The Fourteenth Banker Blog

June 21, 2010


Filed under: Running Commentary — thefourteenthbanker @ 9:50 PM

The focus of compensation practices inevitably goes to executive compensation. After all, executive compensation is obscene. Then it goes to a discussion of million dollar and up bonuses paid to investment bankers and top corporate bankers. Here, Yves comments on a recent NYT piece by Robert Shiller.

Now some readers will argue that financial services industry pay is market determined and therefore virtuous. That’s a misconstruction. Compensation in the financial services is a classic example of market failure.

The big banks and broker dealers ALL went into the crisis badly undercapitalized. Why? Because the industry engaged in a variety of practices that allowed them to rely on what amounted to fictive capital. For instance, credit default swaps allowed them to hedge risk with undercapitalized counterparties like AIG and the monolines. When the hedges failed, the banks showed spectacular losses. Similarly, banks shifted assets into structured investment vehicles and other off balance sheet entities, but earned fees both for setting them up and providing services to them. When these entities started showing serious losses, the banks discovered they weren’t so “off balance sheet” and tool losses.

If the banks had accounted for these risks properly, they would have had to carry higher capital levels and would therefore have had to retain more in the way of earnings and pay less to employees. And the idea that escalating pay levels was needed to retain “talent” was dubious. The threat was that the best staffers would leave for hedge funds. But let’s face it, they did regardless, and hedge funds employ comparatively few people in comparison to the banks and broker dealers.

Now these points are all dead right. Pay is too high. Let’s say one firm brought down its level of pay. It would lose its mercenaries. So what! If the mercenaries are of value because of their connections, then pay is not in fact based on merit. The whole baloney about meritocracy is just that. If pay is based on talent, there is no shortage of talent. People will move up in the ranks and the talent is replaceable. If that is not the case, then why do banks allow such massive turnover in their retail divisions, caused by such massive pressure to produce daily? Have you seen the revolving door in retail banks?

What is actually needed on Wall Street is a purge of this so-called talent. It is a wealthy boys and girls club operating in an illusory universe. This talent is focused on the next deal, the next quarter, the next kill. Until there is a purge of this poisonous toxic talent, there is no real change in the system.

Pay at the top is not the only problem. The philosophy of the hunt has permeated these organizations. The customer becomes the next meal. There are two goals for the typical employee. One, make big money while the making is good. Two, survive in a culture that culls its bottom 10%. This is the Wall Street culture. It has infected organizations through and through. The shift from salary to incentive compensation exacerbates the problems just as much in the traditional banks as in the investment banks. The salary is sometimes just not enough to maintain middle class lifestyles. The incentive has become a “must”. Therefore, anything will be done to earn the incentive. So even the least corruptible employee is under enormous pressure to dissemble. That is how the upper class wants it. They want dependency. Dependency protects the upper class. Dependent people will not rock the boat, will look the other way, will be complicit.

All these mortgage originators that submitted bad loan apps, knowing all along that is what they were doing, did not start off as fraudsters. Senior management made fraudsters, even banksters, out of them.

So let’s not just focus on executive pay, let’s focus on corrupt pay practices.


  1. Great post. Thanks! Especially resonant to me are –

    1. The distinction between the hard/soft incentive differential between the most senior executives – who, essentially receive an entitlement – and the rank-n-file – who are arm-twisted into driving the numbers that pay for the Seniors’ entitlement, just to maintain a middle class comp. level themselves.

    2. The point that incentive comp. – designed to tie pay to performance which, in theory, is a good thing – can be perverted by short-term performance metrics which are designed to drive profits (and the Seniors’ entitlement) short-term, but have the long-term effect of running the business into the ground.

    All of these lessons are irrelevant, however, when our glorious Seniors can count on the misguided US Government to play by their perverted rules too.

    It’s all an academic discussion until we have substantive election reform.

    Comment by Lucy Honeychurch — June 22, 2010 @ 12:28 PM | Reply

  2. […] is looking an awful lot like we are in the grip of what has been termed a “pay cartel.” As the Fourteenth Banker has aptly observed, current compensation practices are proving to […]

    Pingback by captains, masters, and the tyranny of chutzpah | theParetoCommons — June 23, 2010 @ 10:44 PM | Reply

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