Those Bonuses

Today’s New York Times hyperventilates about financial industry bonuses. There are no fewer than three articles, each with an angle on what appears to be a major topic. So I think we need to take a deep breath and approach things more calmly.

First: we should not conflate the entire financial industry with Wall Street. The industry is both huge and diverse. Not all employees of financial companies are making those legendary salaries and bonuses that have so caught the public’s eye. Average pay in finance is indeed higher than in other industries, and part of that discrepancy is due to the bonus structure we are all complaining about. But there are factors too. Notably the concentration of the industry in relatively high wage areas like New York City and California. Indeed the industry has spent a ton of energy in moving jobs away from those areas to places like Charlotte and Florida in order to reduce labor costs. We all moan about outsourcing from America to places like India, but outsourcing from New York City to Charlotte has exactly the same effect: it reduces wages.

Second the average bonus paid out this year is approximately $113,000. This looks very high by everyday standards, but is actually between 30% and 40% down on last year. Plus it appears to be the mean, not the median, so that number is telling a distorted story. A smaller number of very high bonuses pulls the mean up, whereas the better figure to look at, but which is not published anywhere that I know of, would be the median. I imagine the median is much smaller. It is those fewer very large payout we are so angry about. But we should not forget that there are a very large number of smaller payouts included in the aggregate figure. And they don’t look so bad.

Third: the salary structure of the financial industry has changed over the past two decades. During the high profit era of the past two decades more and more companies have emphasized bonuses as opposed to straight salaries. They did this not just to provide incentives but also to control costs. Bonuses are not guaranteed. Salaries are. As the component of pay due to bonus went up more and more employees within the industry found that they were no longer getting pay increases, instead they were getting variable ‘incentive’ payments. Often these incentives had nothing to do with their own performance, but were tied to the company’s profits. The effect was to broaden the number of employees who were dependent upon bonus pay as part of their regular compensation. It was no longer truly a ‘bonus’, but was a variable part of regular pay. This complicates the attack on bonus payouts: there are very many people receiving modest bonus payments who actually rely on those payments instead of salary. Eliminating them puts those people at risk. And most of them have nothing to do with the scams and incompetence that drove the industry over the edge.

Fourth: the incompetence was focused within the old investment banks, the hedge funds, and the trading floors of the big banks. This is where our ire should be directed. These are the fools who brought the derivative debacle to us, and they are the ones who should pay the price on the down side. they should be fired, not just take a pay cut.

Fifth: along with the fools in the trading rooms we should direct our attention to the payouts that the executives receive. These are usually even more egregious. More so because they appear not to be attached to actual performance – too often a CEO receives a chunk of money even as the stock of the company plummets. Nor does there appear to be an incentive to build long term wealth for the shareholders – payouts are based upon very short term results that could be completely invalidated by the next year [or even quarter]. There is no way to ‘claw’ back such a short term payout. This is particularly galling at the moment when CEO’s are getting big checks for last year’s profit, even though we already know that their actions have plunged their companies into the red subsequently.

For all these reasons I look at the ‘bonus problem’ as being more complicated than the screaming headlines indicate.

Further I do not think the problem only exists now that the taxpayers are involved as part owners of the banks. The problem is one that has been with us for a long time and will take both legislative and regulatory action to resolve.

I would advocate:

There should be claw back provisions for all short term payouts. Either that or put payouts in escrow and make them contingent on the sustainability of the profit for which they are paid.

We should rely less on bonuses and make base pay higher for the large number of people who are not directly involved in the high risk/high reward part of the industry.

We should legislate to allow shareholders to be more involved in compensation issues. Right now pay is usually set by a very small and inbred, self selecting group of directors who are beyond the control of the shareholders. As a rule I would like to see more shareholder activism across the board – our major companies are currently run more for the benefit of management than to make a profit for shareholders. Hence at least part of the pay problem.

We should remove the tax advantages accruing to the sundry ‘perks’ that add to CEO and Executive pay. Those corporate jets should not be a tax deductible expense. Nor should Mr. Thain’s $1,000 waste paper bin.

Finally we should take tight direct control of the compensation of the executives in any company taxpayers invest in. For instance they could immediately fall into the pay scales we use for our government.

The reason I think we need to take a more sober look at the ‘bonus problem’ is that it is systemic and has been around for a while. Executive pay has grown dramatically even while average wages have stagnated. The inequality implied by that is both disturbing ethically and potentially destabilizing politically. The populist backlash we are now seeing supports that view. We should remember that Wall Street was looked at with contempt only a few decades ago – memories of the Depression and the Gilded Age lingered long into the post war era. It was only with the advent of the Reagan era and its free market deregulatory ideology that the stock market and Wall Street gained the cachet it had up until last year. It became acceptable to pay huge amounts because it was assumed that huge wealth was being created. The bonus problem was symptomatic of an era. It didn’t happen in isolation. So as we attack the bonus payouts to the CEO’s and their staffs, we should take a moment to ponder the ideology that enabled those payouts and the social milieu that made them acceptable.

Plus, all that money flowing to finance diminished the flow into other things. The huge payouts on Wall Street sucked in talent. The proportion of graduates going into finance rose radically from 1960 through 2008, from a low of 4% to as high as 40% at some of the top schools. We cannot afford to starve other walks of life that way, especially engineering and the sciences where we now have a growing talent shortfall.

So the bonus problem is emblematic of the passing of an era. We should assess our reactions to it in that context and not hyperventilate over short term headline grabbing numbers.