Wall Street Déjà Vu: Lackluster Profits Equal . . . . Record Bonuses?

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Former Pay Czar Kenneth Feinberg is among the people who have tried to rein in Wall Street pay (Jason Reed/REUTERS)

When it comes to bonuses, Wall Street is stuck in the hot tub time machine.

Apparently, it takes more than the fall of two storied investment firms, a financial crisis, a bailout, Andrew Cuomo, a pay czar, the Great Recession and regulatory reform to bring down bank pay. Investment banks and financial firms are reportedly planning on handing out fatter paychecks and bonuses this year than in 2009. Top Wall Street pay consultant Alan Johnson says he expects compensation by Wall Street firms to rise 5% in 2010. An analysis in today’s Wall Street Journal predicts a similar 4% rise. (The article comes complete with a very cool interactive graphic worth checking out.) That’s not a big jump, but at a time when earnings appear to be faltering on Wall Street, higher year-end bonuses are raising eyebrows all over again. Here’s why:

Wall Street reforms were supposed to force financial firms to better align pay with performance. That doesn’t seem to be happening this year. Profit-wise the second quarter was a disappointing one for many of the large banks. After what was by all measures an amazing profit rebound in 2009, this year has been a dud. For most firms, Wall Street bottom lines are supposed to be about what they were a year ago. Some firms may even see profit drops. Not much to reward workers for, at least not a record levels as the Journal predicts, you would think. To be sure, banks have yet to make their final decisions on what they will pay in year-end checks. But the early indication is the firms plan on paying their employees well despite their ho-hum bottom line performance. A recent survey of financial firm professionals said they expect higher pay in 2010 than they received a year ago. “If the object of Wall Street pay reform was to make bonus payouts less risky, then I think that has been achieved,” says Johnson, who cites clawbacks and other pay provisions that have sought to remove the incentive for deals that create short-term profits, but can leave the firms open to much bigger losses in the future. “But if the object was to reduce the absolute level of pay on Wall Street, then I think reform has been much less successful.”

So why are paychecks rising? Part of the reason has to do with an unintended consequence of Wall Street pay reform. Traditionally, Wall Street pay rose and fell with profits–20% of pay checks were guaranteed salary and 80% were year-end bonuses based on whatever profits the firms generated that year. As the financial crisis showed, that system encouraged traders to take huge risks in search of big pay days. So in the past year regulators have pushed financial companies to cap the percentage of pay that fluctuates each year. In order to make up for smaller bonuses, some firms have boosted salaries, and that means many of their employees’ pay checks are rising despite the firms’ week performances.

No where does pay seem more out of whack than at Goldman Sachs. The financial services firm has struggled with regulators and profits in 2010. In July, Goldman paid a $550 million fine to the Securities and Exchange Commission to settle charges that it fraudulently mislead investors in a bond deal tied to subprime mortgages. Goldman has suffered in the market as well. Fewer client transactions, and a weaker stock market, has caused the firm’s trading revenue to tumble. Analysts expect Goldman’s earnings to fall 26% in 2010. But is that going to stop Goldman from boosting its year-end reward pay? It appears not. So far this year, the firm has set aside 43% of its revenue for salary and benefits. Based on that payout, Goldman employees are expected to receive a collective $16.8 billion, or nearly $500,000 per employee, which is 4% more than the firm paid out a year ago. Goldman declined to comment on what it plans to pay its employees. But the story is much the same to a lesser degree at the other banks.

Along with the changes in the structure of Wall Street pay, also driving up salaries and bonuses is the fact that foreign firms like Japan’s Nomura, and such smaller firms as Jefferies have been aggressively adding employees during the downturn in bid to steal business from Citigroup and other large banks that were battered in the financial crisis. Citigroup has recently fired back, luring away a top energy banker from UBS with a reported $9 million annual pay package. That hiring war is driving up pay, says Johnson. “If these firms could pay less they would,” says Johnson.

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