Wall Street Deserves a Pay Cut
by Jonathan Slone
Posted November 10, 2008
Over the past few days, I have received a flurry of phone calls concerning compensation and the finance industry. After making an internal announcement that CLSA would be asking top executives to voluntarily cut their salary 25% in order to bring our cost income ratio in line with budget at 50%, I was surprised to see this become front page news in many newspapers globally. The fact that a financial services company would take a pay cut seemed to strike a cord. At the same time, it also hit front pages that Wall Street has been accruing a bonus pool of roughly $20 billion to pay its top executives. This is roughly the same amount that the U.S. government has spent to shore up the capital of various investment banks in light of the current credit crisis. This has generated some limited outcry, but I have yet to see a regulator or government agency begin to ask the right question: How is it that an industry that has lost so much money and generated so much economic pain be so brazen to even propose such a plan?
The fact is, that the parts of Wall Street that are intending to pay these bonuses no longer have a relationship with Main Street, but have amassed a pool of capital and resources that allow them to profit despite the state of the economy. This part of the Street has strayed far from its roots of intermediating the market, raising capital and providing sound investment advice. Instead, the deployment of massive capital and the need to provide returns has turned these companies into large hedge funds that have gone about their business of risking shareholder capital in an ever more leveraged fashion. What used to be a client business has now become a business of trading against the client facing the market for the firm’s own profit. One would have thought that by now people would understand the model is broken, but as demand for bonus shows, Wall Street itself has not come to that conclusion.
So how did shareholders get left holding a bag in the first place? For the most part, Wall Street has given itself a free ride. By allowing financial service companies to get away with valuations that treat trading income similar to recurrent fee or other income, shareholders have unwittingly financed bonuses that have no relationship to their underlying economic value. Traders who claim it was their acumen and talent made all the profits have neglected to take into account the cost of leverage, or its abundant availability. This leverage, combined with a 15 year bull market, created an army of Masters of the Universe unrivalled in size, somewhat humbled by recent performance, but not yet out of the game. Those Masters who still have a job are now being called on to work their magic again and we are told those bonuses are necessary or the best and brightest will leave for better payouts elsewhere.
If the markets would force the investment banks to lower their leverage, shed their massive capital base and return to the business as it was played 20 years ago, the billions of bonus would no longer be needed to support the outsized traders and deal doers. Instead, analysts, salespeople and managers would be facing off once more against a client rather than the marketplace itself in order to generate profits. No one is against traders making huge gains. Hedge funds generate massive pay offs, but here the method and intent is clearly stated and limited partners clearly understand the risk. In an investment bank, the risk is similar, as we have now discovered, but shareholders were largely in the dark thinking that they had invested in a client facing business with all the risk management and internal controls that high bonuses could buy.
One would think that the marketplace would adjust investment banking leverage back to reasonable levels by now, but the government stepping in to avoid a wholesale collapse of the system has changed the equation. While the financial system is worth saving, the investment banking model is not. The question of investment banking bonuses is a symptom of this and Main Street must not be asked to support firms that insist on continuing to operate as if the financial crisis had never taken place. The model has to change and the idea of investment bankers taking a pay cut is a good place to start.
Jonathan Slone is the chief executive officer of CLSA Asia-Pacific Markets.
