Bonuses: Best explanation I have seen of what caused the crisis

http://www.nytimes.com/2008/12/18/business/18pay.html?_r=1&ref=business

Excerpt:

"Merrill handed out $5 billion to $6 billion in bonuses that year. A 20-something analyst with a base salary of $130,000 collected a bonus of $250,000. And a 30-something trader with a $180,000 salary got $5 million.

But Merrill’s record earnings in 2006 — $7.5 billion — turned out to be a mirage. The company has since lost three times that amount, largely because the mortgage investments that supposedly had powered some of those profits plunged in value.

Unlike the earnings, however, the bonuses have not been reversed."


The whole article is worth reading. Now I understand exactly where the money went and why it's not coming back. And also why so much of it was lost - these guys had a huge incentive to rack up gains on one side and losses on the other.

There should be a lot of people in jail after this. So far, no one.

I always thought he was one of the good guys...warning about the Housing Bubble early on. I guess he was just covering his own butt.

And, the article sort of says nothing will be done about these crooks. Just move on and forget the past. How much more crap can be swept away on Wall St. and in our Government?

more from the article:


For now, most banks are looking forward rather than backward. Morgan Stanley and UBS are attaching new strings to bonuses, allowing them to pull back part of workers’ payouts if they turn out to have been based on illusory profits. Those policies, had they been in place in recent years, might have clawed back hundreds of millions of dollars of compensation paid out in 2006 to employees at all levels, including senior executives who are still at those banks.

In that movie, early on, Bud hasn't made any sales, so he is literally broke and down to his last $20 and has to borrow from an office mate. Well, that's how the Wall Street pay structure works. They make relatively little in salary (emphasis: "relative," compared to obscene total comp), and the overwhelming amount of their compensation is in "bonuses."

Most Wall Streeters have already spent their bonuses long before they receive them. Some even have taken "draws" or advances and loans on their bonuses, so if the bonuses aren't paid, the employees are in debt to the bank.

Also, each department calculates bonuses based on the performance in that department. So the fact that the bank is failing overall because of the mortgage security division, can't necessarily prevent the bank from having to pay bonuses to, say, a trader at an equities trading desk, who met and exceeded his performance goals.

Crazy system, and the salary + bonuses are way excessive anyway, but it doesn't surprise me that the banks won't avoid paying bonuses.

because the illusion that the "low" salaries give on the books tends to soothe the ruffled emotions of stockholders who know they're getting screwed on the dividends because so much is being raked off at the top.

You're also right that most of those guys are in hock to their eyeballs. They've been encouraged to think the good times will last forever, and they've all gone into hock for gold plated lofts commensurate with their importance to the universe and which they now have no hope of paying for or selling to a bigger fool.

Anyone the banks and brokerages need to hang onto will get that bonus.

There's no doubt that the bonuses paid out are over the top, but this did not cause the financial crisis.

The financial crisis was caused at the front end by lax monetary policy which allowed people to borrow too easily and ran up the values of residential real estate.

The Bush Administration couldn't bring themselves to rein things in because they were worried about public perception during a war.

In short, just about everyone participated in the run up that led to the crash.

If it was only about lax lending standards and corrupt mortgage bankers encouraging unqualified borrowers to buy overpriced real estate, we'd be in a manageable recession. However, those bad mortgages were levered (up to 40 times), scrambled and sold around the globe to unsuspecting investors, laying the ground for the worldwide economic collapse. Financial institutions essentially created their own printing presses.

Wall Street's greed ranks right up there with the Fed's complicit foolishness and congress's sleazy quid pro quo system in the myriad list of causes.

due to the monetary policy at the time.

The engine was the continued creation of the mortgages, not what was done with them afterwards.

After home values slowed and defaults began increasing, the Wall Street creations began to get affected.

In general, the theory behind the mortgage packages worked, there was just an inadequate allowance for the underlying risk (which was that the mortgages might fail).

What made the difference and lead to this disaster was the REpublicans mantra of "DEREGULATION" - and the Commodities Futures Modernization Act.

"The Commodities Futures Modernization Act 2000" is what made trading in Credit Default Swaps legal AND COMPLETELY UNREGULATED. It is precisely because humans are greedy and some predictably will cheat (especially when there is a great deal of money to be made) that you must have regualtions to keep people from going crazy (and for example not keeping enough assets in reserve to back up the debt you are holding).

PHIL GRAMM was the major proponent of Deregulation of the Financial industry. He slipped the CFMA in as a rider to the Omnibus Spending bill 2000 - a 11,000 page document which was passed on the final day of the congressional session of 2000. Almost nobody even knew they were voting on this "Financial Bomb" hidden in the OSB. Gramm knew this was about the only way he could get this bill passed. On the last page of this law there is language specifically forbidding states from enforcing "anti-bucket shop" laws against banks trading in CDSs.

It was this law which set the stage for the abuses which produced the Credit Catastrophe 2008.

more on the CFMA:http://en.wikipedia.org/wiki/Commodity_Futures_Modernization_Act_of_2000
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The "Commodity Futures Modernization Act of 2000" (H.R. 5660) was introduced in the House on December 14, 2000 by Rep. Thomas W. Ewing (R-IL) and cosponsored by Rep. Thomas J. Bliley, Jr. (R-VA) Rep. Larry Combest (R-TX) Rep. John J. LaFalce (D-NY) Rep. Jim Leach (R-IA) and never debated in the House.<2>

The companion bill (S.3283) was introduced in the Senate on December 15, 2000 (The last day before Christmas holiday) by Sen. Richard Lugar (R-IN) and cosponsored by Sen. Peter Fitzgerald (R-IL) Sen. Phil Gramm (R-TX) Sen. Chuck Hagel (R-NE) Sen. Thomas Harkin (D-IA) Sen. Tim Johnson (D-SD) and never debated in the Senate.
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..... The bill was never debated by the House or Senate. The bill by-passed the substantive policy committees in both the House and the Senate so that there were neither hearings nor opportunities for recorded committee votes. In substance, it appears that the leadership of the Republican-controlled Senate and House incorporated the deregulation of credit default swaps into an omnibus budget bill (without hearings or recorded votes)at a time when the outgoing president was in no position to veto anything.
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Let there be no confusion here. The CFMA legalized Credit Default Swaps and prohibited any regulating of trading in them. This is what set the conditions, which many people feared would happen (that's why Gramm had to slip the bill through as a rider to a 'must-pass' funding bill).