Are the Good Times Really Back On Wall Street?

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Your 401(k) balance might be stuck somewhere south of the border and the stock market might still be off 40 percent from the post-bubble high, but in recent days the headlines have been about big profits and bonuses making a quick comeback on Wall Street and in European financial capitals.

Based on financials from two quarters, analysts estimate that Goldman Sachs, fresh from repaying its government bailout money, will dole out $20 billion in salary and bonuses this year, an average of $700,000 per employee, while Morgan Stanley's compensation will range between $11 billion and $14 billion--in the neighborhood of $300,000 per employee. Executive recruiters quoted in news stories are claiming ‘it's like 2007 all over again' as firms dangle big upfront pay packages to lure top talent into the fold, or to keep it from going elsewhere.

There's nothing like a few headlines about big Wall Street bonuses to get the blood boiling, or the talk going in Washington about legislation to limit executive compensation. But don't get your blood pressure up just yet (or your hopes, if you work on Wall Street). While a few firms left standing after the 2008 slaughter are well-positioned to capitalize on big shifts in global trading patterns, and a few star players will get rewarded for their uncommon expertise, the financial industry is in for a tough slog that makes talk of big bonuses for some seem mostly besides the point.

For one thing, Wall Street's fortunes really are tied to Main Street over the long term, which means that it's hard to imagine a sustained boom in financial markets when national unemployment is in double-digits (where it seems almost certainly headed), when wages are under pressure in most industries, and when consumers are being so cautious about spending. In fact, over the past 50 years, profits and pay at securities firms have generally tracked larger economic downturns except from 1980 through 1982, when Paul Volcker's successful battle against inflation with tight money provoked rising unemployment but also brought stability (and rising profits) in financial markets.

Although government policy is again driving opportunity in the markets, the prospects are limited and the gains will be hard to sustain until the larger economy turns around. Stock underwriting volume leaped in the first half of this year after the federal government told a handful of big financial institutions they had to raise more capital in the market, prompting a few mega-deals. Meanwhile, super low-yields on government securities have sent some investors scrambling after better-performing corporate and junk bonds, which not only boosted underwriting business for firms but made experienced fixed-income traders into hot commodities on the Street. A big hunk of bonus money that's likely to be paid out this year will go to them.

But opportunities for new business based on solid fundamentals are still limited right now. For one thing, we're unlikely to see too many more mega-financing deals in the stock market of the sort sanctioned by Treasury earlier this year. At the same time investors' appetite for riskier bonds is already waning. And securitizations of loans-not just risky subprime mortgages but virtually all types of lending-have ground to a halt, depriving the world economy of liquidity and Wall Street of transactions.

All of this is reflected in a smaller financial industry. Last year, for instance, not only did the total bonus pool paid by firms in New York contract by nearly half from the 2006 high, but the number of people working in the industry locally who got bonuses declined by 8 percent. Job losses in the industry are likely to be far larger this year, as workers let go in late 2008 now start appearing on unemployment rolls as their severance packages run out.

Many institutions, meanwhile, still have toxic assets on their balance sheets, and the Obama administration's plan to have private investors buy them up isn't going well, in part because investors fear that if they join the program and manage these assets profitably they'll wind up getting bashed in Washington for benefiting from America's woes.

At the same time, despite all the talk of rich bonus packages, firms are moving to change their compensation structure to a less controversial model. Bank of America and Citigroup both restructured their pay packages earlier this year to make bonuses a smaller part of total pay, for instance.

But when it comes to pay on Wall Street, it's hard to satisfy everyone. When Morgan Stanley announced a similar effort to shift some of its compensation away from bonuses and into base pay, the president of the American Federation of State, County and Municipal Employees, a public-sector union, complained that the move "weakened the link between top executive pay and performance" and accused Morgan of paying executives for "just showing up for work." That was ironic considering that AFSCME rarely negotiates contracts for the government workers it represents which include pay-for-performance standards.

Still, if the economists who advise New York City government are correct, securities firms will collectively lose money again this year and total wages paid in the finance sector will decline by more than 10 percent--driven by another drop in the bonus kitty that reflects broad economic woes.

While the prospect of big pay packages may get some folk's blood boiling, given what's actually ahead I long for the day when Wall Street's compensation pool overflows again.

Steven Malanga is an editor for RealClearMarkets and a senior fellow at the Manhattan Institute

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