Wall Street banks are set to do it again. It?s bonus time. The top 5 banks of the Magnificent Seven (US investment banks that got TARP money) have parked $90 billion for compensation. Almost half of it will be paid as bonuses in the current year, with the rest going to salaries and other benefits. Reportedly, Goldman Sachs will pay $5,95,000 on average and JPMorgan Chase, $4,63,000. AIG is said to have paid $3 million to consultants to justify inflated compensation and lacklustre performance.
Last year, Citi paid $5.33 billion in bonuses while losing $27 billion with plummeting stock and receiving $45 billion from TARP. Bank of America paid $3.3 billion in bonuses and received the same figure from TARP.
All this is happening as the US economy reels from 10% unemployment. Fearing public outcry, some investment banks reduced the percentage of revenue reserved for bonuses. Goldman Sachs reduced that percentage from 50% in the first quarter to 43% in the last quarter of 2009. However, many investment banks did extremely well in 2009 with record-breaking revenues, hence the magnitude of compensation will soar even if the percentage itself is lower.
This raises a host of questions. First, how was it possible for these banks to make huge sums of money as businesses on Main Street languished, inventories piled up and net lending to businesses exhibited negative growth? The second question is, if a private bank pays its employees out of money it made, why should that be a concern for others? Doesn?t it amount to gross interference in the basic freedom granted to institutions to make decisions about paying their employees? True, it looks a bit odd when lavishes are showered upon a few chosen people at a time when many others are without jobs, but that happens at other times to other people and nobody makes a fuss about it.
The real question is how much of current revenue generated by Wall Street banks comes from investing their own hard-earned money. Many of these institutions, including Goldman Sachs, have been converted to bank holding companies, enabling them to access the Fed?s discount window. On top of it, they also received TARP money, subsidised loans, loan guarantees and other sources of cheap funding. In addition, they can assume shareholder debt on a tax-free basis, enjoy easy borrowing and execute mergers with ease. Of course, these advantages are conferred on bank holding companies for their enormous importance to the banking system. Such policies are meant to bolster the rest of the economy via injection of credit and liquidity when necessary. However, given that net business lending decreased in 2009, where did they earn this huge bonus generating revenue? Instead of injecting credit with these subsidised loans, most of the banks reaped profits from trading in foreign exchange and other securities and conducting business for the government that could have been allotted to others. For example, much of Citibank?s profit from its Global Transaction System depends partly on the Fed and the US government for activities such as passport processing, fund transfers and currency conversion, and the group received an additional government subsidised loan of $20 billion during this time.
Hence, quite a big part of the revenue earned by these banks and the percentage allocated for bonuses originates in part from a huge direct government subsidy, partly due to conversion to bank holding status, and the rest due to the banks? own value-adding activities. This has two broad implications. First, getting access to funds as a bank holding company and then using a part of the funds for trading and not for lending betrays the original purpose of these subsidies. Second, diversion of subsidised loans to riskless activities like trading in securities or transfer of funds implies that banks are devoting their resources to low-risk activities by switching away from relatively more productive activities like extending and ploughing back loans to businesses that deserve loans. That is, if prior to the financial crisis, investment banks ?overpushed? loans to riskier mortgage business, in the post-crisis era, they are doing the opposite by rationing loans to better projects and channeling funds towards low-risk (trading) activities while enjoying all the benefits of a bank holding company.
Of course, these banks have expertise in earning money by trading various securities, but the point is that they should finance such operations either from their own internal resources or from funds obtained from the market, not from subsidies from the Fed meant for doing something else. At the least, then, they should refrain from paying large bonuses and add this money to their capital base. However, blaming these banks for this is futile. This sad state of things rather reflects the poor design of bailout plans, absence of a regulatory structure for effective monitoring and lobbying power, as well as the political clout of Wall Street banks.
The author is reader in finance at Essex University
