Greed is Good?

Prof. Roy C. Smith, former managing partner at Goldman Sachs and my professor at NYU talks about bonuses at Wall Street firms. We discussed this topic in class and his rationale and points were worthy. Or was it that they seemed right because I was on a different side of the line? The professor said that the headline was not his idea and he didn't like it as well. He also said that he got close to a hundred hate mails for the article which appeared in the weekend edition.

Produced in verbatim, the article written by Prof. Smith in the Wall Street Journal
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1973 was a terrible year on Wall Street. An unexpected crisis in the Middle East led to a quadrupling of oil prices and a serious global economic recession. The president was in serious trouble with Watergate. The S&P 500 index dropped 50% (after 23 years of rising markets), and much of Wall Street fell deeply into the red. There were no profits, and therefore no bonuses.

I was a 35-year-old, nonpartner investment banker then and was horrified to learn that my annual take-home pay would be limited to my small salary, which accounted for about a quarter of my previous year's income. Fortunately the partners decided to pay a small bonus out of their capital that year to help employees like me get by. The next year was no better. Several colleagues with good prospects left the firm and the industry for good. We learned that strong pay-for-performance compensation incentives could cut both ways.

Many wondered if that was still the case last week, when New York State Comptroller Thomas DiNapoli released an estimate that the "securities industry" paid its New York City employees bonuses of $18 billion in 2008, leading to a public outcry. Lost in the denunciations were the powerful benefits of the bonus system, which helped make the U.S. the global leader in financial services for decades. Bonuses are an important and necessary part of the fast-moving, high-pressure industry, and its employees flourish with strong performance incentives.

There is also a fundamental misunderstanding of how bonuses are paid that is further inflaming public opinion. The system has become more complex than most people know, and involves forms of bonuses that are not entirely discretionary.

The anger at Wall Street only grew at the news that Merrill Lynch, after reporting $15 billion of losses, had rushed to pay $4 billion in bonuses on the eve of its merger with Bank of America. Because Merrill Lynch and Bank of America were receiving substantial government funds to keep them afloat, the subject became part of the public business. The idea that the banks had paid out taxpayers' funds in undeserved bonuses to employees, together with a leaked report of John Thain's spending $1 million to redecorate his office, understandably provoked a blast of public outrage against Wall Street. The issue was so hot that President Barack Obama interrupted his duties to call the bonuses "shameful" and the "height of irresponsibility." Then, on Wednesday, he announced a new set of rules for those seeking "exceptional" assistance from the Troubled Asset Relief Program in the future that would limit cash compensation to $500,000 and restrict severance pay and frills, perks and boondoggles.

In the excitement some of the facts got mixed up. Mr. DiNapoli's estimate included many firms that were not involved with the bailout, and only a few that were. Merrill's actions were approved by its board early in December and consented to by Bank of America. But the basic point is that, despite the dreadful year that Wall Street experienced in 2008, some questionable bonuses were paid to already well-off employees, and that set off the outrage.

Many Americans believe that any bonuses for top executives paid by rescued banks would constitute "excess compensation," a phrase used by Mr. Obama. But no Wall Street CEO taking federal money received a bonus in 2008, and the same was true for most of their senior colleagues. Not only did those responsible receive no bonuses, the value of the stock in their companies paid to them as part of prior-year bonuses dropped by 70% or more, leaving them, collectively, with billions of dollars of unrealized losses.

That's pay for performance, isn't it?

Source:Wall Street Journal
Wall Street" has always been the quintessential, if ill-defined, symbol of American capitalism. In reality, Wall Street today includes many large banks, investment groups and other institutions, some not even located in the U.S. It has become a euphemism for the global capital markets industry -- one in which the combined market value of all stocks and bonds outstanding in the world topped $140 trillion at the end of 2007. Well less than half of the value of this combined market value is represented by American securities, but American banks lead the world in its origination and distribution. Wall Street is one of America's great export industries.

The market thrives on locating new opportunities, providing innovation and a willingness to take risks. It is also, regrettably, subject to what the economist John Maynard Keynes called "animal spirits," the psychological factors that make markets irrational when going up or down. For example, America has enjoyed a bonus it didn't deserve in its free-wheeling participation in the housing market, before it became a bubble. Despite great efforts by regulators to manage systemic risk, there have been market failures. The causes of the current market failure, which is the real object of the public anger, go well beyond the Wall Street compensation system -- but compensation has been one of them.

The capital-markets industry operates in a very sophisticated and competitive environment, one that responds best to strong performance incentives. People who flourish in this environment are those who want to be paid and advanced based on their individual and their team's performance, and are willing to take the risk that they might be displaced by someone better or that mistakes or downturns may cause them to be laid off or their firms to fail. Indeed, since 1970, 28 major banks or investment banks have failed or been taken up into mergers, and thousands have come and gone into the industry without making much money. Those that have survived the changing fortunes of the industry have done very well -- so well, in fact, that they appear to have become symbolic of greedy and reckless behavior.

The Wall Street compensation system has evolved from the 1970s, when most of the firms were private partnerships, owned by partners who paid out a designated share of the firm's profits to nonpartner employees while dividing up the rest for themselves. The nonpartners had to earn their keep every year, but the partners' percentage ownerships in the firms were also reset every year or two. On the whole, everyone's performance was continuously evaluated and rewarded or penalized. The system provided great incentives to create profits, but also, because the partners' own money was involved, to avoid great risk.

The industry became much more competitive when commercial banks were allowed into it. The competition tended to commoditize the basic fee businesses, and drove firms more deeply into trading. As improving technologies created great arrays of new instruments to be traded, the partnerships went public to gain access to larger funding sources, and to spread out the risks of the business. As they did so, each firm tried to maintain its partnership "culture" and compensation system as best it could, but it was difficult to do so.

In time there was significant erosion of the simple principles of the partnership days. Compensation for top managers followed the trend into excess set by other public companies. Competition for talent made recruitment and retention more difficult and thus tilted negotiating power further in favor of stars. Henry Paulson, when he was CEO of Goldman Sachs, once remarked that Wall Street was like other businesses, where 80% of the profits were provided by 20% of the people, but the 20% changed a lot from year to year and market to market. You had to pay everyone well because you never knew what next year would bring, and because there was always someone trying to poach your best trained people, whom you didn't want to lose even if they were not superstars. Consequently, bonuses in general became more automatic and less tied to superior performance. Compensation became the industry's largest expense, accounting for about 50% of net revenues. Warren Buffett, when he was an investor in Salomon Brothers in the late 1980s, once noted that he wasn't sure why anyone wanted to be an investor in a business where management took out half the revenues before shareholders got anything. But he recently invested $5 billion in Goldman Sachs, so he must have gotten over the problem.

As firms became part of large, conglomerate financial institutions, the sense of being a part of a special cohort of similarly acculturated colleagues was lost, and the performance of shares and options in giant multi-line holding companies rarely correlated with an individual's idea of his own performance over time. Nevertheless, the system as a whole worked reasonably well for years in providing rewards for success and penalties for failures, and still works even in difficult markets such as this one.

As firms became part of large, conglomerate financial institutions, the sense of being a part of a special cohort of similarly acculturated colleagues was lost, and the performance of shares and options in giant multi-line holding companies rarely correlated with an individual's idea of his own performance over time. Nevertheless, the system as a whole worked reasonably well for years in providing rewards for success and penalties for failures, and still works even in difficult markets such as this one.

At junior levels, bonuses tend to be based on how well the individual is seen to be developing. As employees progress, their compensation is based less on individual performance and more on their role as a manager or team leader. For all professional employees the annual bonus represents a very large amount of the person's take-home pay. At the middle levels, bonuses are set after firm-wide, interdepartmental negotiation sessions that attempt to allocate the firm's compensation pool based on a combination of performance and potential.

Roy C. Smith, a professor of finance at New York University's Stern School of Business, is a former partner of Goldman Sachs.

To be or not to be

An oft asked question. A rarely given answer

For starters, the real [and only true] question that you need to ask yourself as you get out of Atria mall and take a cab down to Worli Seaface and walk by as the water hits the walls is... Why do you want to pursue an MBA?

* Is it only because the world does it?
* Is it only because you want to see what else is there to offer?
* Is it only because you want to move away from where you are?
* Is it only because you want to be independent and away from home?
* Is it only because you could live in NY?
* Is it only because you want to make shitloads of money?
* Is it only because you want to be successful in life?

If you answer in the affirmative to any of the questions other than the last, you probably want to re-assess why you want to pursue an mba and the self doubt is well-placed. If you affirm to the final question though, you are probably on the right track.

The MBA today has become [unfortunately] a fashionable thing to do. It is like colouring ones hair [ I swear i couldnt get a better analogy and this isnt aimed at anyone in particular ] or getting the latest phone. People pursue it because everyone else does it. People go to some random school to pursue it, if they have to. It is a rat race and they think they are missing something if they don't run that race as well. They don't know why they are running. They have no freaking clue. All they know is that they need to run.

Another reason is because people are generally escapist [I do not judge, it is perfectly fine to want something that is out there that one wants and cannot get to] and want to run away from what they are currently doing. One major reason for the plethora of engineers/IT guys after that MBA dream is that they don't like what they do and see this as an avenue to escape. This is a fair reason, a good reason. But I am sure there are other ways to do what they want to do. Also, the world after an MBA is not some super rosy place where there are no assholes, back-stabbers and super-achievers. On the contrary, it may be far worse sometimes.

Inertia is a bad thing. It makes things difficult to start moving. Things are easy the way they are and most people like to keep them that way. Then, there are others for whom change needs to be constant. For some, that change never came. They have lived where they have [albeit a few geographic changes] all their lives. Life has been sheltered and they haven't seen the world outside. They yearn to break the proverbial shackles, to travel to lands unseen and to live life as they want to. Life at their pace, where they are in charge of their destiny. They love their parents to death. Yet, they desire to experience life as a lone stranger who walks down Marine Drive, assimilating the wonders and experiences of life. They want to shave their head bald, to colour their hair blonde, to wear those plunging necklines and to live-in with their girl. And yet, not have to deal with the frown of daddy and mummy dearest.

Someone liked the city so much, they decided to name it twice. Hence, it is New York, New York. The Greenwich Village, Central Park, Wall Street, Broadway, Chelsea, TriBeCa and the Washington Square Park are places they want to be and visit. Friends was their favorite show and they like all things American. They speak with the American slur, believe that colour should be color and not the other way around. The Lion King, Phantom Of the Opera and other shows on Broadway are on the top ten things on the list of things to do. Wouldn't they kill to get that elusive American visa, land on the chimerical soil and live that elusive dream? Touted to be the best city in the world, a reputation one believes that it lives up to. A good reason to try to land at JFK or EWR and believe that they have Truly Arrived!

Green is good, green is fashionable. A few extra thousand to spare, those elusive Jimmy Choo stilettos, that Brooks Brothers tailored single button suit, the Roger Vivier tag in the closet, the Bulgari dress watch, the Hermes and Ferragamo ties, the Lexus Sedan and that annual trip to the Alps. The life in the dreams, one that you always wanted, but was very much out of reach. So out of reach that you didn't even know anyone who had even one item in the list. You could have been the person that told Dawar Seth in Deewar, 'Main aaj bhi phenke huey paise nahin uthata'. You wanted to be there since a kid and would put in whatever effort it would take.

You have a dream. You want to make it big. You have an interest. You want to pursue that interest. You don't work for charity, and yet money is not the only thing that drives your career ambitions. You have things to prove to yourself. You want to chart new territories. Have a great life along the way. Meet great people, have awesome experiences while you do so. Rise up fast and yet know what you are doing. Be the star that people talk about, yet have your feet on the ground. In short, be something. There are many ways to get there. An MBA is merely one of them.

Some of us are brilliant. We become the Bill Gates of the world. Some of us are gifted, we become the Richard Bransons of the world. Some of us pursue a dream, we become the Jyotiraditya Scindyas of the world. Some of us have the vision, we become the Laxmi Mittals of the world. The others try to get to where these people are. They try to pursue utopia. Some succeed, some don't. They do because they are what they are. Not only because they did what they did.

There are many ways to the top of the pyramid. Some paths are easy, others are hard. Some paths need luck, others need a fairy godmother standing by. The MBA is not a sure shot to success. It merely offers a ladder. The biggest lesson in business school is not taught in class. It is in the experience. One learns from the situations, one learns from their peers and most importantly one learns from themselves. As one chugs through the two years, one learns things that cannot be learnt from reading text or watching videos. One learns from experiences. If these experiences come in a multi-ethnic setting in the midst of minds that think much differently from your own, they are worth all the more. Living in India, studying in India prepares us to a particular mindset. An education in a different setting teaches us things we would never have imagined or been exposed to.

You research on schools, you write LONG applications. You edit and re-edit. You take exams after a long hiatus. You beg and plead people for recommendations. You beg and plead people to review your essays. You study day and night for the GMAT. You miss the neon lights, the whiff of white wine and the adrenaline rush of dancing to Punjabi MC. You apply. You pray. You interview. You beg and plead. And finally you get in where you want to. It seems like a lot of work. It seems like it's hardly any fun. It hardly is. But at the end of the day, the sweet pleasure of two years that were the best you ever had... more than makes up for it.

I think that coming to the US to study is the best investment you can make in yourself. It is fun that I cannot explain. You have to study, it can be strenous. But you won't hear people complain about it, other than a random bitching. Secure job in one of the MNCs is great. But I am sure you want and can do better. Manager position is good. The question is: what next? An MBA gives you the tools and the pedigree to succeed. Not only at the job you have, but also the one when you need to switch. i believe that the math changes a lot.

That said, the MBA pours you the drink. It doesn't sip it for you.

It is most definitely and certainly worth leaving and coming. the funds are probably the single most difficult reason. The thing is that it can be totally funded on loans. If you have someone in the US you know well who can cosign your loan, you can get the entire education funded on loan. Else, you can fund it with a mix of educational loan in India and the US [no co-signer required]. It is not the most lavish of life, especially after not thinking twice before spending the money. But it can be managed. Dad may have to be your guarantor, which I am sure he will, if you call him daddy dearest from now on until the fateful day.The exposure is enormous. The ROI depends solely on what you want to do with your life. I think its an investment. A very good investment in yourself. Sometimes, its obvious right from the word go. Other times, its more intangible.

The proverbial ball is in your court. The question is, what do you want to do with it?

The Incorrigible Optimist

What’s the definition of optimism?
An Investment Banker ironing five shirts on a Sunday evening.

In the times that we live in, it is an unfortunate joke that is perched on the pedestal of possibility. Given the weird and incessant layoffs that we see day in and day out, it is not difficult to assume that the above joke is not far from reality. Every other day, I get the unfortunate news of someone I know who was asked to leave.

Mostly, I would add for little to no fault of theirs. All those who are crying hoarse for the blood of investment bankers need to realize that the Associate and to a large extent the Vice Presidents have had nothing to do with the current issue other than to be the menial labour in the chain.

Unfortunately, the bleeding just doesn't stop. What that means is that good and deserving candidates like us [ take a hike if you think otherwise :P ] don't get an entry into the door to show our wares.

This is likely to go on for long, though we would like to hope and wish that this was not the case. Aah well, the problems of an incorrigible optimist I guess. Another thought of hope I guess.