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The great train robbery

September 26th, 2008 · No Comments

We have nothing against capitalism and free markets, quite the contrary. But we have argued that a dogmatic (and, to be frank, rather blind) attachment to market fundamentalism is at the root of the present mess. It caused woefully under-regulated financial markets, which lead to excesses which then came crashing down. Here is another excess.

The fact that the Paulson bail-out plan main function is ‘price discovery’ might be a rather ironic testimony that markets, especially those where complex financial products are traded, do not always work very well and are in need of regulation in order to function better and reduce the chance some parties are opportunistically exploiting information advantages.

We also have no objections to people earning large amounts of money, either as a reward of (personal) risk taking, or of the combination of brilliance and/or hard work. But, as so often, one can have too much of a good thing, as the following Bloomberg story testifies.

It’s one thing that people earn large amounts of money, it’s quite another that the hard work/brilliance/ or risk taking is absent, in fact, when people are rewarded for taking exorbitant risks but have very little themselves at stake, or where any relationship, however spurious, to performance is lost, that’s where it gets stuck in our mind.

Such situation can tear at the social fabric of society, and the rebellion in main street against the bail-out plan are the first signs that this is already happening.

It’s not only the moral and social dimensions, having such big incentives in place no matter what the outcome, produces ‘one-way-bet’ situations that provide large incentives to both excessive risk taking and creative accounting (or, in some cases, even both).

Shareholders should unit to limit these incentives, if not, regulation should do the job.

Wall Street Executives Scored $3 Billion as Banks Rose and Fell

  • By Tom Randall and Jamie McGee
  • Sept. 26 (Bloomberg) — Wall Street’s five biggest firms paid more than $3 billion in the last five years to their top executives, while they presided over the packaging and sale of loans that helped bring down the investment-banking system.
  • Merrill Lynch & Co., once the largest U.S. brokerage, paid its chief executives the most, with Stanley O’Neal taking in $172 million from 2003 to 2007 and John Thain $86 million after a month’s work last year. The company agreed to be acquired by Bank of America Corp. for about $50 billion on Sept. 15. Bear Stearns Cos.’s James “Jimmy” Cayne made $161 million before the company collapsed and was sold to JPMorgan Chase & Co. in June.
  • Democrats and Republicans in Congress are demanding that limits be placed on executive pay as part of the $700 billion financial rescue plan proposed by U.S. Treasury Secretary Henry Paulson. The former Goldman Sachs Group Inc. CEO, who received about $111 million between 2003 and 2006, said in testimony to Congress on Sept. 24 that he would accept such limits as part of the plan, after initially opposing them.
  • Shareholders and boards should have done something about this a long time ago,” said Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware in Newark. “They justified these levels of pay on the idea that they’re all geniuses. I think that balloon has burst.”
  • Wall Street firms have shared profits liberally with employees. The five biggest — Goldman, Morgan Stanley, Merrill, Lehman Brothers Holdings Inc. and Bear Stearns — paid their 185,687 employees $66 billion in 2007, as problems with subprime mortgages mounted, including about $39 billion in bonuses. That amounts to average pay of $353,089 per employee, including an average bonus of $211,849. The five firms had combined net income of $93 billion during the five years through 2007.
  • CEO Pay Doubled.
  • The $3.1 billion paid to the top five executives at the firms between 2003 and 2007 was about three times what JPMorgan spent to buy Bear Stearns. Goldman Sachs had the highest total, with $859 million, followed by Bear Stearns at $609 million. CEO pay at the five firms increased each year, doubling to $253 million in 2007, according to data compiled from company filings.
  • Executive-compensation figures include salary, bonuses, stock and stock options, some awarded for past performance. The options were valued at a third of the fair-market price of the stock at the time the options were granted, a method recommended by Graef Crystal, a compensation specialist and author of the Crystal Report on Executive Compensation, an online newsletter. The companies value the options using different methods.
  • `Make It Rain’
  • Wall Street firms have paid employees a greater share of revenue than any other industry, about 50 percent, Crystal said. That tradition at investment banks comes from their history as closely held partnerships of investors who put their own capital at risk, he said.
  • “In Wall Street and Hollywood, the profits tend to come in great big packets, and everyone wants a piece,” said Crystal, a former Bloomberg columnist. “Whether it’s the movie `Dark Knight’ or a huge merger deal, he who can make it rain, he who can bring everyone to the theater, can earn whatever he wants.”
  • Until the rain stops.
  • Lehman Brothers filed for the biggest bankruptcy in history on Sept. 15, with more than $613 billion in debt. The same day, Merrill Lynch was sold to Bank of America for $29 a share, about 70 percent below the stock’s high of $97.53 on Jan. 24, 2007.
  • Goldman and Morgan Stanley, the two biggest independent U.S. investment banks, were forced to convert to bank holding companies, giving them more access to Federal Reserve funds and buying time to acquire deposits. Goldman Chief Executive Officer Lloyd Blankfein made $57.6 million in 2007 in salary and bonus, which includes stock and options granted at the beginning of the fiscal year to reward performance the previous year. Co- presidents Gary Cohn and Jon Winkelried each got $56 million.
  • `Tied to Performance’.
  • Morgan Stanley’s current and former chief executives, John Mack and Philip Purcell, were paid about $194 million over the last five years.
  • Mark Lake, a spokesman for Morgan Stanley, pointed to Mack’s decision not to take a bonus for 2007 and said he doesn’t make “a lot” compared with other CEOS.
  • “He has taken everything he had since rejoining the firm in equity, other than salary,” Lake said. “There’s a difference in taking stock in the firm as a bonus and taking cash. Stock in the firm, obviously you are tied to performance of the firm.”
  • Goldman Sachs spokesman Michael Duvally declined to comment. Merrill Lynch spokeswoman Jessica Oppenheim, JPMorgan spokesman Brian Marchiony and Lehman spokeswoman Monique Wise didn’t return calls for comment.
  • Paulson, Bush.
  • The American people are angry about executive compensation, and rightfully so,” Paulson told a House panel on Sept. 24, departing from his prepared remarks. “We must find a way to address this in the legislation, but without undermining the effectiveness of this program.”
  • President George W. Bush said that night in a televised address to the nation that the plan would provide “urgently needed money so banks and other financial institutions can avoid collapse” and “should make certain that failed executives do not receive a windfall from your tax dollars.”
  • Congressional Republicans splintered late yesterday over the proposed rescue $700 billion rescue plan, imperiling prospects for an agreement just hours after a bipartisan group of negotiators and the White House said one was near.
  • Weak Record
  • The U.S. government has a weak record when it comes to regulating compensation, said Kevin Murphy, a professor of finance at the Marshall School of Business at the University of Southern California in Los Angeles.
  • Every government attempt that has existed to limit or regulate CEO pay has backfired,” Murphy said. “I’m fairly confident this one will backfire too. There are always loopholes.”
  • Regulation of golden parachutes, or protection for executives in the case of an acquisition, were circumvented in the 1980s with severance agreements, and Nixon’s wage-and-price- control experiment in the 1970s ultimately failed, Murphy said.
  • “It’s either the compensation committee or the general counsel or the head of human resources who are trying to negotiate a pay package with someone who will be their boss in a week,” he said. “These are things that can be done a lot better.”
  • Corporate Governance
  • Rather than government regulation, the solution is in better corporate governance, Elson said. Companies should negotiate more aggressively with executives and should establish rules that encourage shareholders to protest excessive pay. The rescue package is not the place to have that debate, he said.
  • “This will get in the way” of passing the $700 billion financial rescue legislation, Elson said. “We are in a crisis. The patient is dying. Let’s work on the details as soon as we get the patient out of the emergency room when we can do it in a thoughtful or deliberate manner.”
  • Not all Wall Street CEOs have escaped unscathed. Cayne sold a Bear Stearns holding once worth $1 billion for $61 million in March. Lehman’s Chief Executive Officer Richard Fuld, who made $165 million between 2003 and 2007, sold 2.88 million of his firm’s shares for 16 cents to 30 cents apiece, or less than $500,000, according to a regulatory filing.
  • Fuld owned 10.9 million shares and restricted stock units as of Jan. 31, valued at $931 million at their peak. He also had in- the-money options and other stock worth almost $300 million, according to Crystal.

So, shareholders unite!

Tags: The Markets