Case for the worst job ever...

Early during my first year at university I was involved in a "getting to know each other" conversation with some of the guys at the dorms I was living in. The topic of discussion was "What's the worst job you've ever had". It was pretty clear from the outset that I wasn't going to win this contest - my various bar-work, waitering and delivery jobs didn't really cut it against the real contenders. The ultimate winner, was the son of an abattoir owner from Northern Ireland. He told a story about his first day working for the "old man", where his chores ranged from tenderising recently slaughtered pigs with several thousand volts to throat slitting the poor animals, presumably for some religious requirement of a section of the abattoirs custom. We were impressed.

In a similar vein (perhaps the wrong word to use), I was impressed this week by a lady called Ann Bevitt, who was quoted in an article addressing the hot topic of bonus payments to bankers, and the potential litigation work that will arise because of the lack thereof. A partner at the City law firm Morrison and Foerster, Ms. Bevitt was quoted in a typically understated British way: “It’s not always the most uplifting type of work in this economy but there are always a lot of issues we need to deal with." Much like my pig-disimbowelling friend, I was impressed by what humanity will do to earn a crust.

In the current environment, fighting for bankers rights to bonus payments seems to rank ever so slightly ahead of child molesting or mass-murder as respectable occupations go. Taxpayers have been forced to bail out many of these institutions and now the prospect of paying out performance based bonuses to the not-so-star pupils at these institutions is understandably riling. The case against these sorts of payouts is potentially quite strong, based on write-downs, share-prices, client performance or any other backward looking measurement you might use. Take for example - in its last three years Bear Stearns paid $11.3bn in employee compensation and benefits. Lehman Brothers paid out $21.6bn in the period 2004-2007, while Merrill Lynch and Citigroup paid out $45bn and $34.4bn respectively in the same three years.

In return, the various other stakeholders have received, well, almost nil. Lehman's shareholders, have received precisely nil. It's creditors/ bondholders, who don't see the upside that shareholders do in the good times as they are theoretically taking less risk, are likely to receive only fractions of their invested amounts from the bankruptcy process. Investors in Bear Stearns received around $1.4bn of JPMorgan Chase stock, now worth just under $700mm. Merrill Lynch's shareholders got shares in Bank of America which are now worth $9.6bn, less than a fifth of the original offer value. Citigroup now has an entire market capitalisation of around $17bn; just under half what it paid out to employees in the 2004-7 period.

Looking at things on an individual-by-individual basis, potentially paints an even starker picture. For example, Jay Levine, who ran the US investment banking subsidiary of RBS (Greenwich Capital), was paid close to £40mm in the 2004-7 period. This is roughly four times the amount the heavily vilified former RBS CEO Fred Goodwin received during the same period, but the sum wasn't disclosed so openly because Levine wasn't on the board of directors. Levine was responsible for ramping up the US based exposures to sub-prime mortgages, asset-backed securities and CDOs. Since he left RBS Greenwich Capital in December 2007, RBS has unveiled £12bn of write-downs, almost half of which are attributable to the US based arm. As an institution RBS are poised to unveil full-year losses of up to £28bn - the biggest loss in UK corporate history. In the US, there are now six class-action lawsuits that have been filed against RBS, in the Southern District Court of NY, alleging that RBS misled investors on the true state of its accounts in a series of filings with the US Securities and Exchange Commission (SEC).

With this sort of context the public outcry, particularly in the case of part-nationalised institutions, is understandable. Politicians have already started to react to this public disaffection, with the government in the UK imposing restraints on executive pay packages at RBS and Lloyds, and likewise Barack Obama has curbed executive pay structures for the part government owned US banks.

Personally though, I think a lot of the outcry is misdirected, and a cover for a whole raft of mistakes that governments, regulators and investors made when analysing these institutions. The personal incentive schemes operated by each of the vilified institutions received the backing of each of these parties during the "good times". Effectively these stakeholders should look at why they stood by and effectively allowed these banks to receive a free call option on the markets - i.e. the banks and their employees could bet these stakeholders' investments and retain the majority of the upside, with none of the downside. The various pension funds and insurance companies that manage money on individuals behalf should look at why they allowed themselves to invest in such one-sided bets.

This is not an attempt to deny the incorrectness of the managements of these banks for setting up faulty incentive schemes, or to pardon those who wilfully participated in those schemes, but more to clarify that there is, as always, a bigger picture. Culpability is always easier to place with one group, that way the blame can be more focused, and the world is kept simple.

As a UK taxpayer, and consequently a fractional owner of both Lloyds and RBS, I want those employees to be incentivised to make a solid return on the money we have all invested. I would be generally against pay caps or restrictions on management methods for compensating the best performers. I'm glad that the UK government wants to play the role of "activist investor", that many private investors failed to do "on the way up". What I would like to see though, is a better alignment of my interests with those of the employees. From my experience, the incentive of an employee was very much based on the short term. A common theme when structuring trades (like the ones that Jay Levine was involved with) was figuring out how to "upfront" the cashflows the bank would take from a particular trade - i.e. you would be much more concerned about risk that might affect you in the next year, than risks that might occur in later periods. People used to ask, "how is your year going", never anything longer than that. As a shareholder, typically the time horizon is considerably longer, and if it isn't then you probably should count yourself as a gambler. I'm not going to propose an exact solution as to how, as a shareholder, I am going to be properly aligned with the employees. All I would say is that, given that my financial stake is what is at risk, I should get my share of the profits ahead of the employee, or at the very least at the same time.

Rarely, if ever, did I see bonuses paid for poor performance. People like Jay Levine, during the good times, would have made many, many multiples of the amounts that they were paid for their banks, and consequently their stakeholders. What was at issue was that these performance measurements were short-sighted, and didn't consider the longer term risks that were being taken. I don't blame Jay Levine for that so much as I blame the other stakeholders for paying insufficient attention. It's wishful thinking to hope that somebody is put into an incentive scheme like the average investment banker has been put, and hope that they will act in a way that is counter to that incentive set-up. Nevermind the fact that they wouldn't get paid a bonus, they would probably be removed from their position pretty quickly. The incentives were wrong, but the individuals didn't set out the incentives. It doesn't remove them from culpability but they weren't acting alone and they weren't acting in secret.

Anyway, I'm certainly pleased to have identified Ann Bevitt's case for "worst job ever". I think she wins, just, from the pig-disimboweller. Any other contenders, please let me know.