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You'll be hearing a lot about banker bonuses in the coming weeks. Big banks will officially report "the number," or the average total compensation per employee for 2009.
How much money are we talking about? At trading banks Goldman Sachs (NYSE: GS) and Morgan Stanley (NYSE: MS), this number could be ridiculous -- perhaps $700,000 per employee. It isn't as shocking at commercial banks like Bank of America (NYSE: BAC) and Citigroup (NYSE: C) because the total workforce is substantially larger, made up of tens of thousands of lowly paid tellers and back-office staff. In either case, average compensation masks that a few traders, executives, and department heads can literally make tens of millions of dollars (in some cases upward of $100 million). There's a good amount of skewing here.
For Goldman and Morgan Stanley, here are a few numbers to chew on:
Goldman Sachs
| Metric | 2008 | 2007 | 2006 |
|---|---|---|---|
| Revenue/Employee | $739,000 | $1.51 million | $1.42 million |
| Compensation/Employee | $364,000 | $661,000 | $622,000 |
| Earnings per Share | $4.47 | $24.73 | $19.69 |
Sources: Company filings, author's calculations.
Morgan Stanley
| Metric | 2008 | 2007 | 2006 |
|---|---|---|---|
| Revenue/Employee | $479,000 | $571,000 | $691,000 |
| Compensation/Employee | $262,000 | $340,000 | $324,000 |
| Earnings per Share | $1.45 | $2.98 | $7.07 |
Sources: Company filings, author's calculations.
In all likelihood, 2009's compensation will eclipse 2007's record. That makes people want to scream. That bankers get record pay a year after essentially failing and being saved by taxpayers seems completely absurd. And it is.
Here's my view
Prior to joining The Motley Fool, I did brief (thankfully) stints in investment banking and private equity. This was 2006-2007, when cheap money bubbled out of the drinking fountains.
At the investment bank, compensation for mid-to-upper level employees was based on deal volume generated. If you put together a $50 million merger, add that to your scorecard. Same with private equity. Private equity firms rarely sell their portfolio holdings, so yearly compensation was typically based on the size of companies purchased. If you helped acquire a $100 million business, add it to your scorecard.
In both cases, you ate what you killed. Employees were paid for performance. This is the argument bankers use to defend their pay: "Yes, we make ungodly amounts of money, but we earn it. Capitalism, my friends."
The problem with this argument is that it doesn't consider what percentage of the "scorecard" comes from bankers' skill and hard work versus factors outside their control, like monetary policy and favorable regulations.
Here's an example: 2006 and 2007 were golden years at the private equity firm. You could finance anything -- anything -- you wanted at ridiculously low interest rates. So-called "deal flow" was endless. Many, many large acquisitions were made, and record compensation followed accordingly.
But were employees earning this pay due to superior intelligence and sophisticated market insight? Ha … ha … ha. Hardly. They were riding a speculative wave of cheap money largely engineered by the Federal Reserve. A large portion of pay was based on factors they had nothing to do with.
This isn't to say bankers aren't hardworking people. There's truth to the saying, "If you don't show up on Saturday, don't bother coming back on Sunday."
But solely attributing their stupendous pay to hard work and skill is fantasy. One columnist recently opined that those decrying banker bonuses "rarely have the numerical skills necessary to put together mergers and trades." Maybe so. But do all bankers themselves have these skills? How about the highly paid mortgage traders whose 2005 models didn't even allow the possibility of declining real estate prices? We can debate whether that took "skill." In many cases, they were simply in the right place at the right time.
That brings us to 2009
Over the past year, substantially all of Wall Street's profits came from fixed-income trading. See for yourself here, here, and here. Moreover, nearly every bank's earnings came from this segment, not just a smart few.
This happened for one of two reasons: (a) Every fixed-income trader suddenly woke up in early 2009 with newfound brilliance; or (b) they're riding the largest wave of cheap money in history, financed by the Fed lending money at 0% that traders then use to buy ultra-safe government securities yielding 2%-4%. Guess which one. Furthermore, Bear Stearns and Lehman Brothers were allowed to die while others seemed chosen at random to be saved, eroding competition for the lucky survivors.
How are these factors -- all completely outside bankers' control -- accounted for when determining compensation? They aren't.
That's what's infuriating about banker pay. It isn't that they're earning mountains of money. It's that they're earning mountains of money based on factors they had nothing to do with. Other companies that employ equally intelligent and driven workers -- Johnson & Johnson (NYSE: JNJ), Google (Nasdaq: GOOG), Microsoft (Nasdaq: MSFT) -- never see that kind of advantage. The success of banking, more so than any other industry, is based on privilege rather than performance.
