As many readers of the Toomre Capital Markets LLC ("TCM") no doubt are aware, there is an on-going populist revolt on-going against the "fat cats" of Wall Street. The national politicians are responding to the deep-rooted anger of their constituents about how the $700 billion TARP program was urgently needed to "bail out" the major American global and investment banks. Hence, there is considerable rhetoric about "Main Street" vis-à-vis "Wall Street".
Much of the populist anger has centered on the large amount of pay and bonus compensation that the Wall Street investment bankers and traders receive, which is multiple times what professionals in other non-finance industries receive. The general thrust seems to be "What work exactly do these investment bankers do that is so special that these professionals are 'entitled' or 'deserve' to receive bonuses that are hundreds of thousands or even multiple millions of dollars?"
New York Attorney General Andrew Cuomo appears ready to proceed to beyond mere populist rhetoric. Using his authority under New York State's fraudulent conveyance legal code, he recently has written to each of the banks that have recently received capital infusions under the TARP program. He has demanded to receive information about executive compensation and how their 2008 bonus pools were calculated as well as information on the 2006 and 2007 bonus pools. He has ominously warned "We will have grave concerns if your expected bonus pool has increased in any way as a result of your receipt or expected receipt of taxpayer funds from TARP."
Partly as a result of this political pressure, the top seven executives at Goldman Sachs recently announced that each of them will be receiving no bonus at all for 2008. UBS quickly followed suit for its top executives as have Deutsche Bank AG and Barclays Plc subsequently. Other banking institutions receiving TARP funds are being pressured to likewise eliminate 2008 senior executive bonuses in the coming weeks.
With senior executive bonuses being eliminated or likely to be, the next challenge is what to do with the bonus pools for the lower levels of each of these banking institutions. Clearly, the bonus pools will shrink in size. However, the key question is by how much? Should they shrink to zero like many populists want? Or should the bonus pools be compressed only to the point where they can hope to retain their most important assets – their people? And if the latter is the objective, how much of a decline will be sufficient to prevent those "star" investment bankers and/or traders from moving to one of their competitors, a hedge fund or an asset manager?
Clearly, if Bank A pays zero percent of previous year's bonuses and its competitors pay about half of the previous year's amounts, the most talented personnel at Bank A will tend to move to competitors with better compensation, thereby hurting the future earnings prospects of Bank A. Likewise, if Bank A pays about half of the previous year's amounts and its competitors are at zero percent, Bank A will receive incredible political rhetoric and potentially legal inquiries by New York Attorney Andrew Cuomo. Hence, the board of directors and senior managements at each of these institutions are in a difficult position.
On Wednesday November 19th 2008, The Wall Street Journal printed the article Top Traders Still Expect the Cash written by Ann Davis. The sub-title of the story is "Wall Street CEOs Are Giving Up Pay, but Hotshots Are Another Story." The gist of this article is that there are a small group of Wall Street traders, primarily trading commodities, currencies and/or interest-rate products, who have had extremely profitable years and these traders expect to be compensated for excellent, if not career, years in terms of profitability.