Daniel Gross

Wall Street Pinches Pennies in Effort to Avoid Bonus Cuts

Contrary Indicator

At Goldman Sachs, employees now have to use debit cards to pay for sandwiches and salads. Cafeterias are going cashless. As Susanne Craig and Kevin Roose report in the New York Times, it's all part of an effort to save on the cost of having armored cars come and haul the cash away. (Insert your own Goldman heist joke here).

When company executives take unpopular cost-cutting moves, they frequently blame Wall Street. Investors are dissatisfied with results. They're focused on the bottom line. They must be appeased. As a result, employees in companies and industries enduring a tough spell frequently find that life imitates Dilbert: the memos on using both sides of the paper, hiring freezes, draconian new expense account reimbursement policies, the blunt instrument of layoffs, the pointless exercises in pinching pennies. Now, as I discuss in the accompanying clip with the Daily Ticker's Aaron Task, it seems like Wall Street is finally getting a taste of its own medicine.

It's been a miserable several years for stockholders of Wall Street firms, even if their employees have been doing quite well. Over the past two years, as this chart shows, the KBW Capital Markets Index is off about 30 percent, while the S&P 500 is up about 10 percent. The heads-I-win-tails-you-lose-but-I-still-win-because-I-have-an-MBA mentality held through the first few years of the post-Lehman bust. But many of Wall Street's underlying businesses aren't that profitable in non-bubble environments. When volatility spikes and markets slump, it's even more difficult. Throw in the poisonous overhang of toxic debt, and regulatory requirements to hold more capital, and it's shaping up to be a tough year on Wall Street. So with time winding down on 2011, executives are springing into action.

Across the board cuts? Check. Bank of America said two weeks ago it will lay off 30,000 employees.
Going after the little people first? Check. Credit Suisse has laid off administrative assistants in its investment banking unit. Niggling cuts designed by bean counters? Check. Roose and Andrews report that Goldman is cutting the size of the drink cups in the cafeteria from 12 ounces to 10 ounces, that Morgan Stanley is now cutting back on watering the plants, and that Barclays is telling people not to use cell phones for non-business use.

Such small-bore efforts are even more ridiculous at Wall Street firms than they are at, say, a paper company like Dunder Mifflin. Why? Because the money saved by such efforts pales in comparison to the compensation of top executives. However much Goldman is saving by cutting the size of paper cups, it is almost certainly dwarfed by the $13.2 million CEO Lloyd Blankfein earned last year. If there are pennies lying around the coffee-break room, there are $500 bills lying around the C-Suite.

In addition, the focus on the cost of administrative assistants, or on the number of minutes employees use on their wireless plans, is a vast effort at redirection. Bank of America isn't a single-digit stock because it has 30,000 too many employees. Rather, it is suffering because its executives made horrific lending decisions during the credit boom, and because former CEO Kenneth Lewis compounded such efforts by acquiring Countrywide Financial. Wall Street's problem today isn't excess spending on supplies and overhead. The problem is a business model and culture that is hostile to clients, shareholders and, frequently, the public interest.

In industrial firms, where materials and distribution account for 80 percent of total costs, re-engineering can make a significant difference. But Wall Street doesn't really spend money on anything but employee compensation. It's not uncommon for investment banks to spend half their revenues — not half their profits, half their revenues! — on salaries and bonuses. In 2010, the compensation-revenue ratio at Goldman was about 40 percent in 2010, up from 35 percent in 2009. Morgan Stanley last year paid out 51 percent of revenue in compensation, though that was down from 62 percent in 2009. At boutique bank Lazard, compensation was about 58 percent of revenues in the second quarter.

Companies serious about raising the bottom line would focus on compensation first, and on things like cell phones and free sodas second. But that's not what Wall Street has done. As Andrews and Roose write: "During the first six months of the year, Citigroup, JP Morgan, Goldman, Morgan Stanley and Bank of America set aside $65.69 billion to cover compensation and benefits, up 8 percent from a year ago, according to data provided by Nomura."

That would be acceptable if Wall Street firms were outperforming the market, or at least not lagging it. For years, Goldman has been compensating its executives and employees as if they are the world's greatest managers and investors. But as this long, sad chart shows, Goldman has lagged the S&P 500 over the last five years.

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Goldman Sachs

Wall Street has no problem paying huge bonuses and excessive compensation in the face of pathetic stock results for two or three years -- but not for four or five. And that's why the news on penny-pinching is inspiring anxiety on trading floors and in real estate offices in the Hamptons. If Wall Street really wants to get serious about reducing expenses, it'll have to cut bonuses.

But don't expect Wall Street CEOs to launch a preemptive strike. The prospect of a big year-end payout is literally the only thing that gets many people on Wall Street to show up in the morning. Without the carrot of a bonus for 2011, competent employees would start seeking greener pastures. Besides, there's always the chance that a huge rally, or a few awesome trades, could save the year. If that doesn't happen, come January Wall Street managing directors will find themselves pining for the days when morale was sapped by edicts to use Google instead of dialing 411.

Daniel Gross is economics editor at Yahoo! Finance.

Email him at grossdaniel11@yahoo.com; follow him on Twitter @grossdm

His most recent book is Dumb Money: How Our Greatest Financial Minds Bankrupted the Nation

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