a minimum bonus, rather than baking that money into base pay: it’s not included in pay-rise calculations, for starters. But when banks start getting multi-billion-dollar government bailouts, it looks really bad if they then just turn around and spend a similar amount of money on bonuses.

I spoke to a friend of mine on Wall Street a few weeks back. His point amplifies what Salmon says. People adjust their standards of living – mortgage payments, kids’ schools being the big ticket items – to an expected compensation level that includes that implicit minimum bonus.

At Infosys bonuses in the sales organization did not have an implicit minimum. Or rather, the implicit minimum was zero. The bonus pool was decided based upon how well the company and the sales teams had done. Business heads were encouraged to have a high standard deviation in the bonus awards. And some folks did end up getting no bonus. We had arguments every cycle about the fairness of a zero bonus for people who may have tried but not succeeded in meeting their goals for the period. But ultimately, I believe, it was the right thing to do. It creates a performance oriented culture. It also gets folks used to the idea that there is no implicit minimum bonus.

The more difficult task is to convince high performers that their bonus will be zero because the company can’t afford to fund the bonus pool, which is the situation on Wall Street. High performing producers can up and leave if there are other opportunities in the market. My sense is that there was a bit of game theory going on on Wall Street. CEOs were probably thinking “I know I’ll look bad if I pay out bonuses this year after losing gazillions of dollars. But if I don’t and [insert investment bank names here] do, I’ll lose all my best performers to them and then when the market turns around, I’ll lose market share.”

But somehow I don’t think that’s what they were thinking. That would imply that they were thinking long-term and I don’t know how many CEOs on Wall Street can think beyond the next quarter right now.

Satyam Next Steps

India’s regulatory authorities have made a great start on the Satyam accounting fraud scandal. The two bodies that would have regulatory oversight over such a situation – the Ministry of Company Affairs and SEBI – are both playing this on the front foot. The Raju brothers the CFO have been arrested and remanded to judicial custody. The Satyam board has been sacked and very quickly a new board is being assembled. So far so good.

More on Satyam

We are where we are. The biggest corporate fraud in India’s history was disclosed by its perpetrator yesterday. Where we go from here, as I wrote yesterday, this is a test of our regulators. How they handle this crisis will determine how investors see the Indian market in the future. Frauds happen everywhere. But if in India, fraudsters go scot free or with just a slap on their wrists, we will damage the trust that investors – both within India and outside – must have to get back into Indian markets when things start looking up.

I find it hard to believe that this fraud was committed to inflate earnings. If that were the case, the Rajus would have sold at least some of their stock. Did they believe that this was going to continue forever? As others have pointed out, a 3% operating margin is very hard to believe. The downward pressures on rates in IT Services simply isn’t enough to cause that, assuming that salaries were on par with other IT Services companies. So the question is, where did all that money go?

I think Raju is doing a Madoff – taking the fall for the rest of the family. It is impossible to cook the books of a large company for this long without half a dozen people being complicit. That includes their auditors by the way – PriceWaterhouseCoopers – who must be held to account.

The way this investigation is carried out and its outcomes will be closely watched. The net must thrown wide to catch everyone involved. Follow the money and you will find them. The court cases should not drag out. Justice must be expedited with its proceedings as open to the public as is permitted. And along with the due punishment under law, we must seek disgorgement of ill-gotten gains. It would be a downright shame if at the end of this, just one person gets a light sentence and $1 Billion, or whatever part of it is truly missing, is never recovered.

I understand Merrill Lynch resigned the Satyam account. That doesn’t change the fact that they were advising Raju on the Maytas acquisition, which stank to high heaven.

I wonder what’s going on in the heads of Satyam’s clients? Well for one, every CIO of Satyam’s client companies will be wondering if the people from his company who were involved in the selection of Satyam did so entirely on the merits of their proposal. Next, he’ll be worried about business continuity. A major service provider that’s been delisted on the stock exchange doesn’t exactly give you the confidence that your systems are in safe hands.

On the other hand, this could be a great opportunity for a dirt cheap acquisition. If only we knew what their true accounts looked like.

What an amazing destruction of a company, its shareholders practically wiped out, dispirited employees who would be heading for the door if there were jobs out there and customers who are ruing the day they hired Satyam. And for what! Truly, greed has no limits.

Questions re Satyam

While I was out of circulation and not blogging (business trip and vacation) the Satyam saga was unfolding. I remained abreast of what was happening but didn’t post anything on it. It’s been well covered by other bloggers and the media in general both in India and abroad. So I won’t bother adding my opinion except to say that if India Inc. is to redeem itself, what happens from here on out is what matters. The Rajus, on the other hand, cannot redeem themselves. Nor can the independent directors, unless they publicly say that critical information was withheld from them.

But I have several questions about the whole affair. Some of them are rhetorical, others are real questions. So if you know the answers or where I can read up on material, please let me know.

Fewer Finance Jobs Isn’t All Bad

Wall Street While people in the capital markets or selling to it lament the “It’ll never be the same” nature of recent events, there is an emerging meme that says that this is perhaps a good thing.

Fareed Zakaria in a recent column in the Newsweek titled There is a Silver Lining:

Wall Street will also need to change. Paul Volcker has long argued that the recent spate of financial innovation was nothing of the kind: it simply shuffled around existing resources while contributing few real benefits to the economy. Such activity will now be reduced significantly.

The Future of a Finance Job

Even among economists and finance gurus, there is disagreement about the financial rescue package that the US Congress approved last week. A very well argued viewpoint, which does not agree with the Treasury’s plan, is here. But the one thing everyone agrees upon is that Wall Street is going to change forever.

While legislators and companies look at what this means for the economy and for their businesses, most people, particularly students who are looking at a career in Finance, wonder about what this means for them. What follows in this post applies more to developed markets like the US and Western Europe. In developing markets like India, the same trends will manifest but I expect that the effect of the underlying economic growth on the financial sector can more than compensate for it.

Bailouts and the Fog of Finance

“Bailout” was a bad word in the US to begin with. The current financial crisis and the US government’s $700 B plan to revive the market for troubled mortgage based assets have made it toxic.

What does “bailout” mean to Joe Citizen? It means that a company made mistakes and as it suffers financially, is perhaps close to bankruptcy, the federal government rides to its rescue using taxpayer’s money (“my tax dollars”) to rescue the company. To any logical person that seems unfair.

But Joe Citizen is not all logical about this. There is a lot of emotion and mental imagery involved with the current set of bailouts.