Docking Bonuses, or How They Stopped Working For A Big Bank

If Congress moves to limit Wall Street compensation as was outlined last week, and other big banks follow UBS’s lead by squashing cash bonuses, offering stock-only incentive checks while instilling some seriously tough claw back provisions, armchair anti-Wall Street quarterbacks will have reason to cheer, but if this does occur, things inside big-bailed-out-bank board rooms could potentially look a lot worse than they do now in some not-so-distant fiscal quarters.

A few more thoughts on the proposed salary cap/bonus cutbacks, focusing on what a large portion of Main Street might not realize about Wall Street:

Investment banks do more than make bad trades: Investment banks have multiple divisions—in addition to sales and trading, they have corporate finance, merger and acquisition, equity and fixed income underwriting, and leveraged finance units, among others—and certainly not all of these divisions at all bailed out firms were responsible for the billions in losses topping headlines. At some banks, certain divisions made considerable profits in 2008, which were lost (in the shuffle, and literally) due to their firm’s enormous trading and investment losses. If you remove the more profitable divisions of certain firms, instead of needing $X billion in bailout money, now they need $X + $Y billion (of course, X > Y). That said, it does make sense that the executive suite should not receive bonuses during years in which overall profits were not profits at all but losses, since all of a firm's divisions report to the suite. (Exhibit A: Deutsche Bank’s CEO elected to not receive a bonus this year, and his staff received 60 percent, on average, less in bonus pay for their work in '08 versus '07, and those in divisions directly affected by the worldwide crisis such as proprietary trading and mortgage securitization were hit the hardest.)

There’s more than one way to make a million bucks: It’s already been happening, but if salary caps are enlisted to affect all senior bankers, then expect even more high-level staff at government-bailed-out banks to leave for middle-market banks, boutiques and straight-up advisory firms that didn’t receive bailout money. Or, these senior bankers at bailed-out banks might just start up their own advisory firms, like the Perella Weinbergs and Moelis & Companys of the world; senior bankers' incentive to stay at firms with restrictions on compensation will be just about nil if they can land on their feet elsewhere. Of course, without big dealmakers next year (or in 2010 and 2011 and beyond), bailed-out banks won't have to pay big bonuses, but it’s likely they will book far fewer profits and (see above) could need even more bailout bucks as a result. (Exhibit B: Evercore’s new MD.)

This is no Dolly Parton-type of gig: As was written about on CNBC.com and other places in the past few days, what the majority of the U.S. public does not understand is that in investment banking the word "bonus" has never actually meant "bonus" but rather "deferred compensation"—compensation which is verbally implied if not explicitly written into a bankers’ contract. And though these “bonus” numbers are astronomical versus the average corporate worker's salary, bankers (junior and senior alike) do not typically work 9 to 5 M-F schedules but more like 9 to 10 (pm) ones M-S (and this S often stands for the Lord’s day, not the one after Friday). As I see it, lowering the pay at the top will lower the pay at the bottom will lower the incentive for everyone left at these firms to work long hours will lower the deals being done per year will lower the bottom line potential at these firms will lower their stock price valuations (while lowering their ability to pay back any borrowed bailed-out cash) and thus will lower bankers' annual compensation payouts even further (granted that they receive more of their comp in stock). (Exhibit C, I think.)