Good for Goldman

Searching through my RSS feed*, I observer that not many people have commented on Goldman Sachs’s stunning compensation announcement (except for Felix Salmon), perhaps because it came out on the same day as the “Volcker Rule,” perhaps because bloggers are not wired to say nice things about Goldman. But I’m going to make the sure-to-be-unpopular statement that Goldman did the right thing here.

We all know that Goldman made a lot of money last year: $35.0 billion before compensation and taxes, on my reading of the income statement (that’s pre-tax earnings plus compensation and benefits). Many people think that it made that money because of government support, but that’s beside the point here; right now, this is purely a question of dividing the spoils between employees and shareholders.

Historically, investment banks have given a large proportion of the profits (here, meaning before compensation and taxes) to the employees. For example, in 2007 Goldman gave $20.2 billion out of $37.8 billion to its employees, or 53%. There are undoubtedly many reasons for this. One reason is the idea that investment banking is a business that depends on individual “talent,” and therefore employees have to be paid their marginal product or they will leave for other firms. More insidiously, investment banking executives tend to see their employees as younger versions of themselves, which creates a sense of solidarity; at traditional investment banks, the management committee was composed of partners who worked their way up through the ranks. Contrast this to, say, Wal-Mart, where top management has very little in common (socially, educationally, economically, politically, etc.) with the vast majority of their employees.

As a result, investment bankers are overpaid. Now, before all the bankers get all indignant on me, let me say that bankers should make more money than average people, at least according to the normal rules of our society; for one thing, they are, on average, better educated than most people. (As I’ve written before, I don’t think there’s any moral reason why people should make more money simply because they are better educated, or have unique skills, or are more intelligent, or work harder; but that’s the way the world works, and most people are OK with that in principle.)

How much more overpaid? I’ve previously written about the paper by Thomas Phillipon and Ariell Reshef on wages in the financial industry. According to Figure 10, you would expect wages in finance to be about 30% higher than in the economy at large because of higher education and lower job security; yet, also according to Figure 10, wages in finance were over 70% higher than average earlier this decade. 40 percentage points divided by 1.7 implies that wages should come down by about 25%. This an industry-wide figure, however, and recent wage growth has been much higher in investment banking than in the rest of the industry (largely banking and insurance), so 25% is probably a very low figure for investment banking. But without more data, that’s the best I can do.

Now, Philippon and Reshef’s data only go through 2006. In 2006, Goldman paid $16.5 billion out of $31.1 billion of its profits to employees (53%, the same as in 2007), which worked out to about $620,000 per employee. (In 2007, that figure was about $660,000.) Subtracting 25%, we get that Goldman employees should have earned abut $470,000 on average. This is probably still much too high, because that 25% figure is undoubtedly far too low for investment banking. But it’s a starting point.

Now, what did Goldman do for 2009? Through September, they had already set aside $16.7 billion for compensation, a 57% payout ratio; annualized, that comes to a stunning $22.3 billion, or $700,000 per employee. In Q4, however, they did the unthinkable; it reduced its compensation expenses by $500 million.** This lowered the annual compensation pool to $16.2 billion, or $500,000 per employee, and lowered the payout ratio to 46%.

In their press release, Goldman trumpeted the fact that compensation was down 20% from 2007 and the payout ratio was the lowest ever.*** They neglected to mention that total compensation was the same as in 2006 and over 30% higher than 2005, when per-employee compensation was $500,000. (So on a per-employee basis, we’ve just rolled the clock back to 2005.) But still, $500,000 is better than $660,000 (2007) and a lot better than $700,000 (2009 through September).

I’m sure most people wrote this move off as a public relations stunt, and maybe it was. Maybe management leaked to employees that 2010 bonuses will be extra-good to make up for 2009. But there’s another possibility, as Salmon pointed out, which is that Goldman realized it simply doesn’t have to pay its employees as much. Goldman is the premier investment bank in the world, and the gap between it and its rivals has gotten much bigger; if someone is unhappy with his bonus, where is he going to go? Citigroup? Bank of America Merrill Lynch? If Goldman’s management team really wants to maximize shareholder value, then this is exactly what they should be doing. (The big problem, as the New York Times points out, is other banks that are paying big bonuses despite having bad years–like Citigroup, whose payout ratio is over 100%.)

The test, of course, will be next year. Goldman should reduce its per-employee compensation expenses even further, and should try to push the industry to a new equilibrium where the payout ratio is in the 30-40% range and average compensation for investment bankers is in the $300-400,000 range. And Goldman’s shareholders should apply pressure to make this happen; basically, they should try to squeeze labor.

Will they? Shareholder governance is something we usually celebrate about our economy. But I wonder if it works for investment banks. I wonder because the institutional investors that control most of the shares are the same kind of people as the bankers who work at those banks. Yes, it’s the buy side (people who buy securities) versus the sell side (people who sell them), but they went to the same colleges, they go to the Hamptons together, their kids go to the same schools, and so on. It’s probably easier for an institutional investor to swallow $600,000 per year compensation at Goldman than it is to swallow $10 per hour at Wal-Mart. Maybe class bonds outweigh economic interests.

My prediction is that this is just a PR stunt and next year (assuming it is a good one for the banks), per-employee compensation at Goldman returns to at least $600,000 and maybe $700,000. But I would love to be wrong.

* One of the best things about reading news and blogs in an RSS reader like Google Reader is that it works like a perfectly-targeted meta-search: You can search your preferred information sources all at once in one place, as opposed to using Google web search where you get the entire universe in one haphazardly-ordered list.

** This means that it reduced its bonus pool by even more, since during the quarter it had to accrue its employees’ ordinary salaries and benefits; assuming $40,000 per employee, that comes to $1.2 billion, meaning that it reduced the bonus pool by $1.7 billion.

*** Goldman uses compensation divided by net revenues, which gives them different percentages from mine, but the substance is the same.

By James Kwak

57 responses to “Good for Goldman

  1. Thank you for writing this, despite the “sure-to-be-unpopular” fear.

  2. What do you think of the idea that investment bankers need to be paid exorbitant salaries and bonuses to reduce their incentives to just steal the money? Or engage in illegal but hard to track insider dealing (which is essentially the same thing)?

  3. (stolen from panel show):
    “Bankers are like star footballers – you have to pay high to attract talent.” Yes, but the full analogy would involve your talent scoring a hatrick of own-goals, punching the referee in the face, and then causing the collapse of the state.

  4. So you think investment bankers should make $300k – $400k and also 30% more than the average American. Given that the average American makes $50k, wouldn’t that put them at more like $65k? The average scientist or engineer is equally or more educated, intelligent, and hard working than the average banker. They also lack job security but only make ~$100k or less. Guess that’s why so many of them work in the finance sector. But is that desirable? Do we want to encourage this trend going forward? Where are our hardest problems that need the smartest people?

  5. I don’t care if their compensation doubles.

    It is the too big to fail crap that bothers me.

  6. The real problem is Goldman is still soaking up too damn much money — money that SHOULD be out there building our economy.

  7. The purpose of banks should not be to make money. Their purpose should be to store money so that it can be redistributed and used to productive purpose. Money sitting in big piles is absolutely useless, like piles of manure not being used to grow crops.

  8. There was an extensive discussion of that topic on this blog here — http://baselinescenario.com/2010/01/12/more-from-the-lion/#comments

  9. “Many people think that it made that money because of government support, but that’s beside the point here; right now, this is purely a question of dividing the spoils between employees and shareholders.”

    No, it’s not besides the point; it is the point. The “spoils” exist to be divided up in no small part due to Goldman’s ability to borrow at virtually no cost (0.66% if my memory is correct) thanks to the government backing its borrowing.

    So, why are taxpayers being put on the hook, but only the employees and shareholders get to divvy up the “spoils”? Sounds uncomfortably similar to the magic formula for Fannie Mae. Socializing costs while privatizing benefits is not a sensible way to run a financial system.

  10. “me say that bankers should make more money than average people, at least according to the normal rules of our society; for one thing, they are, on average, better educated than most people.”

    what about doctors? that’s my only objection to how much they get paid. Our doctors do far more for the benefit of our society and get far more education than any of us, yet many are consistently underpaid, especially compared to Goldman.

  11. I agree with this comment. It also creates businesses that cater to the ultra-wealthy. We all end as satellites to the rich.

  12. Outstanding essay. Thank you for taking the time to write it.

  13. “Will they? Shareholder governance is something we usually celebrate about our economy. But I wonder if it works for investment banks. I wonder because the institutional investors that control most of the shares are the same kind of people as the bankers who work at those banks. Yes, it’s the buy side (people who buy securities) versus the sell side (people who sell them), but they went to the same colleges, they go to the Hamptons together, their kids go to the same schools, and so on. It’s probably easier for an institutional investor to swallow $600,000 per year compensation at Goldman than it is to swallow $10 per hour at Wal-Mart. Maybe class bonds outweigh economic interests.”

    Mere speculation, but are there actually economic interests at work here, too? First, don’t the buy-siders have an incentive to keep sell-side compensation up because it can help them keep their own compensation up by increasing the compensation levels of sophisticated financial professionals more generally? Also, given the buy-siders need to deal with salesman on an everyday basis, perhaps there’s some concern about keeping in their good graces. The clerk at Wal-Mart won’t know you were institutional investor that fought to keep hourly wages down, but the salesman at the bank surely will know you were the guy to keep their bonuses down.

  14. Hillbilly Daryl

    This discussion thread, like the infinite number of other discussion threads on the compensation question is interesting. In my view it is most interesting for what it doesn’t address. That being, what Goldman actually “did” to make all of the oodles of money from which Goldman can pay its astronomically exhorbitant compensation packages.

    And, the truth is, Goldman has made the vast majority of its money trading. Proprietary trading with computer programs that insert its orders before others, or after others depending on what benefits it. Arbitraging. Swapping. Goldman is one massive hedge fund.

    Goldman is no longer the staid investment bank circa Barbarians at the Gate that makes its money through investment banking activities, performing M & A, structuring deals, and securing financing for companies that engage in economic activity. The portion of its P+L contribution that can be tied directly to these historical investment banking activities is negligible-probably enough to pay the light bill. Goldman has become a massive gambler which sets the rules, bets on or against its own issued securities, is able to morph into a bank holding company to raise capital and secure guarantees if it so desires and if it makes financial sense to Goldman. And, Goldman experiences zero effective regulation. We regulate our casino enterprises much more rigidly than we do Goldman in an effort to secure a modicum of a level playing field.

    Trading involves winners, and losers. For Goldman to make such massive profits from trading, other had to lose massively.

    What is completely absent from this discussion is objective recognition and analysis of, and reflection on the activity engaged in by Goldman, and realistic assessment of how this activity helps or hinders the larger economy, or the American people. IE where does Goldman’s economic activity fit into equitable public policy analysis. Do we really desire, want, or need entities like Goldman that engage in the activities it does? Do these entities benefit the larger society?

    I submit that Goldman’s activity, and for that matter the activities of massive unregulated hedge funds in general, in the final analysis provide zero positive value to the public in general, and most assuredly quite negative value-their profits come from the losses of others. Goldman is truly a parasitic entity.

    Does Goldman design, manufacture, distribute, sell, or otherwise make anything? No. Does Goldman any longer generate profits by facilitating others in doing this activity? No. Hedge funds like it, are literally large enough by several multiples to control whatever markets it chooses to play in at any time. And, with Free money from the Fed…

    The discussion needs to be centered on what Goldman does, and the decision needs to be made on the question of whether we really desire this activity, and if it really benefits the economy, or the public in general.

  15. Re: Where unhappy Goldman bankers will go

    You’re right that unhappy Goldman bankers certainly will not go to BAML or Citi. But they will go to (a) hedge funds, (b) private equity firms, (c) boutique investment banks (Greenhill, Lazard, etc.), (d) start-up firms, or (e) government service.

    The important question to ask is whether the talent that doesn’t leave (i.e., those that value the brand of the firm name more than most and/or the up and coming young bankers) can replace the production of those that do leave on account of the lower compensation percentage.

    Whether this loss of production (if any) exceeds the amount saved by lowering the compensation percentage is the threshold inquiry for determining the decision that is in the best interests of Goldman’s shareholders.

  16. first off, you don’t even get a chance for an interview at one of these places unless you graduate from the top b schools. Second you get fired if you don’t produce what the frim expects. Third you are expected to work veery long hours sometimes around the clock if that is what is expected. So to talk about per employee of who’s their mommy or daddy hould not be part of the discussion. If pressed goldman will hire more workers to work less hours for less money from less presigious schools, BUT that formula was used at BEAR STEARNS. Street savey traders with a 200k salary cap, mandatory 10% to charity and bonus paid in 5 year vested stock options. Sounds like what everyone is proposing for Goldman. But, WHERE IS BEAR STEARNS NOW

  17. The trouble is that whether or not GS bankers are better than average might be a moot point, the real issue is that everyone has taken this as a benchmark and applied similar criteria. This is bad management fundamentally, supine boards and remuneration committees with a vested interest in keeping rewards high. It is very doubtful that bankers will ever revert to more sensible levels, but that brings up the question of the “social usefulness” of these overpaid people. Much of this is a merry-go-round of a much too close embrace with Government. There are many more “socially useful functions” in society than much of what passes for such in banks. When will people focus on what leverage does to amplify returns/losses as built-in to the system of fractional reserve banking and a hell of lot less to do with the so-called bright and talented bankers.

  18. Are you kidding? Doctors in the US make more nominally and relative to the average citizen than any other country and it’s not even close. It’s not uncommon for specialists to make $200k – $500k/yr and even general practitioners can easily make $150k. I’m not saying that they don’t deserve it just that they do in fact make a lot of money and it seems are not very appreciative of it. Some are so adament about their pay that they appear as greedy as bankers.

    It’s ok to want more but I wish they would be more humble and appreciative. A better way to focus on relative doctor pay is not to focus on how little they make but on how much others make. Yes some bankers can make more but the injustice isn’t that “doctors are underpaid” but that bankers are overpaid. Heck, complaining about engineer pay earlier, even they have it pretty good compared to their Indian and Chinese counterparts.

    Don’t forget that as a doctor you have benefits that the GS employee doesn’t: incredible job security, freedom to work anywhere you want, stable income, respect, a job that rewards in ways other than money, etc

  19. I am amazed that anyone would do business with them after hearing the number of times that they bet against the very products they sell the customer. That would seem to be actual evidence of fraud.

  20. “Now, before all the bankers get all indignant on me, let me say that bankers should make more money than average people, at least according to the normal rules of our society; for one thing, they are, on average, better educated than most people.”

    The author appears to be confused here.

    a) There is not direct correlation of Education and Net Worth (not wages) – else all professors would be billionaires!

    b) That the bankers make more money is a fact. The author states here that “they should make more money according to the ‘normal’ rules”. From where does this baseless sense of entitlement come?

    c) Managers make money for the firm / shareholders and they get a piece of the action. That is the bedrock of capitalism. But why this metric (compensation/revenues)? We should be focusing on (compensation/increase in shareholder value)

    <<<>>>

    WE GET THE BANKERS WE DESERVE.

  21. Now that’s easy to understand – their business doesn’t come from people who are investing their own money. Often times there’s incentives thrown their way to attract business. Other times decision makers are afraid of the consequences to their careers if they try and go cheaper, a problem they wouldn’t have if they owned the business or were investing their own money.

  22. First balor123, thanks for the comment. Second, let’s not get into a downward bidding war where we move everybody’s wages down instead of up.
    My point is that I think more highly of my doctor and value his contribution to society FAR MORE than I do my banker. So why do bankers make more than my doctor? Isn’t the service he provides to make me and other people healthy more important than a GS banker? So to follow thru on my logic, we as a society value GS bankers far more than we do our doctors. They now are paid so outrageously that it’s as if they are kings.

  23. A downward bidding war is better for the competitiveness of this country – which let’s not forget is a war that we’re losing thanks to the costs of services such as finance and health care – than an upwards bidding war. I wouldn’t mind it so much except that money represents an allocation of wealth, which means that every dollar that a banker makes is a dollar that someone else doesn’t have. If there were infinite amounts of it, then only a jerk would suggest that others should be poorer.

    I do agree, however, that doctors provide more value than GS bankers and I even conceded that doctors deserve the pay they get. Both of them have one thing in common though: their customers can’t afford the products that they buy and the government is stepping in to pay for the losses (they aren’t free markets). In the case of bankers it is bailouts. In the case of health care, it is entitlements. Both are and have been increasing in cost faster than inflation for a long time and appear poised to continue to do so.

    In any case, I’m not sure that bankers make more than them. On average perhaps but the typical banker at GS is probably getting only ~$300k as it is weighted heavily towards the high end, making them comparably compensated.

  24. “Maybe class bonds outweigh economic interests.”

    That would explain a lot, wouldn’t it? :)

  25. balor123: “A downward bidding war is better for the competitiveness of this country – which let’s not forget is a war that we’re losing thanks to the costs of services such as finance and health care – than an upwards bidding war.”

    A downward bidding war would benefit the rentier class. That is a trend we need to reverse. (Not that we need an upward bidding war, either. What we probably need is a robust international labor movement.)

  26. so now the extraordinarily talented and worthy goldman stockholders will get paid more

  27. I totally agree. JK seems to take for granted that a company like GS deserves to exist and then goes on to dissert about their compensation.

    For the life of me I cannot see what their contribution to society is. If GS were to disappear tomorrow everybody would be better off. That such a giant parasite is allowed to pump the blood out of our economy is a testament to our stupidity or carelessness.

    “Maybe class bonds outweigh economic interests.”
    Probably true of JK too, law student at Yale. Will probably never be invited to join Skulls and Bones, but must be making good connections.

  28. … it was allowed to fail because they didn’t have enough alums in the government. It’s not a testament to how their business worked any better or worse than the others. It just signals to other places that you need to keep powerful friends in high places and keep them happy, otherwise you wind up like Bear Sterns in the end.

  29. Do you really think average Wallmart employees get $10.00 an hour? I don’t know for sure and maybe it varies geographacilly. I always assumed generally walmart paid minimum wage. In Ca. I think that is $6.75. with no benifits. As I understand it the average employee is Written up for not taking breaks at precisely the prescribed time or for working more than 35 hours a week. Too many write up and you get fired. But I understand this isn’t about Walmart it is about goldman sachs.

  30. On point analysis on analysis of labor market for traders and ibankers. Generally congenial relationship between traders and directors is very true. However, finance, as an industry that requires employees to have significant freedom and responsibility, is a very good place to pay efficiency wages.
    While in the short run, a squeeze in the labor demand market can allow banks to skimp on compensation expense, because the incentives efficiency wages bring currently exist due to labor squeeze (as summarized by “where are you going to go, Citigroup?), long term this will not be the case, unless the sector is undergoing significant shift, which is unlikely as of now.
    So my question is, could the congenial relationship between “management and labor” be the result of this effect, rather than vice-versa? In other words, a striking auto worker can put the wrong color carpet in, a single angry trader can bring down a bank (remember Barings?), and there is no way to manage this risk without significantly reducing operational efficiency.

  31. Rickk from Canada

    Jack 54 wrote:

    “But I understand this isn’t about Walmart it is about Goldman Sachs.”

    Cheers

    —-

    This may add another perspective – U.S. websites only…

    http://vodpod.com/watch/1531016-clusterfuk-to-the-poor-house-goldman-sachs-connections-the-daily-show-comedy-central

  32. Rickk from Canada

    KA wrote:

    “So my question is, could the congenial relationship between “management and labor” be the result of this effect, rather than vice-versa? In other words, a striking auto worker can put the wrong color carpet in, a single angry trader can bring down a bank (remember Barings?), and there is no way to manage this risk without significantly reducing operational efficiency.”

    “Under free trade the trader is the master and the producer the slave. Protection is but the law of nature, the law of self-preservation, of self-development, of securing the highest and best destiny of the race of man. [It is said] that protection is immoral…. President William McKinley

    http://en.wikipedia.org/wiki/Free_trade

  33. Rickk from Canada

    “On Tuesday night’s Daily Show, bailout watchdog and financial reform advocate Elizabeth Warren told Jon Stewart that “this is really the moment” that will determine the future of America’s middle class — the system must be fixed or “the game really is over.”

    http://www.huffingtonpost.com/2010/01/27/elizabeth-warren-the-chip_n_438379.html

  34. Goldman is posturing, pure and simple. The answer to this BS is twofold:
    -prevent investment banks (after being separated from commercil banks) from being publicly owned. Make them employee-owned. They can raise all the money they want in the debt market, and buyers of their debt should continiue to perform due diligence. But make bankers put their own futures and fortunes at risk, not ours.
    -Stop the casino. The development and sale of zero-sum products for speculation, as distinguished from hedging, diverts investment dollars from supporting investment in the expansion of industry and the development of new industry. It changes the market to a casino. It is no longer assisting the allocation of capital and management of risk. It increases risk by creating a zero-sum environment that promotes bets on the future, not investments in it.

    Goldman, I suspect, is posturing to avoid public outrage and real reform. As far as I’m concerned, let them get rich by helping the country’s industries grow and develop, but stop the casino culture and the practice of betting against clients that buy the bankers’ products. If they can’t live by that minimum ethic, let them sell aluminum siding door to door.

  35. Rickk from Canada

    Jim Coffman wrote:

    “….stop the casino culture and the practice of betting against clients that buy the bankers’ products.”

    “There are certain basic things that the investor must realize today. In the first place, he must recognize the weakness of his individual position… [T]he growth of investors from the comparative few of a generation ago to the millions of the present day has made it a practical impossibility for the individual investor to know what is occurring in the affairs of the corporation in which he has an interest. He has been forced to relegate his rights to a controlling class whose interests are often not identical to his own. Even the bondholder who has superior rights finds in many cases that these rights have been taken away from him by some clause buried in a complicated indenture…

    The second fact that the investor must face is that the banker whom tradition has considered the guardian of the investors’ interests is first and foremost a dealer in securities; and no matter how prominent the name, the investor must not forget that the banker, like every other merchant, is primarily interested in his own greatest profit.”

    (1937)

    False Security: The Betrayal of the American Investor
    Bernard J. Reis and John T. Flynn
    Equinox Cooperative Press, NY

  36. banks should pay the cost of the bailout – all of it, including the costs of guarantees (that have upkeep costs) and it should cover the total amount of the bailout (not just one bank’s individual share – they can sue each other for the difference). THEN they should hold reserves for the the eventual full implementation of FASB 166/167 and the unpleasant balance sheet problems that bringing these things back onto the balance sheet at market value.
    Unless I’m missing something, THEN and only then pay bonuses, as much as they can loot.

  37. I really don’t care how much they make, I just wonder if everything would be adjusted appropriately if Glass-Steagall was once again invoked. And I wouldn’t care if they did, because what they make, even the disparity may not necessarily be bad, if they are helping the economy. Unfortunately, with things the way they are, Goldman, et al, of the TBTF Oligarch Set are absorbing too much of the GDP, and so long as they do, the economy won’t rebalance, and we will not recover, soon, if ever, from what they did to us ending in catastrophe about 15 months ago.

  38. You forgot to mention that the banks are still sitting on huge amounts of toxic assets that have been shoved out of sight. They are entities that are in effect bankrupt and the fact that they are too big or too important to allow them to fail doesn’t mean that they didn’t get a second chance at the expense of the taxpayer. Employees of bankrupt businesses are lucky to get their pay and bonuses should not even be considered.

  39. Banker pay, even for rank file, rose A LOT over the past decade. What I wonder, is how can it recover to sustainable pre-bubble levels, when all banks insist on paying competitively and they started competing at bubble levels?

  40. This is a bunch of crap, James. It’s like applauding that a mafia gang only bumped off 80 people this year instead of their usual 100.

    I’m sick of the financial sector patting itself on the back for creating casinos and “winning” because they are the house – AND – expecting the rest of the world to think they provide some value to humanity.

    It is sickening. And YOU apparently drank the kool-aid.

    Let all the banksters go live on an island together and leave the rest of us alone. I can only wish them a “Lord of the Flies” experience. Feel free to join them.

  41. We, the taxpayers, have shelled out at least $11 Trillion (11,000 Billion dollars) to shore up the financial sector. * http://www.demos.org/pubs/prins_bailoutsubsidization.pdf

    If you use the U6 unemployment figure, there are approximately 27 million people unemployed, underemployer, or marginally attached. If each of the 27 million people were given $40K/year for 5 years, the total would be $5.4 Trillion.

    Let’s see, which would have been better for stimulating the real economy?

    Any wonder why there is rage in this country?

    So, how about getting some perspective.

  42. Agreed!

  43. Two wonderful incredibly bright people, Warren and Stewart.

    Hey, maybe a good ticket for 2012?

  44. Chicago George

    James, If you want to know just how hard it is to change I-bank compensation look at what Warren Buffett and Charlie Munger had to go through at Salomon Brothers in late 80s/early 90s. Buffett and Munger were on Salomon’s board already when they saved the firm from bankruptcy after short-term financing couldn’t be rolled over. Buffett stepped in as CEO, went before Congress, begged for mercy with TreasSec Nick Brady, staked his personal honor as the best and most widely respected investor on the planet, and owned a big stake in the firm. Yet Salomon STILL, after all of that, shoveled most of the gross profits to employees rather than shareholders, who got little to show for all the risks they took. Berkshire got very lucky that Travelers bought them out. If Berkshire couldn’t change Salomon, even their 10% stake (plus other shareholders’ stakes) in Goldman won’t let them do much of consequence.

  45. Here’s an alternative way of looking at things.

    In 2007, GS interest expense was US 42B (liabilities were about 1.1 Trillion). In 2009, interest expense was just US 6.5B a US 35B fall in interest expense, coincidentally the same figure as their 2009 earnings before taxes and compensation.
    Now admittedly, borrowings had dropped about 25% between 2007 and 2009.

    But how do you account for the dramatic fall in interest expense between 2007, the height of the credit bubble, and 2009 after GS had almost gone the way of Lehman just 12 months before?

    It has to be two things – the ability of GS to borrow at the Fed window at a rate of about .5% and the implicit government backstop. Both are gifts to GS from the taxpayer and they represent more than GS entire earnings before taxes and compensation.

    So the GS staff deserve to earn – nothing!

  46. Two questions for those who are interested:

    1) When GS changed to a bank holding company they also changed the way the counted their employees. Formerly, they only counted direct employees. I believe they now also count contractors. While this may only have a small (~10%) effect on the comp/employee, it could go a long way towards wiping out the decrease that James is commenting on.

    Anyone know what the adjustment should be?

    2) My understanding is that non-vested deferred compensation is not accounted for as compensation expense until the year in which it vests. Given that GS, in common with all the other major banks, is expected to give a lot more deferred comp this year than in past years, that should reduce the accounting compensation figure relative to the headline (that employees are told) compensation figure. For example, GS could have chosen to promise $21BN of headline comp, but with $5BN deferred, which would have shown up as $16BN of accounting comp.

    Anyone know what these details are? Will they be available in the footnotes of the 10-K?

  47. “the institutional investors that control most of the shares are the same kind of people as the bankers who work at those banks”

    This is a hugely important point.

    I doubt that any hard stats exist but presumably a great many institutional investors (i.e. fund managers) will either have worked previously or expect at some point in the future to work at an investment bank.

    And even if they don’t how many won’t have a brother, son, cousin, nephew or close friend at an investment bank?

    One British academic being quizzed by a Parliamentary committee recently cited James Burnham’s book the Managerial Revolution from 1940 as having accurately predicted what we are now seeing – senior managers of big business institutions (and state institutions like the Fed and the Treasury that have been colonised by them) now form a genuine new class and you can not realistically expect one section of it to act effectively against the interests of another section.

  48. I would approach this issue differently.

    Considering that GS seems to make most of its money off trading and packaging securities that it sells to clients–including garbage securities that it may well bet against, a practice that the government SHOULD constitute as fraud and make a prosecutable offense– I don’t see any reason for GS to have access to Fed benefits.

    In fact, this access more or less guarantees that they will not work in the interest of ANY other clientele. There’s no real need to attact private investment money when they can jam their vampire suckers right in government largesse. WHO EVEN KNOWS what marginally legal scam they’ll come up with next.

    Fed backing makes them MUCH WORSE than a hedge fund, even LESS socially useful even within the limited social utility of that world, where traders are at least subject to sharing the interests of their clients.

    GS, and similar trading entities within other banks, need to get cut off from the Fed, re-submitted to market discipline by having to attract private investment money, and–for the safety of the broader US and global economy–re-submitted to a legal regime with teeth.

    Once those social objectives have been reached, their hot shot traders will discover their new rate of pay.

  49. In other words, I disagree that you can isolate the pay question from the social welfare question because it’s the social welfare and the TBTF guarantees that is corrupting the enterprise, in the sense that there is no need for employees to align their interests with their clientele or their shareholders:

    “Many people think that it made that money because of government support, but that’s beside the point here; right now, this is purely a question of dividing the spoils between employees and shareholders.”

    How did nearly destroying the company in 2008 while employees kleptocratically extracted money from the housing bubble they helped create benefit GS shareholders? It only benefitted shareholders if they cashed out at the right time. Everyone else, including buy and hold pension funds etc, was left holding the bag.

    Sorry if it sounds too “conservative,” but the GS captured government is the enabler here. It’s not at all “besides the point.”

  50. Steven Nagourney

    Compensation per employee should not be based on education levels and job security, as he claims, but rather on revenues/profits per employee, and the relative contribution of labor and capital to those profits. On this basis, shareholders have been ok paying our 48% the last few years, not because their kids go to the same schools (give me a break), but because 52% of those revenues is more than 65% of what revenues would be if they had cheaper employees.

    This year the shareholders paid less (35%), and many employees accepted less because they realized a higher payout would have brought down the wrath of the populists in Washington, to everyone’s detriment.

    Nonetheless, I’m sure we’ll continue to see an exodus from big banks to hedge funds and smaller boutiques where compensation is greater and public scrutiny is less.

    Why isn’t the public upset about John Paulson and other HF managers, who make many multiples of what Hank Paulson ever made, yet have no clawback provisions should they give back performance in future years?

  51. “Maybe class bonds outweigh economic interests”

    For those of us who have worked in this world – class bonds have nothing to do with it.

    It is simply raw, fiduciary-duty traducing self-interest.

    If you are a buyside institutional investor, playing with other people’s money (at only some moderate, long-term risk to yourself – how many CALPERS/CASLSTERs workers have been laid off?) then

    *YOU MAKE NICE WITH GOLDMAN, SO THAT GOLDMAN WILL MAKE NICE WITH YOU – PERSONALLY – LATER ON DOWN THE ROAD*.

    In other words, you look the other way on shitty Goldman deals, selling out your members – whose money you are actually investing – so that your own career prospects (inside or outside of Goldman) are greatly enhanced.

    It is *exactly* the same revolving door dynamic that drives Congress and lobbyists.

    *EXACTLY*

    It isn’t a mystery and it isn’t complicated.

    It is simple personal corruption.

  52. What an eloquent series of analytical comments on James Kwak’s “Good for Goldman” post. But there is one commentator missing and that is the author James Kwak.

    Mr. Kwak, I appreciate that you’ve laid out the standard reasoning why Investment Bankers should be so richly rewarded for their “work”. Now, please take the time to respond to the commentators of your article, most of whom find the notion that Goldman is being sensitive this year, to limit it compensation to only $500,000 average per employee and that they deserve that bonus, disgusting. Even you think it is just a PR stunt.

    This new Financial Expertise Class, too self-important to question, is a hoax, just a bunch of clever swindlers gambling with other peoples money and buying off effective regulation against themselves with campaign contributions and lobbyists. They are not growing the American economy; they are draining the financial blood from it. This is vampire banking..

  53. I recently read that Pensions are looking to leverage on “safe securities” like treasuries to earn equity-like returns. With the carry trade, the Fed is going to be stuck with low interest rates for risk of causing a lot of collateral damage to the economy. With interest rates stuck low, speculation will continue out of control and compensation will continue to rise in finance. The cost of living will continue to increase, further increasing the profits of this field sending even more people there. Then we’ll all be living in London where we are all perpetually in debt way over our heads just trying to get by while the bankers continue to get richer and richer until there’s a set of systemic defaults like we have on our hands now.

    I think the 2000 – 2020s will be remembered as the years that the malignant banking tumor killed governments and economies.

  54. It’s a private company, you confiscatorialist! If their shareholders are dumb enough to put up with it, it’s their right to do it. Your encyclopedia of “shoulds” go no further than your own imagination with no grounding in law, morality, or the Constitution.
    Now, if you think it was bad for YOUR elected officials to subsidize GS, then your beef is with those geniuses.

    Stop moralizing like you are God of the universe.

  55. Others have already opined at length on “institutional control” of bank shares, but after 10 years of working on the buy-side (at 3 bulge bracket investment bank asset management divisions) I can attest to the fact that portfolio managers are some of the most negligent participants of all when it comes to exercising shareholder rights.

    Everything has been outsourced to the likes of ISS or RiskMetrics, it’s no wonder CEOs think they can get away with whatever they feel entitled to. We may as well hand our proxies straight over to management to vote for all the oversight “professional” money managers are performing.

  56. And with index funds for large companies like GS taking on an increasing role, there’s even less incentive for owners to take an active role in policing companies. People have been talking about the need to revise the way public companies are managed for at least 20 years now but little seems to come out of it.