Tuesday, January 19, 2010

A word about bonuses

It's bonus season on Wall Street and the paper's are going nuts with the news that even though the economy is in the crapper, bankers are receiving "obscene" bonuses (their quotes). I'm here to tell you all to calm down while I explain why banker's bonuses are so large and why they will, and should, stay that way.

These "bonuses" (my quotes) that you hear about in relation to Wall Street are not the same as the bonuses that you and I might receive in our regular jobs. If you work in a hardware store and do an exceptional job all year, your boss might give you a few hundred dollars as a reward for working so hard. Or you might get treated to a nice dinner. Or you might get some form of profit sharing from the company as an incentive to work hard.

Wall Street bonuses are not the same as these type of bonuses. Instead, Wall Street bonuses are VARIABLE DELAYED INCENTIVE COMPENSATION. Let's break that down:

VARIABLE - Varying. Different. Not always the same.
DELAYED - Not right now. Later.
INCENTIVE - A stimulus to promote a certain type of behavior.
COMPENSATION - The important part. What you get paid to do work.

On the surface, this sounds like a Main Street bonus, but the word 'Compensation' is the give-away. The Wall Street bonus is PART OF THE NORMAL PAY. I repeat, PART OF THE NORMAL PAY.

You and I get paid a certain amount of money and that will remain the same throughout the whole year no matter how well we perform. If we do extra well, our bosses may deign to gift us a bonus. Wall Street bankers get paid a fraction of what they're worth throughout the year and are paid the majority of their income (the 'obscene bonus') at the end of the year as part of their normal pay. So, for instance, a Managing Director who is the head of a trading desk might make $400,000/year as their base salary while receiving $5 million as a 'bonus' at the end of the year. That end of year lump sum will go up or down depending on how their trading desk performed, but the total compensation will usually fall somewhere in the range of normal compensation for the banking industry. Lest you think $5.5 million is a lot, a trading desk doing good business can easily make $50 million in profit for the bank. If you are the head of the trading desk and your efforts generate $50 million in profit, would you stay at the bank that paid you $2 million? Heck no! You'd find out what the market could bear for your services and go to the bank that paid you that amount! And a business would be foolish not to pay for someone who could make that much.

If Wall Street bonuses are regulated and/or capped, the only effect will be that the base salary of these bankers will jump greatly to match the market rate for these profit centers. And 'profit centers' are what they are. As soon as they stop making money on a regular basis, they get fired. No two ways about it. I remember when I was working at JPMorgan that a trader got canned after losing a lot of money in a bad quarter and his boss told him, "the company would have been better off if you had just stayed home the last three months". There's a limited number of seats on the trading floor and if you can't make money, and a lot of it, they'll find someone who can.

Keep in mind, that these large bonus numbers only apply to the elite traders and desks who have been proven money makers. Desks which lose money usually have their personnel fired and/or their bonuses cut drastically. And the middle tier of traders and the bottom tier of everyone else (technology workers, research analysts, custodial staff, etc...), get paid MUCH less than the top traders. Which is why the top trading positions are so coveted, of course.

So don't be too upset that some Wall Street workers are being paid this much money. They earned it. Wall Street as a whole, on the other hand, that's a different story.


ASG said...

You're not going to win this argument. This essentially is saying if somebody was only paid $2M/yr instead of $5M/yr, they wouldn't take the job. Not only that but this year part of what got Wall Street so much money was from the government so essentially the tax payers are paying for the bonuses this year.

Wolynski said...

I agree with ASG - what's wrong with even $400,000 a year? Walmart workers have made that family one of the richest in the country - do they get a piece of it? Not even a decent wage.
You're saying Wall St workers are entitled to obscene money, but no one else is.
Seeing that all banks and financial institutions went bankrupt last year, these people are damn lucky to have their jobs at all.

Jamie said...

This isn't an argument guys, it's me trying to explain how things work.

@ASG - Yes, they wouldn't take the job for $2 million a year. You know why? Because someone else would pay them more. I would take the job for $2 million, but they wouldn't offer it to me because I can't do it correctly. Trading for profit is not an easy thing and it's in high demand.

@Wolynski - Nothing's wrong with $400,000. But market forces are going to pay more for someone who's pulling in $50,000,000 in profit to a company. If you sold $50,000,000 in product for your company and they paid you $400,000 and you got 10 calls a day from other companies saying they'd pay you 10 times that to jump ship, wouldn't you do that? I'm absolutely not saying that Wall Street is entitled to anything. I'm simply saying that those who make a lot of money, deserve a lot. That goes for any industry.

Yes, a lot of banks got government money to keep their operations going, but that has nothing to do with compensation at profitable positions.

If you want to make an argument about *executive* compensation, that's something entirely different. I'm talking about the folks on the front lines of the trading desks who work for a living.

And if you think trading and sales isn't work, try being in a job where one bad week can wipe out 20 years of goodwill.

ASG said...

Jamie, its the how much more they make than the average person that causes the ire. Yes, you're right, its competition capitalism that's the motivator but that doesn't make a $5M salary any more obscene.

I heard a proposal from I think Gregg Easterbrook that a person should only be able to make a max of 100X the lowest paid guy in the company and I'm enough of a commy not to be against this idea. :)

Booby Stealz said...

"So don't be too upset that some Wall Street workers are being paid this much money. They earned it"

i understand your explanation Jamie (because thats how this a capitalistic driven society works), but listening to you justify bonuses in one of the worst economic times in history is a tough pill to swallow.

the Wall Street business (like poker) is a 0 sum game; that is, in order for one to make money, others must lose.

In the case of this past year, the every day man has been the loser. and for every bonus being paid off this year, there are hundreds of joe schmos getting laid off.

it seems to me that people who feel a sense of entitlement are living in a bubble, knowingly or unknowingly oblivious about what is going on in this country.

again, i understand that you are strictly looking at this from a business perspective and it makes sense. but saying things like its ok because they earned it, simply will not go well to the guy who just got laid off and has a family to provide for.