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The Solution to the Goldman (and by Extension, the Securities Industry) Compensation Dilemma
Here is a different way of looking at the compensation issue. I believe I was one of the first of this new wave of blogger/investors to short Goldman publicly in early 2008 (see Goldman Sachs Snapshot: Risk vs. Reward vs. Reputations on the Street and Reggie Middleton on Risk, Reward and Reputations on the Street: the Goldman Sachs Forensic Analysis).
The impetus behind the short thesis was simple. Goldman is an
investment bank, just like its bulge bracket brethren, and the risk in
its environment threatened all of them the same. Contrary to popular
belief, Goldmanites bleed red blood and spend green dollars, just like
the rest of us.
As you can see above, Goldman actually tends to move in tandem with the rest of the street.
| Correlation to June 2008 | |
| 77.95% | GS and MER |
| 84.98% | GS and LEH |
| 69.57% | GS and MS |
| Correlation before Securitization Crisis Starts (10/06) | |
| 91.26% | GS and MER |
| 91.57% | GS and LEH |
| 56.19% | GS and MS |
Bear Stearns went down and contrary to popular belief, it was obvious
to see it months before hand as I clearly pointed out nearly a quarter
before they collapsed, see "Is this the Breaking of the Bear?".,
as did Lehman (who also forcasted their demise through their balance
sheet so it shouldn't have been a surprise to anyone either - "Is Lehman really a lemming in disguise?", Lehman rumors may be more founded than some may have us believe, and Lehman stock, rumors and anti-rumors that support the rumors.
Morgan Stanley was next up on the chopping block as the "then" "The Riskiest Bank on the Street",
as was Merrill Lynch. Then they all got saved. Merrill was overpaid for
by BofA through and apparent extortion deal. GS and MS became
government chartered financial holding companies (basically federally
insured banks) quick fast.
"Why do you bother to show the similarities between Goldman and the
other banks whose demise you forecasted so publicly?" you ask. Because
it goes right to the root of this compensation issue. If Goldman were small enough as to not pose a systemic risk, I really wouldn't care how much Goldman pays its employees, nor how they paid them. Alas, they do pose a systemic risk. The
dilemma currently at hand is not that Goldman pays their employees too
much (although they do, but that is an issue between the shareholders
getting raped and the company management, much like the issue of Tiger
Woods or Bill Clinton's fidelity issues - it is really between them and
their families, not us) it is that Goldman effectively paid their
employee bonuses with tax payer monies. It was a doomed company, just
like Bear Stearns, just like Lehman, just like Merrill if the BofA deal
would have taken a week or two longer to close. Don't think I know what
I am talking about? Take a look at the dates of the doomed Ibank links
above. I have a pretty good track record. Did you hear any of these
banks say that their brethren were going to fail? 'Cause you damn sure
heard it from me. It has nothing to do with me being smart, either (I'm
actually an average intellect type). It has to do with being objective
and observant. I do pay attention.
The taxpayer dove in and saved them in a myriad of ways, including
the AIG flow through, TARP, bond guarantees, ZIRP, and the list goes
on.
To pay bonuses with taxpayer money is a travesty, and is literally
antithetical to the concept of capitalism. To do such is to declare
yourself a ward of the state, not an icon of capitalism. Thus the
recent stated solution of paying the top 30 executives bonus in
restricted stock subject to clawbacks not only fails to go far enough,
but also goes in the wrong direction (but it does scrape the surface of
holding upper management more accountable for risk). Even that
restricted stock was earned using taxpayer dollars. It should not be
granted at all without the taxpayer getting paid the "vig". Once the
taxpayer is made whole for all of those hard money loans that were
given (currently about 16% plus 6 points up front), then we can discuss
what is essentially Goldman's return to its partnership days where
partners were forced to risk their own capital in lieu of risking
shareholder capital. Notice how, when I banks were partnerships and
before they had other peoples money to blow up, these occurrences
happened much, much less frequently.
In addition (and this is a BIG addition) limiting the restricted
stock/clawback provisions to just the top thirty executives fails in
that most of the transactional and enterprise risk is generated from
the guys who actually create the products and perform the transactions.
These guys are significantly below the hierarchical threshold announced
by this plan. By limiting the (truly) meritorious pay to their boss's
boss's boss, you at the very best are exposed to supervisory error and
at the worst collusion. Everyone should be included in this program,
particularly traders, financial engineers, salespersons, analysts and
bankers.
Lest we not forget, any loan program that allows them to monetize
the restricted stock should be FULL RECOURSE!!! That means that if
they borrow off of the stock then get busted doing the GSAMP thing to
their clients (see Reggie Middleton vs Goldman Sachs, Round 1
and the graphic below), the company goes after them for the capital,
regardless of the current situation. It this is unpalatable, then there
should be no lending off the restricted stock. That's right, I am even
going far enough to presume that Goldman (and all banks) should have a
fiduciary duty to their clients!
On a final note, while it is always fun to pick on Goldman, this is not
a Goldman thing. It is a Wall Street, City (the Brits, too!) thing. JP
Morgan poses much more of a threat to the global economy in case of a
blow up than Goldman (see An Independent Look into JP Morgan, please!). Shouldn't those guys' risk taking incentives be reigned in first???
Click graph to enlarge
Cute graphic above, eh? There is plenty of this in the public
preview. When considering the staggering level of derivatives employed
by JPM, it is frightening to even consider the fact that the
quality of JPM's derivative exposure is even worse than Bear Stearns
and Lehman‘s derivative portfolio just prior to their fall.
Total net derivative exposure rated below BBB and below for JP Morgan
currently stands at 35.4% while the same stood at 17.0% for Bear
Stearns (February 2008) and 9.2% for Lehman (May 2008). We all know
what happened to Bear Stearns and Lehman Brothers, don't we??? Fail to
heed my warnings if you want to... (Is this the Breaking of the Bear?).
Well, that's my 90 cents worth. It was my two cents worth, but I levered up 22x!!! For those sharp folk who are wondering, I have the rest off balance sheet :-)
In the news:
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How's that MAC trade working out for you dog?
It's going as is expected.Why would you even bother to ask so early in the game? It has not been on but a very, very short period and these things take time to develop. You're definitely not going to know if you are wrong or right in a couple of weeks. Surely, you knew this, right Mr. Anonymous?
GGP took nearly a year to run full circle. Was it worth it? I think you mistake me for a trader, which I am not.
Oh relax RM. Any word about the bobbleheads? Will they be in the ZH Store before Xmas?
Reggie, thank you very much for your enlightening work.
Have you ever reckoned what the capital requirements would be if regulations were to require most derivatives trades to go through a clearinghouse and how that might affect the capital structures of the largest holders?
Interesting as always, Reggie. In a future post, could you elaborate on what the realization of JPM's derivatives exposure could look like. With the government backstop to everything, it seems most people have become complacent to these risks. I'm not asking for your insight as to what will finally cause the event, but rather what the event will look like. Does JPM go into bankruptcy? Does USG finally takeover the banking industry? Do we end up with a currency crisis that is exceeds the damage to JPM? Curious your thoughts.
It's all speculation, but I think if something were to kick off it would result in a domino effect of counter party defaults, very similar to what almost happened with Lehman, what would have happened with AIG if the USG didn't step in, and what would have happened with Bear Stearns without the USG.
Going by precedent, the USG is the ultimate put option behind imprudent counterparty risk. The real question is how much collateral damage will the USG be forced to let fly the next time around. That is something which I will not even try to speculate, but I do know that the government feels the need (politically) to let the weak fail.
Thanks, Reggie.
pay all bankers in the face value of CDS with CDS. Pay all bankers in derivatives.
I like it. PIK. We might get a read on what that sh*t is really worth from the bonus babies aftermarket.
The solution is far simpler. Kick the shit out of anyone who got a bonus this year at the expense of citizens. Let's shoot for one in three children on food stamps. Is that enough!?
You fucks of finance think that you need guns? You better not miss because I won't.
As usual sharp as a tack and 2 the point Reg--ditto JohnKing---
Reggie here is something to chew on
Table 1A as always adjusted adjusted adjusted
Table 1B not adjusted---wait till the xmas blowhole is shut.
http://www.census.gov/retail/marts/www/marts_current.html
I believe the optimal solution (certainly over a "transaction tax") would be to require investment banks to set aside capital in the form of maintenance margins for the derivatives they create. This would simultaneously limit the growth of the derivatives, the institutions, compensation, etc. while limiting systemic risk.
A 2% margin requirement on say $684 trillion outstanding OTC contracts (as of June 2008) would be $342,000,000,000 or roughly 21 times JPM's current market cap. I know there is bilateral netting, but the numbers are ginormous and it would take JPM years of actually retaining profits just to build the required capital to put them in the ballpark.
Goldman is a free market failure and a welfare recipient. No one at that firm nor the shareholders are entitled to any "profit" sharing until all forms of welfare (including backstopped loans) are replaced with private capital.
nice reggie. I think its very important to keep focusing on how the continued explicit (bond guarantees, etc) & implicit (pushing up asset mkts) by the fed/govt & ultimately the taxpayer continue to drive these profits. Especially guys like MS & GS who dont make actual loans to small businesses / people, but can borrow @ the discount. They all know they were saved by the govt, & wouldn't exist w/o all of the moral hazard. I would know, I was on the receiving end of it when I was employed @one of these firms, & John Mack got them to prohibit short selling on the financials to get a stay of execution last fall.
That stay actually drove the value of my existing puts through the roof!
nice. that move also blew up the convert mkt. unintended consequences from when scared, rattled amateurs play the game
Great point. It is what I have been telling everybody. We never hear of a whiff of a scandal from Brown Brothers Harriman, the last of the old-time banking partnerships. And this isn't because the BBH partners are move virtuous than their corporate colleagues. Not at all. I am sure that they are as greedy as anybody at Goldman or Morgan. The difference (all the difference) is that they are greedy with THEIR money. 100% of what they put at risk is their money, and only their money. Concentrates the mind, doesn't it. Back to the partnership model. Long live PRIVATE GREED.
wgpitts:
The caliber of people working at the major financial institutions today is outstanding. The rif-raff that got us into the sub-prime mess has, for the most part, been washed out of the business.
What's left are the best-educated, hard-working, most-conected folks out there. They work hard, but deserve the fruits of their labor in the form of solid year-end bonuses. Of course, this will also have a trickle-down effect, keeping landscapers, caterers and others in business as the upper-class starts spending again.
The world needs an affluent upper-class even if it at the expense of taxpayers over the short-term.
From
http://www.goldmansachs666.com/
As you will see, the news of the day is GS eliminating "cash" bonuses for many of its top exec's. Everybody - again as you will see - is talking about this. There are a few who are still talking about the GS gun toting employees but few report on the real issues of
Goldman Sachs.
We provide these daily links to allow you to view what is "out there" about GS. From the New York Times to the Wall Street Journal to Reuters and Bloomberg News as well as many bloggers and financial and economic blogs. Yet, with all the information out there, with the admission of Lloyd Blankfein that they caused the economic crisis and even offered an apology, NO ONE IS WRITING ABOUT IT!
Worse yet is the fact that NO ONE is taking legal action or initiating investigations. Where is our Justice Department? Where is our Congressional oversight? Where are our 50 states and their regulatory agencies? I just don't get how someone can admit to conning the world to the tune of trillions of dollars and then try to make amends by saying no cash for bonuses.
As to no cash for bonuses, don't be the least bit fooled by this new PR attack. At the rate they are manipulating, pillaging and profiting using free money, getting a dollars
worth of stock instead of the dollar in reality pays them MUCH MORE.
Unfortunately, most poeple in this country listen only to small sound bytes from our national media like NBC, CBS and ABC. Sure there is FOX and CNN but the big three have the market share and until they run the story at "the top of the hour", most Americans just don't know. They will not, so it is up to us in this world of the blogosphere to spread the word and the news around.