Bank bonuses out-size market cap

Source : Economist

“ISN’T it funny/How they never make any money/When everyone in the racket/Cleans up such a packet.” That Basil Boothroyd poem was originally written about the movies, but it could just as well apply to banking.

In its last three years, Bear Stearns paid $11.3 billion in employee compensation and benefits. According to its 2007 annual report, Lehman Brothers shelled out $21.6 billion in the three years before, while Merrill Lynch paid staff over $45 billion during the three years to 2007.

And what have shareholders got from all this? Lehman’s got nothing (the company went bust). Investors in Bear Stearns received around $1.4 billion of JPMorgan Chase stock, now worth just half that after the fall in the acquirer’s share price. Merrill Lynch’s shareholders got shares in Bank of America (BofA) which are now worth just $9.6 billion, less than a fifth of the original offer value. Meanwhile, Citigroup paid $34.4 billion to its employees in 2007 and is now valued by the stockmarket at just $18.1 billion.

All this has reinforced the idea that banking is simply a gravy train for employees. The row over the early payment of bonuses at Merrill Lynch shows yet again that insiders’ interests come first (those to BofA staff, however, are likely to shrivel).

The case against banks goes something like this. Over the past 25 years, the cost of finance has been low and asset prices have generally been rising. That has encouraged banks to use more leverage in order to earn high returns on equity. The process of lending money against the security of assets, or trading assets with the banks’ capital, helped to push asset prices even higher. A sizeable proportion of the profits that resulted from all this activity was then handed out to employees in the form of wages and bonuses.

But when asset prices started to fall, the whole system unravelled. Banks were forced to cut the amounts that they had borrowed, putting further downward pressure on prices. The “shadow banking system”, which relied on bank finance, started to default. The result was losses that outweighed the profits built up in the good years; Merrill Lynch lost $15.3 billion in the fourth quarter of 2008 alone, compared with the $12.6 billion of post-tax profits it earned in 2005 and 2006 combined.