WHETHER OR NOT YOU AGREE WITH President Obama's new proposals to restrict the size and activities of America's big banks, it's hard to argue that he shouldn't have a role in the policymaking process. But when it comes to cutting Wall Street pay, he's barking up the wrong tree.
It's up to management and corporate boards to rein in compensation because it's in shareholders' interests to do so. Shareholders own these companies, not employees, although the firms have long operated as if employees' interests were paramount. Lower pay probably will mean higher profits and bigger capital cushions against potential losses. It's time for an end to the notion that Wall Street employees are entitled to half the firm's profits.
Goldman Sachs and JPMorgan Chase are starting to get it and that's good news for investors. Goldman (GS) surprised Wall Street last week when it reported that its ratio of compensation to revenue was 36% last year, the lowest figure since it went public in 1999 and below the annual average of 47% over that span. JPMorgan (JPM) set aside 33% of net revenues as compensation in its large investment bank during 2009, down from 62% in 2008. Morgan Stanley's (MS) ratio of compensation to revenue at its institutional securities division stood at 40% in 2009, adjusted for the big impact of movements in its debt spreads on its financial results. That was down from an outsized 110% in 2008.
The political backdrop obviously helped drive the new pay restraint, but the trend ought to continue, with a 35% compensation ratio becoming the new norm. Lower compensation is good politics and good business. It's notable that another people-intensive business, asset management, has a compensation-to-revenue ratio of around 35%, including industry leader BlackRock.
There is enormous franchise value at companies like Goldman Sachs, JPMorgan and Morgan Stanley owned by shareholders and built up over a generation that allows current traders and investment bankers to earn some of the best pay in America. Having a Goldman Sachs business card is a big help to the firm's investment bankers and Goldman bond, equity, currency and commodity traders benefit from knowing what big institutional investors are doing. Bernstein analyst Brad Hintz wrote that he's regularly asked how bond trading desks can make money without taking a lot of proprietary trading risk. "It's like being an 8-year-old child standing over an ant hill. The child sees patterns in all the ants' movements" while the individual ants only "see the tail of the ant ahead of them."
Part of the 2009 compensation decline is cosmetic because firms are paying a greater proportion of employee bonuses in stock rather than cash. Stock awards are expensed over the life of the vesting period, which typically runs three to five years, while cash is expensed immediately.
The game, meanwhile, is getting tougher on Wall Street because of higher capital requirements, tighter regulation and potential new taxes. In an environment of lower returns and potential curbs on trading, major firms need to retain more of their profits for shareholders to maintain profit levels and returns.
Shares of Goldman, Morgan Stanley, JPMorgan and Citigroup (C) fell sharply Thursday and Friday after the Obama administration proposed new rules to curb proprietary trading. Obama isn't popular on Wall Street but he has a point here. All the major firms benefit from a federal financial safety net. Why should they take advantage of that backstop to gamble with firm capital? If they win, they reap the benefits. If they lose badly, taxpayers may have to foot the bill, as they did for AIG and Bear Stearns.
A separate, proposed new tax on non-deposit liabilities would sting trading operations and potentially cost JPMorgan and Citigroup $2 billion annually and Goldman and Morgan Stanley, $1 billion each, KBW analysts have estimated. "The political pressure probably will be around for a while," says Keith Davis, an analyst with Farr, Miller & Washington, a Washington, D.C., investment firm that holds Goldman and JPMorgan shares. "I think the compensation-to revenue ratio is going to be something south of historical levels for a while, whether its 34% or the high 30s. The actions by Goldman and JPMorgan incrementally take some political heat off them, but the absolute pay numbers are still huge. They're still paying a ton of money to their traders."
Wall Street employees may represent the most highly paid large group in the country, with a more restrained Goldman still rewarding its 32,500 employees an average of $500,000 in pay and benefits last year and JPMorgan doling out an average of almost $400,000 in 2009 to the workers at its investment bank.
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