Dear Rain-makers, friends & colleagues,
You have been asking how exactly our 2009 bonuses will be structured and paid? As some of you will know 2008 bonuses were the same as in 2004, and all paid in cash!
2004 (28 April) was also when the USA's SEC relaxed leverage ratios on investment banks; following which we all in the UK followed suit, mainly by upping our % bonus pool to profit ratio by a fifth.
FSA's Financial Stability Report in 2009 found that if Britain's troubled banks had retained 20% of remuneration bonuses & shareholder dividends (£75bn or $120bn) instead of paying these out based on short termism (so-called) that actually exceeded what was needed subsequently (in 2008 and 2009) in government and central bank supplied capital support (in preference share equity) to the same excessive bonus-paying banks. This I will show is a false correlation, what some culture experts might call a "post-modern relativism", usefully summed up by the following cartoon that I urge all non-bankers to take to heart as we bankers do.The years from 2004 on were also those when bonus pools exceeded profits, which only appears absurd at first sight, but not when we look at the matter more profoundly. This is for the excellent reason that our human capital is our most valuable asset, and what else is to be done when everyone else (other banks, especially US ones) do this, pay over the odds. All banks are in firm agreement about the deservedly high return necessarily payable to human capital compared to the return to passive shareholders or that old saw of "internally generated capital build-up", which we know would have just gone up in flames with nominal losses - far better to be retained by our staff and productively invested, I should think?The equation of bonus pool to government funding support is false, because we would have simply used the retained profit to narrow our funding gap by 8% or less (and depending on whether our share cap would have fallen further on lower dividends) and that £75bn (in the case of UK banks) is dwarfed by the £500bn in asset swaps to shrink our funding gaps by getting all that off balance sheet via SIVs in return for Bank of England treasuries and deposit balances. What choice did the SEC have (Paul Atkins, Cynthia Glassman, William H. Donaldson, Harvey J. Goldschmid and Roel C. Campos, SEC commissioners, pictured above, along with Christopher Cox, SEC Chairman, and Annette L. Nazareth, SEC dir. market regs.) when faced by a joint motion for relaxation of reserve ratio (leverage) requirements by Goldman Sachs, Lehman Brothers, Merrill-Lynch, Bear Stearns and Morgan-Stanley. SEC did not have models capable of predicting any outcomes of that decision; they therefore should not be blamed for the severe embarrassments that all of the above banks faced as a result of their over-leveraged trading books and unsustainable bonus pool growth.
The plain fact is that high bonuses are market-dictated with the weight of an immemorial tradition, socialised via top-dollar real estate prices. We are not "banksters"; we pay our taxes eventually. Furthermore, it is quite clear that leverage variance is simply what we need to do to maintain stable return on equity ratios and why bonuses are genuinely just that, bonuses! Who should begrudge anyone for legitimately striking it rich? There should be no limit to opportunity. What right has government to restrict incomes in any selected profession; that would be an attack on basic human rights or free market rights?Some bankers have sabre-rattled that severe cuts to bonuses will entice us to move our headquarters to Paris or Frankfurt or Hong Kong, who are offering us low tax inducements to move there. But, we don't go along with that shallow selfishness; where else will we find a central bank with the creative flexibility of the Bank of England, with the deep treasury pockets in money market operations to see us through stressful turbulent times?
US media comment has reported London bankers saying they would crash their own country’s economy by departing for foreign parts unknown if that's what it takes to defend bonuses. We have no part in that and know of no reputable British banks who think that is a realistic option.
Some calculations of government support to "bail out" us banks have supposed this to be a cost to all citizens. That is a false premiss. Governments have merely stepped in to fill a gap that opened up when the private sector failed to maintain inter-bank liquidity (funding gap financing). The bail-outs are not net costs but have valuable assets that will profitably reward taxpayers and the economies eventually. In my view therefore all of the supposed loss in wealth per citizen as shown in the graphic below will be restored and added to by at least half as much again over the medium term. Hence our bonuses need not be attacked, surely?It is altogether fair, however, that because of recent experience, shareholders and others ask why we pay bonuses in cash (out of profit or loss) and not as shares (or share options)? Apart from conflicts of fiduciary responsibility to alternative investment customers, and the net interest differentials between stock-shorting and interest bearing assets like cash (note that we never countenance any insider dealing type arbitrage or shareholder dilutions or trading to peddle our own share value upwards against a falling market), nein, n'immer, keineswegs, kommt nie im Frage, non, pas de tout, au contraire!
We paid bonuses as cash and not in shares or prefs for good prudential reasons, to safeguard against the temptation to create false markets in our stock, when annual bonuses can be 10-20% of capital or even 10-20% of capitalisation! When US investment banks' leverage restraints were loosened, US commercial banks and UK banks immediately ratcheted up their leverage ratios. These were years when risk management was considered anti-enterprise, anti-profit, anti-growth. We banks all used higher leverage to increase our own-portfolio trading rather than use the leverage to increase customer lending, which was facilitated by selling off parts of loan-books via securitised bonds. Kneejerk regulatory responses, so-called Basel III and CRD III, following the credit crunch experience, by making us increase our regulatory capital reserves and economic capital buffers to include liquidity risk and counter-party risk reserves - these are forcing us to shrink our own portfolio trading somewhat faster than we were doing anyway (to shrink our funding gaps and to focus better on only the most profitable net interest income sources).
Less capital for own trading when markets are volatile and there are rich pickings for clever arbitrageurs has hit our bonus pool. But I take comfort in the poor performance of hedge funds including macro-funds. Our fee income is up in part from stricter credit conditions, but mainly from restructuring customers' debts. This revenue stream is declining, but it looks like M&A and MBO activity is surging again. All in all, with net interest income stabilised, there is modest optimism about our return on human capital, our bonus pool growth, which we calculate based on a weighted peer-group algorithm that includes Goldman-Sachs and JP Morgan-Chase. What is now to change is how we are paid our bonuses and over what period of time. We are moving towards less cash and a medium term roll-over, what some of our sovereign debt traders are dubbing Euro-billions roll-over, an ugly expression I do not want to hear again!
Bankers are the elite of the business world. Our remuneration levels track the art market and have recently overtaken it. As someone with a collection of superior quality to that of Mr & Mrs Dick Fuld, I take this as a benchmark of our uniquely valuable creativity. Our bonuses are justified rewards for superior creative human capital and should not be relativised to the bottom line of mere profits or any other mundane comparator. I agree with Rene Magritte's comment on relativism.Talking of which, new European Union rules require that only part of bankers bonuses are paid in cash, provisional retention of another part, and some other part that may even need to be cancelled should risk performance outcomes warrant that?
We senior bankers know that our bonuses are a deserved return to 'human capital'. That return was depressed for decades. It directly correlates to the relative superiority of our education skill levels that only in recent years rebounded strongly to regain at last the same relative remuneration and skill in our human capital of the 1920s.Human capital is an asset, as we remind everyone, "the creativity of our staff is our most important, most valuable of all our asses!" Its market value is well attested by how the financial return on human capital investment (total remuneration divided by base salary) that has demonstrably held up well as all other asset classes fell (in mark-to-market terms).
Notwithstanding evidence we presented to demonstrate persistent skill-supply shortage, and using peer-group comparators to disprove the notion that experienced bankers are worth any less today than a few years ago, regulators insist on a more risk-diverse bonus calculation or less-cash only, structure, that offers some sensible tax efficiencies for all - effectively a system for lending by and borrowing from our remuneration bonus pools over time that will deliver yet higher return, what I call pleasure not lost, merely postponed. I wish to make it clear that while we took bonuses proportionate to profits as per our US competitors, it is not sensible to make sudden changes when profits become temporary losses; this is a longer term game.Following discussion with regulators, however, some adjustments are now required. Therefore, according to new guidance, the present value of the average bonus of $1 million per rain-maker in our bank (better than others and 20 times average wage) may be under $800,000, with 40-60% postponed payment payable over 3-5 years. Half of the bonus paid will not be in cash.
This means that you can only get at most 30% of due reward in immediate cash.
For those of us with bonuses of several $millions, deferred consideration is over 60%. A maximum of 20% ($200,000 from $ 1 million bonus) will be cash-credited to you immediately. You want to know how much you will get later, soon. Your deferred bonus of $600,000, half of which can be paid in cash, half in securities. This may be discounted for risk of poor performance and prudentially postponed. But, starting from a low point in credit cycle performance, actual payment has a tremendous upside potential. The superiority of human capital skills & education value among bankers in banks is fully proved by banks profitability and the speed of our recovery from the credit crunch recession, by how we skillfully helped government to help the wider economy by saving the banks painlessly through asset swaps and deposit guarantees for which help we are more than happy to buy government bond issues. We are over-subscribing to new issues and doing our best to squeeze out pension and insurance funds at the long end.
On the matter of deficits and national debts, far be it for me to point out to those who resent government deficits that they should note the obvious correlation of balancing budgets with imminent triggering the next recession, and double-dip will not help anyone, not even if the Euro Area appears to be gagging for one?Saving and rewarding the undoubted values of banks, including remuneration of bankers, is not for everyone, involves a steep learning curve and an inflexion point only after about ten years of hard graft at the front end of financial services i.e. our bankers take years before they earn their bonuses, often also after years of paying high college and MBA school fees, which they have to repay and earn a good financial return on, let's not forget that basic fact of financial life!Regardless of your initial background in say natural sciences, mathematics or some secular philosophy like MBA study, whether you have any formal qualifications in banking, you must have at least 5-10 years valid experience well-earned (keeping your job and getting promoted) before bonus hikes kick in, and that is both only prudential and fair. The Gordon Gekko banker image is Hollywood fiction.Compare this fiction with the very real Jamie Dimon, a great survivor, great leader, a pugilist and realist bar none among top bankers like myself.YOUR 2009 BONUS:
Assuming 5% risk of withdrawal of bonus each year and discount rate of 4% over the present value of money over five years, your bonus cash element falls in NPV from $300,000 to $213,000. That part ($200,000) paid in securities e.g. convertible bonds and in shares ($300,000) the risk of loss is outplayed by upside potential of say 0.75 of book value to 1.25 of book, which could and should be worth a conservatively forecast gain of $250,000, subject to say a % discount risk factor (net $140,000 upside or 28% return on your bonus investment over say 2-3 years, plus perhaps half of that again in annual bonus increases and a rolling additional 14% annual investment gain, say).
The risk factors of say two times 5% plus a hair-cut of 7% and the risk of claw-back given double-dip recession risk hitting our net interest income will modify and postpone tax payable, giving you more capital to play with in the interim than otherwise. Your $million bonuses could and should double every 5 years. That is great news! Other calculations and forecasts are possible, but it will be roughly on the above basis that our rain-makers can obtain personal loans at our lowest internal rate at up to 85% against bonus pool funds.
I for one have no fear of a possible return for a prolonged period such as in those post-WW2 decades when bankers and stockbrokers were considered boring bureaucratic desk-johnny, servile customer service-minded, paper-pushers. We will remain the kings of the global financial jungle - have no fear about that!It is only sensible given our enterprising capital and securities markets skills that we "my word is my bond" bankers are firmly to be counted among the net wealthy, prepared to put our money where our mouth is.
Some analysts quip that in recession and recovery periods our output (wages & profits) and unemployment estimates tend to be over-optimistic. This hypothesis I promise to disprove in the case of banks and bankers, our income, our jobs.In the past great artists and musicians, like today's football stars, were rewarded as a premium quality human capital. "Back in the day" as our American cousins like to say, the great days, uniquely talented individuals would coalesce into groups and teams, and from that tight economic unit create service product of high value for wide distribution. That is the quality and nature of today's creative bankers, a high-value, highly prized industry, however commoditised, reproducible, repackageable, rebrandable, along with the recycling capital that pump-primes it. Where other industries automate and replace human capital with synthetics, we computerise but never forget the human capital and its necessary rewards at the heart of banking.
Those Cassandras who call for a return to boring traditional fraction transaction banking do not appreciate the importance of human capital, or our humanitarian understanding of what is truly important, human capital, why we defend $20-30 billions in quarterly bonuses. Just look at the skills required to be a modern banker:"Our bank canvassed human resources professionals to bring you the following list of CV qualities when seeking or holding down a job at my bank. Qualities include:
1. Dealing experience (ability to grab capital allocations to leverage your bets) in both cash & derivatives markets. Some great skills were required in recent years of markets' undoubted liquidity shortage (double-default in insurance & near zero liquidity in the secondary markets for structured products) problems. Also, we needed skills to navigate how stock markets became shredded by alternative channels, but could hedge those problems as derivatives grew exponentially even if ultimately into a spaghetti mess and reinsurance "snake-eyes". Our rain-makers are syndicators, structured financiers, M&A, mezzanine and MBO specialists, an undoubted skill-set in recent years of MBO dearth and private equity competitive problems, but any booked deals will do for us that show double digit margins. It's experience that counts, especially if you look like understanding the basic intracies of structured products.
2. Be prepared, well groomed, for the interview process for our wealth and private equity divisions where the bar is loaded and set high. We test candidates on anything from financial modelling to verbal proficiency (dealing room and institutional sales jive talk), NPV reasoning and mental math, our smoke 'n mirrors hothouse personality that never forgets the bottom line of how to slice 'n dice the deal and the market. You must demonstrate business judgement of a shark (distressed debt hunting) and the vulture (finding hidden unrealised asset value), and able to think like a day-trade CFD investor.3. Speak one or more foreign (European or Asian) languages. In some cases recruiters say speaking Chinese, French, Japanese, German or Spanish is a prerequisite in primary credit markets, less so in asset management. Our candidates are frequently asked what their third, let alone second language is; first language: MBA English.
4. Show operational and IT experience. Be a team player capable of scoring individual goals. Restructuring or distressed debt experience is popular as we grapple with senior tranche triggers and other portfolio problems. The challenge is to marry deal-making with industry or operational process so that you know your cog and mechanism for how to take biggest bites our of the food chain and our internal 'deal carousel'. It is easy to find dealers, but few who combine that with operational experience to book most nominal profit.
We have moral values to define our bank by. :Our strapline "Money: if you'll take it, we'll make it!"
5. Have the right sector expertise - property and other collateral management, and fixed income (but forget small firms, retail distribution or trade manufacturing unless we post you to Germany or China). Strong sectors where we want hands-in-the-till experience are chemicals, pharma, oil, gas, institutional funds, and healthcare.
We reject Main Street's opprobrium of individual banker's success as unfair in the UK as anywhere:Other quality advice:
1. Don't embellish; cut to the chase, to the bone. A common pitfall is candidates listing deals in their CV they didn't control or had only cursory involvement in. We note when you umm and aah if asked to discuss deal-makers versus deal-breakers, or risk-accounted ins and outs of the deal, or when we ask you for an investor's perspective. If you're too into long term fundamentals you're not worth human capital investment by us.
2. If a trained accountant or actuary or economist, downplay that; classic capital & securities skills have ago changed. We used to look for corporate and treasury finance backgrounds - not any more; today we use deal-closers, salesmen who can talk upside and downside simultaneously polished on whatever side gets us the best upfront margins.
3. Referencing Goldman Sachs won't help - smells of failure in staff turnover stakes; no one leaves GS unless they're crackpots. We need candidates who were highly rated, notn simply having worked someplace unless with a financial regulator or central bank.
4. Don't assume working with large clients qualifies you. Private equity needs people with a broad portfolio of company board-level executive experiences at both large and small entrepreneurial outfits generating double digit returns i.e. an above average bonus history.5. Don't come across as young or naïve, or over 50 (early retirees). Candidates must demonstrate street-fighting skills in algorithmic analysis and monte-carlo research and more and more MBA maths mature. You may not be leading a presentation by a management team, but you will be a basket points or goal scorer."
You must talk the talk while instructing others how to walk the walk.The credit crunch and ensuing crisis exposed flaws in banks' business models to survive a whole credit cycle, but these were merely the flaws in our great society.
So, let's not hear more about the foolish risks of the financial sector or the devastation to the economy, or fiscal deficits. Too little has been appreciated about the wider societal moral deficit that is hardest to correct. We operate on a morality of profits, not deficits. We judge ourselves by peer review, to do better than our competitors have done in the last decade and the next and or last quarter and next quarter.One of the lessons of this crisis is a need for collective action, which is only the role for government. When markets blindly shape our economy and society, doing their level best, we rely on government to pick up dropped balls, run and pass back to us to cross the line. We take care to shape events to what we want going forward; questions of blinkered targets and purblindness we leave to others, to good and sensible government.
best regards to all my staff,
see note attached