The market is down again today and one of the reasons people have cited for the recent 800 point drop in the Dow is that investors are worried about the bank regulations coming out of the Obama administration. The first part of the argument is that Obama’s plan to tax the banks and limit what they can and can’t do will hurt profits of financial firms and possibly drive some out of business. The second part of the argument and why the market is falling in general, so the logic goes, and not just the banks, is that if banks go out of business it will be harder for companies to raise money and expand, thus hurting the economy. This very conventional wisdom these days is, of course, nonsense.
Here’s why: As I have said before and this former Goldman partner and professor agrees, all evidence suggests that regulating the banks, while bad for employee bonuses, will be good for shareholders. The latest piece of evidence comes this week out of investment bank Lazard. Like Goldman Sachs, Lazard is a top ranked investment bank. But unlike Goldman, Lazard was never in danger of failing and never took any of the government’s bailout cash. That’s means Lazard hasn’t gotten a lot of attention from regulators or the scrutiny from the public on their pay or profits.
And what do Wall Streeters do when no one is watching: They start lining their pockets. Lazard announced their bonuses this week, and they were huge. The firm paid $565,000 per employee in 2009 total compensation. Remember that average is being held down by IT guys and other “support” staff. Senior bankers walk away with millions. In all, the bonus payments equaled 72% of the firm’s revenue. Worse, 2009 wasn’t even that great a year for Lazard. It’s profits were down to $11 million from nearly $200 million the year before. The result: money that should be going to shareholders in the form of increased dividends or higher earnings per share end up turning into Ferrari’s and Hamptons houses and African safaris for investment bankers.
Goldman, on the other hand, while no saint, paid out just 38% of its revenue in compensation, far less than they have traditionally done. That added billions to Goldman’s profits. Why did Goldman do it? Increased regulatory scrutiny and an implicit statement from Washington that Goldman had do. The result: A boon for shareholders.
Now Lazard’s executives will argue that big bonuses are good for shareholders because it will allow the bank to retain and attract talent. But that’s a silly justification for padding their own pockets. Few other firms are hiring right now. And if it is all about attracting new people, why not pay the people you have less so you have more money to hire.
I don’t buy the second part of the bank regulation is bad for the economy argument, either. Even if some firms disappear, others will pop up that just do underwriting. And if there is money to be made they will compete on price, driving down costs. Wall Streeters will argue that allowing them to trade for their own accounts and buy into hedge funds boost their profits so they can lower the price of underwriting securities. But we all know where any extra profits at the banks go when no one is looking. Right into the banker’s wallets.