Wall Street Plans $38 Billion of Bonuses as Shareholders Lose
By Christine Harper
November 19, 2007

Nov. 19 (Bloomberg) -- Shareholders in the securities industry are having their worst year since 2002, losing $74 billion of their equity. That won't prevent Wall Street from paying record bonuses, totaling almost $38 billion.

That money, split among about 186,000 workers at Goldman Sachs Group Inc., Morgan Stanley, Merrill Lynch & Co., Lehman Brothers Holdings Inc. and Bear Stearns Cos., equates to an average of $201,500 per person, according to data compiled by Bloomberg. The five biggest U.S. securities firms paid $36 billion to employees last year.

The bigger bonus pool derives from a record $9 billion of fees for arranging acquisitions and $5 billion for underwriting initial public offerings and sales of junk bonds, the most lucrative securities, Bloomberg data show. Bankers' record fees help explain why 2007 will prove to be the industry's second- most profitable after the subprime mortgage market collapse led to losses at Merrill and Bear Stearns. The last time bonuses declined was 2002 when the Standard & Poor's 500 Index fell 23 percent, and Enron Corp. and WorldCom Inc. went bankrupt.

Goldman's record earnings and gains at Morgan Stanley and Lehman mean all the New York-based firms will be forced to pay more in a year when all but Goldman lost more than 20 percent of their market value, said Charles Geisst, finance professor at Manhattan College in Riverdale, New York.

"They're all going to have to fall into line," said Geisst, author of "100 Years of Wall Street." "If Bear and Merrill plead poverty, they're going to lose all of their good people."

Pay for Performance

John Thain, Merrill's newly appointed chairman and chief executive officer, is already grappling with the bonus issue and he doesn't start at the world's biggest brokerage until next month. Thain, whose contract calls for him getting at least $44 million in cash and stock payable over five years, said top performers will receive bonuses while those involved in the subprime market collapse that led to the firm's $8.4 billion third-quarter writedown will be penalized.

"Most of Merrill Lynch's businesses are actually doing well, and so what you have to do in that circumstance is to pay the people who are performing," Thain, 52, said in a Nov. 15 interview. "Getting that balance right, paying the people who perform well and taking enough money from the people who caused some of the problems, that is going to be one of the first topics I address."

Bonus Pool

Securities firms typically use slightly less than 50 percent of their revenue to pay salaries, benefits and bonuses, a percentage that firms adjust throughout the year. This year's bonus estimate was based on the five-year average ratio at each of the five firms. Year-end bonuses usually account for about 60 percent of compensation.

In the first nine months of 2007, Goldman, Morgan Stanley, Merrill, Lehman and Bear Stearns told their shareholders that they set aside $52.4 billion for compensation, up 9 percent from a year earlier. For the whole year, the figure rises to $62.5 billion, according to analysts' estimates that combined revenue at the five largest securities firms will climb 1.7 percent to $135 billion.

That brings bonuses to almost $38 billion. The total increases when bonuses for employees at hedge funds, leveraged buyout firms and banks such as New York-based JPMorgan Chase & Co. and Frankfurt-based Deutsche Bank AG are included.

The industry's bonuses are larger than the gross domestic products of Sri Lanka, Lebanon or Bulgaria. The average $201,500 bonus is more than four times the $48,201 median household income in the U.S. last year, according to U.S. Census Bureau statistics.

`A Good Hand'

It's also enough to buy a Porsche 911 Turbo Cabriolet, a day for two at a VIP spa suite at New York's Mandarin Oriental hotel, and a year's tuition and fees for a high-school student at Trinity School on the Upper West Side of Manhattan.

Goldman is the world's biggest securities firm and also the most profitable. Analysts estimate the company, led by CEO Lloyd Blankfein, will earn an all-time high of $11 billion this year. Goldman reported a 79 percent increase in third-quarter net income, while profits slid at Morgan Stanley, Lehman and Bear Stearns, and Merrill reported a $2.24 billion loss. Goldman set aside $16.9 billion to pay salaries, benefits and bonuses in the first nine months of the year, exceeding the full-year record in 2006.

"They're playing a good hand as aggressively as you can play it," said John Gutfreund, 78, president of Gutfreund & Co. and former chief executive officer of Salomon Brothers, now part of New York-based Citigroup Inc. That has put Goldman's competitors in "an awkward position," he said.

Natural History Museum

Merrill's revenue probably will decline 13 percent this year after losses from mortgage-related bets in the third quarter, analysts estimate. Merrill said last month that it set aside 58 percent of revenue in the first nine months of 2007 for compensation, up from 49 percent a year earlier, to "appropriately reward employees." The firm said the ratio may rise further in the fourth quarter.

"I can understand what they're doing at Merrill," said William Fitzpatrick, an analyst at Racine, Wisconsin-based Johnson Asset Management, which oversees $1.7 billion and holds Morgan Stanley shares. "If they don't pay up now, they could lose a lot of their top performers."

Bankers are showing their confidence about the size of payouts they expect to receive by donating record amounts to organizations including the American Museum of Natural History in New York and the UJA-Federation of New York.

The American Museum of Natural History raised $3.2 million last week at its annual Museum Gala dinner, said communications director Steve Reichl. About 650 people attended, the most ever, he said.

Park Avenue

UJA-Federation, a Jewish philanthropy, raised $41 million, up from $38 million last year, at an annual campaign event hosted last month at the home of Alan Greenberg, the 80-year-old chairman of Bear Stearns's executive committee. The organization hopes to raise at least $21.5 million at its annual Wall Street dinner on Dec. 5, topping last year's $21 million, said Stuart Tauber, UJA's senior vice president.

Demand for "super-luxury" apartments in Manhattan, those priced at or above $10 million, also was at an all-time high in 2007, said Pamela Liebman, chief executive officer of the Corcoran Group real estate brokers. A 12-room Park Avenue apartment placed on the market this month sold in less than a week for more than the $12 million asking price, she said.

"Some people were a little surprised because there's been so much negative talk in the press about the market," Liebman said. "When there's all this talk about the credit crunch and potential job loss and not everybody sharing in the same pie, the ones who are the most fortunate don't want to rub it in anyone's face so they're quiet about their purchases."

Stock Options

Investment banks will distribute the money less evenly than in 2005 and 2006, according to the Options Group, the New York- based firm that has tracked pay and hiring trends for more than a decade. Employees involved in packaging and trading mortgage- backed securities will see bonuses drop 30 percent to 35 percent, while commodities traders may see gains of as much as 20 percent, the company estimates.

Another change this year: 70 percent or more of bonuses will be stock grants instead of cash, up from 50 percent in a typical year, said Michael Karp, Options Group's CEO.

UBS AG, Europe's biggest bank by assets, is capping the cash portion of investment bank bonuses this year at $750,000 and paying anything above that in stock, said a person familiar with the company's plans. The Zurich-based bank, which reported its first quarterly loss in almost five years, is adding a new type of restricted stock award that employees can sell after one year instead of waiting for three years, the person said.

Slumping Stocks

"What they do is they issue the majority of the compensation in shares," said Roy Smith, a finance professor at New York University's Stern School of Business and a former partner at Goldman Sachs. "You want these people to be thinking of themselves as working for the same company, and that means they will suffer and improve with the company."

The size of the payouts is a concern given how badly the shares of most securities firms have performed this year, said Fitzpatrick of Johnson Asset Management.

"They're paid very handsomely in good times because they're supposed to take a hit in bad times," Fitzpatrick said. "Performance has dwindled this year, and I think they should feel that."

To contact the reporter on this story: Christine Harper in New York at charper@bloomberg.net .

Last Updated: November 18, 2007 19:08 EST

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