Problem: Banks Pay Bonuses As Shareholders Make Losses

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Banks and bonuses

Making hay

Oct 16th 2009From Economist.com

Banks are paying bonuses even as shareholders make losses. That is a problem Shutterstock

MUCH of the recent anger over bank bonuses has been focused on Goldman Sachs, which, according to results just published, accumulated a further $5.4 billion for its staff in the most recent quarter. Yet the one thing that can be said about Goldman is that if its employees are making hay partly on the back of an implicit public guarantee, so are shareholders. In the same quarter the bank generated an annualised return on equity of 21%. Not so for some of America’s other banks. There, the owners (and in theory the controllers) of the firms seem to have been forgotten, even though pay remains relatively high. About the only consistent beneficiaries of the new boom are employees.

Take Citigroup. During the latest quarter the firm’s common shareholders suffered a loss of $3.2 billion. Some of that reflected accounting quirks: a generous interpretation of “one-offs” would suggest a small underlying profit had in fact been made, but even then the bank still only generated an annualised return on equity of 2% for its shareholders. At Bank of America (BofA) common shareholders suffered a loss of $2.2 billion, and even adjusting for one-offs they still made a loss. Yet the banks paid out a combined $13.7 billion in compensation during the same quarter. Taken together, on an annualised basis, employees received the equivalent of 27% of the core equity in the firm, whereas shareholders got a return of zero.

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Both firms would no doubt point out that compensation has fallen, that they are being less generous than competitors and that their staff would leave if pay were not maintained. And a big chunk of pay goes to normal employees, not masters of the universe. Still, in order of priority, firms should use profits to replenish inadequate capital, reward owners and only then to pay performance-related benefits to staff. Most business people would regard as insane the idea that to be competitive a firm should push itself into a loss, yet on Wall Street this defence is routine. Four of the worst banking blow-ups—Citi, BofA, UBS and Royal Bank of Scotland—remain among the top ten investment banks by fees and have not allowed their market shares to drop much. All four lost money in their most recent set of results.

Part of the solution may be regulation. For American banks in which the governmen

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Banks and bonuses

Oct 16th 2009From Economist.com

MUCH of the recent anger over bank bonuses has been focused on Goldman Sachs, which, according to results just published, accumulated a further $5.4 billion for its staff in the most recent quarter. Yet the one thing that can be said about Goldman is that if its employees are making hay partly on the back of an implicit public guarantee, so are shareholders. In the same quarter the bank generated an annualised return on equity of 21%. Not so for some of America’s other banks. There, the owners (and in theory the controllers) of the firms seem to have been forgotten, even though pay remains relatively high. About the only consistent beneficiaries of the new boom are employees.

Take Citigroup. During the latest quarter the firm’s common shareholders suffered a loss of $3.2 billion. Some of that reflected accounting quirks: a generous interpretation of “one-offs” would suggest a small underlying profit had in fact been made, but even then the bank still only generated an annualised return on equity of 2% for its shareholders. At Bank of America (BofA) common shareholders suffered a loss of $2.2 billion, and even adjusting for one-offs they still made a loss. Yet the banks paid out a combined $13.7 billion in compensation during the same quarter. Taken together, on an annualised basis, employees received the equivalent of 27% of the core equity in the firm, whereas shareholders got a return of zero.

Both firms would no doubt point out that compensation has fallen, that they are being less generous than competitors and that their staff would leave if pay were not maintained. And a big chunk of pay goes to normal employees, not masters of the universe. Still, in order of priority, firms should use profits to replenish inadequate capital, reward owners and only then to pay performance-related benefits to staff. Most business people would regard as insane the idea that to be competitive a firm should push itself into a loss, yet on Wall Street this defence is routine. Four of the worst banking blow-ups—Citi, BofA, UBS and Royal Bank of Scotland—remain among the top ten investment banks by fees and have not allowed their market shares to drop much. All four lost money in their most recent set of results.

Part of the solution may be regulation. For American banks in which the government still has investments, a “pay tsar” now exists. He took a tough stance with Ken Lewis, the outgoing boss of BofA, requiring him to accept no pay at all for this year. Amid all of this, though, shareholders remain oddly quiet. In America proposed laws will allow them a “say on pay”—an annual non-binding vote on compensation. Perhaps this will help. The biggest mystery is not why banks’ employees, underwritten by the state, want to earn more and expand, but why their owners, having been wiped out, accept such a dreadful deal.

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