Friday, June 12, 2009

Calling Cloud-Cuckoo-Land

Tereus: "So why have you come here? What do you need?"
Euelpides: "To talk to you."
Tereus: "What for?"
Euelpides: "Well, you were once a man, as we are now.
You owed people money, as we do now.
You loved to skip the debt, as we do now.
Then you changed your nature, became a bird.
You fly in circles over land and sea.
You’ve learned whatever’s known to birds and men.
That’s why we’ve come as suppliants to you,
to ask if you can tell us of some town,
where life is sheepskin soft, where we can sleep."

— Aristophanes, The Birds

I suppose I do admire Evan Newmark on some level.

I mean, the former Goldman Sachs investment banker and current Mean Street commentator for The Wall Street Journal certainly sticks to his guns. Free markets, in his opinion, are the ne plus ultra for allocating and distributing economic goods, government interference in free markets is always and everywhere bad or doomed to failure, and government officials, while occasionally smart and/or well-intentioned, can't help but make things worse by their officious intervention. (Unless, of course, such officious, high-handed interference is directed by the former CEO of his previous employer, in which case he judges the man and his actions to be unqualifiedly "heroic.")

But on a more important level I find the man remarkably out of touch. To my experienced ear, he sounds like nothing so much as a throwback to another era, an investment banker of the 1990s and early 2000s who was raised, trained, and promoted in an industry environment which has gone the way of the Dodo bird. I find his fire-breathing defense of untrammeled markets and breathtaking sense of personal entitlement sort of charming, really, like an awkwardly posed sepia portrait from another age. It makes me feel warm and fuzzy inside, like any good piece of nostalgia.

But nostalgia usually makes for bad policy. And, in Mr. Newmark's case, some sadly risible commentary.

* * *

My thoughts turn this direction this afternoon in response to a piece Mr. Newmark penned concerning the appointment of Kenneth Feinberg as the Treasury's “Special Master of TARP Executive Compensation.”

Mr. Newmark does offer a couple nods to Mr. Feinberg's presumed intelligence and demonstrated experience in tackling thorny compensation issues. But he is skeptical that this experience will serve as adequate preparation for the task at hand:

Now, if there’s anybody who can figure this out, it should be Mr. Feinberg. He managed the unmanageable in his 33 months doling out $7 billion of the September 11th Victim Compensation Fund.

But setting pay for the TARP executives will prove much trickier than dispensing monies to the families of 9/11 victims. And that’s because — pardon my bluntness — the execs are living and the 9/11 victims were dead.

In the case of the 9/11 Fund, Mr. Feinberg applied a rigorous quantitative method to come up with a pretty generous payout to each victim’s family. It was largely a static calculation of an extraordinary, one-time payout.

Now, if Mr. Newman means to imply that having almost unlimited power to divvy up a fixed and unchanging compensation pool one time is an easier task than working with the management of TARP banks to set ongoing compensation for their executives, I have to say I agree with him. But that is a trivial and obvious point, and I do not think he means to limit himself to just that objection. He clearly thinks setting compensation for senior executives in the banking industry is a whole other order of magnitude more difficult than that.

He is supposed to determine “appropriate” pay — but good luck defining that.

Of course, Mr. Feinberg will try and come up with some formulas. But the permutations are endless. Look at all the differences in job responsibilities, titles, reporting lines and lines of businesses among the top 700 execs.

Then look at all the existing differences in the size and mix of compensation — the endless variations in salary, bonus, benefits, tenure, lockups, termination clauses, mixes of cash and stock and multi-year vesting schedules.

Finally, consider that this is annual compensation set in an ever-changing competitive marketplace for high-priced talent.

You see, Dearly Beloved: setting compensation for the most privileged and highly compensated executives of one of the most hated industries in America is so much more complicated than communicating the monetary value of a life to the very much alive and grieving relatives of a bunch of publicly lionized terror victims.

Notwithstanding whatever Mr. Newmark's personal experiences were in the conference rooms where he learned of his bonuses over the years, I can guarantee him there is no more fraught and potentially contentious conversation you can have than putting a dollar value on the violently extinguished life of a spouse or a child with that victim's family. And Mr. Feinberg apparently had both the good sense and the intestinal fortitude to come up with a compensation plan that took into account age, relative lifetime earning power, and other distinguishing characteristics, rather than taking the easy way out and paying the relatives of a widowed 63-year old janitor the same as the family of a 28-year old bond trader with a wife and three kids. I do not think Mr. Feinberg will have trouble dealing with complexity, differentiation, and nuance in his job.

And that's another thing. Why would Mr. Newmark assume that Mr. Feinberg plans to cram the endless variety of job function, profitability, and management responsibility among these investment banking executives into some sort of formula(s)? What is to prevent him from discussing, negotiating, and codifying some set of broad principles instead? It's not like he has been given a $7 billion pot of money which he has to allocate to the last penny among a fixed number of claimants, for pete's sake.

Measuring the effectiveness of investment banking management is just not that complicated, when you cut through the crap. You make money, you risk capital, you supervise people, and you build culture. With the potential exception of the last item, all these tasks can be measured pretty easily. So measure them, and pay based on results. Then, overlay on top of annual compensation the idea of deferred pay, which serves the dual function of aligning the manager's interests more closely with those of shareholders and other stakeholders and strengthening the manager's ties to that organization. Bingo. Two principles, six objectives. Simple. Job sorted.

The "endless" permutations and variations in responsibility and pay which Mr. Newmark cites as reason for the impossibility of Mr. Feinberg's task are just bullshit. That is the traditional perspective of a traditional investment banker, who has spent his entire career screaming at the top of his lungs how he is unique, how he is better than his peers, and how he goddamn well better be paid 100% more than the next highest paid guy or he's gonna walk out the door stat. Bullshit, bullshit, and more bullshit. Investment banking is a commodity business, and investment bankers are almost always nowhere near as special as they would like themselves or their compensation committees to believe. They make lots of money because they are in an industry which makes a lot of money. The problem is, they quickly begin to believe they make as much as they do because they are worth it, they are that good. It's like the entire industry is comprised of squeaky wheels constantly squealing for more grease.

* * *

You know who I bet is most looking forward to the arrival of Mr. Feinberg on their doorstep? TARP bank Executive Committees and Boards of Directors, that's who.

These are the people who have had to deal with these overbearing prima donnas for years, and I can guarantee you that nobody likes that job. Wouldn't top management just love being able to tell Mr. Big Swinging Dick that he can't have a compensation package that falls outside the rules Mr. Feinberg has laid down? I know I would. Sure, you might lose a few good bankers to Deutsche Bank, or some other empire-building pack of yahoos who think buying a few dozen high-priced investment bankers will get you up to the level of Morgan Stanley or Goldman Sachs in a couple years. But a) there aren't enough seats in the shrinking industry for all the would-be BSDs to fill anyway, and b) the empire-building yahoos never pose as much of a threat as you fear or they hope. They may make some money for a few years, but they almost never build a sustainable culture, and they usually end up losing their shirts and firing all the washed up rainmakers they poached from their betters. By that time, of course, the bank Mr. BSD jumped from has filled his seat with a younger, cheaper replacement who is just as effective.

There is nothing a negotiator likes more than having a credible excuse that his hands are tied when it comes to certain items. "Sorry, man, I'd love to give you a 1/16 share of the company jet as part of your package, but those government bastards just won't let me. [Snicker]"

And, like most of his former peers in the industry, Mr. Newmark seems to be unaware (or in denial) that most investment bankers are price takers when it comes to compensation packages. Only the top guys get any leeway in writing their own ticket. The rest of us get stuffed with complicated tranches of deferred stock and options, incomprehensible termination clauses, and unconscionable lockup provisions because that's what our employer offers. Any system which could help simplify industry pay practices would not only benefit employees mightily, it would reduce the enormous clerical and legal burden investment banks carry simply administering their boilerplate gobbledegook.

Lastly, for someone who is as fierce an advocate of free labor markets in banking as he is, Mr. Newmark seems to have surprisingly little faith in their robustness. Else, how can he claim that

on Wall Street, decisions at the top flow straight through to the bottom. Compensation is a pyramid. Start tinkering with the pay of the CEO and his lieutenants, and soon the pay of the vice-presidents and associates gets cut.

Uh, no. Even if there are explicit limits set on the pay of senior executives, why would the market laws of supply and demand automatically be repealed for lower level bankers not subject to constraints? It strikes me that Goldman Sachs and Morgan Stanley had better pay competitive market wages for their Analysts, Associates, Vice Presidents, and non-executive Managing Directors—no matter how few millions Lloyd Blankfein and John Mack take home—or their precious franchises will begin to wither away pretty damn fast.

I have no idea what plans Mr. Feinberg may have regarding his position, and what principles or rules he may or may not impose. His admirably rational conduct during the highly public, emotionally fraught process of compensating the September 11 victims gives me great comfort that he is neither a wealth-leveling redistributionist nor a wild-eyed socialist bent on destroying the banking industry. If, however, he intends to undertake what Mr. Newmark calls "the thankless and impossible task of replacing the free market," then he is indeed a fool sent on a fool's errand. I see no evidence of that, but we will just have to see.

In the meantime, the fact that what comprises "competitive" wages is declining in the banking industry has nothing to do with regulation, and everything to do with declining industry profitability. In other words: supply and demand. Evan Newmark should be proud.

* * *

Just for fun, I will leave you on a provocative note. Those free marketeers who have stuck with me this far have the opportunity to get even more riled up over the weekend.

I would not suggest that Mr. Feinberg or anyone else in the Obama administration has such intentions, but I would note that broad based compensation principles might be used in a larger policy context than simply palliating voter anger and (hopefully) mitigating excessive systemic risk. For instance, much has been made of the concept of banks which are considered "too big to fail." If, in fact, there is an urge to limit the size and systemic importance of any one financial institution in the marketplace, perhaps the concept of an industrywide salary cap is worth exploring. I think it would have to have some tie to industry revenues, since presumably no-one wants to limit those ex ante, but it should also be tied to profitability. I am sure there are all sorts of unintended consequences which could arise from such a policy—of which the devoted sports fans among my audience could no doubt enlighten me—but properly structured it might be a very neat way to let free market forces operate relatively untrammeled within the confines of overarching economic policy limits.

Consider: Instead of one Goldman Sachs, one Citigroup, and one Wells Fargo, we could have 50 or 60 little Salomon Brothers, Bank Ones, and EF Huttons. Just think of the sponsorship opportunities!

I encourage fans of Ayn Rand, Karl Marx, and the New York Yankees to discuss this amongst yourselves. I would be happy to join you, but I am afraid I have a previous commitment.

© 2009 The Epicurean Dealmaker. All rights reserved.