Bonus Season Dawns

This year's bonus pool

This year's bonus pool

QE powered markets have been motoring to new highs with all the abandon of teenage lovers. I've been promulgating the view for some time that markets are not pricing in the risk of a demand shock, of any scale, but it has had little resonance until recently. Yet a growing number of commentators are beginning to echo the thought and with a deal more intellectual weight. Upside from here is totally dependent on increasing economic confidence and momentum. Without demand that’s not going to coalesce. The pace of human worker replacement by machines is accelerating, the US consumer is still on the rack even before interest rates move, a reduction in Chinese GDP is self evident, Europe remains the mother of all time bombs and the UK is being flattered by selective house price moves and the auto manufacturing business in the West Midlands. There is an end to all this but a deflationary disruption in demand along the way will eventually rock equities. 

So why are stock markets doing so well? One answer might be from a client who said, “I think governments everywhere are strangling their economies with regulation & taxes. It’s easier to put your money into the stock market than it is to build a business or a house on land that you own so equity markets go up and the real economy stagnates.”

Indeed, how many people do you know from the City or elsewhere  who have retired to invest and or trade under their own steam rather than drag themselves out of bed at 5am in the morning? As we roll into bonus season for the banks another challenge is facing managers on trading floors. The near doubling and more of basic salaries in investment banks, rolled out 4-5 years ago to circumvent an expected clamp down on bonus’s after the crisis, has created other unintended but quite predictable consequences.

Unallocated and allocated costs have soared, (especially as other headcount like compliance has mushroomed). One head of a desk told me the “per head,” number to have a member of staff on his trading floor and I nearly fell over; it was more than twice the number we used when last I worked in a bank and even then my bank was at the top end of peer group. Despite this, most operations have been profitable. However, with structural change being imposed on the bond market by Dodd-Frank and the underwriting of markets by QE on the wane, there will be some tough decisions to make when the tide goes out.

Moreover, the CEO of another operation said to me, “Bonuses’ are not what they were and anyway, only a modest percentage is paid out in year 1. That though is stifling ambition because they feel they just have to turn up and do a good job to bank the pay cheque.” Even at Goldman they are ramping up basics even more in response to EU bonus caps. These are the business economics of the madhouse. It won’t end well and yet again the City is lining itself up for another great reckoning.


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Talking of madhouse business principles, in these days of volatility suppression I’m reminded of another bugbear from my days in a bank. Trading books often have to take provisions against their positions. These provisions will be calculated against a number of metrics, mainly volatility but will include average daily volumes in the name, the average bid/offer spread and so on, and they are usually reweighted weekly. Unsurprisingly, when a bad thing happens volatility spikes and after a big fall for example, traders can expect risk control to wander over and say, “don’t forget, your provisions will rise on Friday.” Similarly, after a prolonged period of flatlining volatility, as we see now, provisions will be released back to the trading books and from their perspective, they’ve recovered hard earned P/L and can now walk the floor looking windswept and interesting rather than gaunt and persecuted.  We see then, that after a bad thing the risk geeks decide that it would be sensible to take out an insurance policy in the form of provisioning but when we’re at all time highs with stretched valuations and low volatility they chuck the insurance policy in the bin.

Is that smart?

Liberals = Bonkers

Matt gets it about right in the Telegraph today when he asks, "Is it me, or does May 6th seem to be getting further away."

Traditionally, I look to the tofu munching Liberals to provide a bit of light hearted entertainment during the whole drawn out election thing. I'm pleased to report that this time round they are determined not to disappoint and have come up with some truly bonkers ideas that put them nicely on the edge somewhere between the pre war Politburo and Arthur Scargill.

Send for the men in flapping white coats in the van with the blue light on top.

This morning the Liberal Democrats have shown themselves to be a real threat to the UK economy with their delusional policy on the banking industry within the City of London . 

Let's just summarise what Mr Clegg and Dr Cable said this morning:
- No cash bonus over £2,500.    
- The rest to be paid in shares that cannot vest for 5 years and cannot be traded.
- No bonuses at board level.
- Full disclosure of any individual that is earning more than the UK Prime Minister - approx £200,000
- A desire to have a strong banking system in the UK.
So, are the Lib Dems just referring to banks that needed Government cash or all banks/brokers that operate in the City of London? What happens when a bank that did seek financial aid from the Government(Tax Payer) has extracted itself from the public sector and returned to the private sector?
What happens to a payment in shares if an individual wished to leave one bank to work for another?High fliers may find a new employer will make a payment to compensate...but then what becomes of the monetary value of the abandoned shares? 
Workers that are not high fliers count on their annual bonus... it can ease the cost of Christmas and for young workers or middle ranking officers they may not be able to walk away from shares in the current employer.
Is this a restraint of this in breach of the employment rules of the European Union?
How are board members to be rewarded? Watch the share price ahead of vesting date!
What is it with the level of income that the PM about we adjust for inflation the income earned for the 5 years after leaving office of Baroness Thatcher, Sir John Major and Tony Blair...the latter has truly coined it since leaving No 10.
Can the Lib Dems really believe that their polices have any merit in making the banking system or the City of London strong? As capital is international so talent can be so as well. Do they not have any concept of the multiplier effect that resonates through London and ripples out across the land?
This was playing to to masses on the grandest of scales. It is sadly in reality a very naive policy. Lending targets should be missed if the target can only be achieved by lending to untenable/uneconomic causes.
The net result of this nonesense will be higher salaries yet again, as I described in an earlier post, producing higher fixed costs which will be passed to the customers.  The banks will then be less competitive against international banks. Oh, and yes, more people will leg it abroad reducing the tax take.
Yes there is a need for reform, we have to celebrate and reward the intelligence and innovation in the City, not give it a dose of euthanasia.  You could hammer six inch nails into their foreheads without causing any damage: I'll say it once more for these stupid people; look through the compensation issues and seek out the leverage and concentration of risk that generate unusual returns. Both Bear Stearns and Lehman had extremely high levels of employee ownership and long term share lock in periods. Didn't help much there did it? Unfortunately, Mr Cable now appears to believe his own PR and has said goodbye to reality. These stupid people are avoiding doing the right thing and enacting good reform to create a more stable banking platform because they are either too stupid, too idle or just like to break things.

God help us if we have a hung parliament and this shower have any say in matters of any import.



Brown, Banks & Bonuses

Constantly Furious highlights some comments by Gordon Brown at the Royal Institution about bankers bonuses, "“This year we have seen a welcome reduction in the proportion of revenues global investment banks have paid out in bonuses." CF has his own take on that; I'm going off in another direction.

It's absolutly hard coded in the psyche of people who work for investment banks to work for, secure and protect their bonuses. This ingrained instinctive behaviour is as predictable as watching a thirsty animal be drawn to water.

Correctly assessing that there would be a fuss over bonuses, partly promulgated by Westminster to deflect criticism of MP's, banks started to adjust pay scales more than 12 months ago. That is, basic pay rates were ramped up by multiples which were not seen even during Big Bang in the eighties. It is now not unusual to find jobs on trading floors paying basic salaries between £200k-350k which eighteen months ago would have been at the £80-150k level.

The quid pro quo here is that there would be less employee dependance on bonuses and therefore a dampening of risk. I'm not so sure about that and anyway, the core issues which led to the crisis have yet to be addressed. The compensation thing is, at best, a red herring and even then it's being spun by the Prime Minister who appears to look but cannot see.

Many banks simply can't believe their good luck. Having driven themselves into brick walls at 70 mph they now find themselves astride the biggest "carry trade," in history. That is, banks have been able to take almost unlimited loans from Central Banks who have in turn purchased many of their toxic assets. Much if not most of the loans have been used to purchase government bonds to allow governments to give their economies some oxygen. This then, gives the banks a guaranteed profit and allows them to rebuild their balance sheets. Without the inconvenience of having to lend to small businesses at anything except draconian rates, and keeping zombie projects and businesses limping along so they don't have to make write offs, the banks can look good, justify the lofty salaries and still have a bonus pool. This is a giant shell game.

The disadvantage is that their fixed costs have gone through the roof, they've hired aggressively to position for an upturn, which is highly suspect, and there have been no meaningful reforms.

Having been through one round of rescuing banks that are, "To big too fail," you might be forgiven for thinking that the solution would be to make them smaller and increase competition. Well, we've made them bigger in fact........ much, much bigger. Little has been done to increase transparency or accountability. Swaps and SIV's are used to hide leverage and true capital structures and nothing has yet been done to regulate over the counter derivatives which must be traded on exchanges, no ifs, no buts.

The bottom line is that banks have used the tools available to them to stabalise and in many cases improve individual compensation from pre crisis levels. This however, is not the right subject to focus on. Shareholders and the taxpayer have not been rewarded with either meaningful reform or protection from future systemic risk and that should be a worry for us all.

Meanwhile, check this out..................... Save Greece!