Bonuses: It's 2009 That Will Hurt More

Posted by urbandigs

Wed Jan 2nd, 2008 09:45 AM

A: This is Manhattan real estate, and this is wall street bonus season. When it comes to wall street bonuses, we must understand one thing: REVENUE vs INCOME. Bonuses are generally calculated using generated revenue, not income, which leads us to what happened in 2007! For the first half of 2007, revenues generated by the investment banks, brokerages, trading desks, and banks were very high! Then came the meltdown in mid July starting with the ABX indices signaling distress in the credit markets. Within a few weeks Bear Stearns started the credit crunch wave by announcing the failure of 2 funds. That is when the credit & secondary mortgage markets changed drastically. My point, bonuses will be granted this year; its 2009 that we will have to worry about!

wall-street-bonuses-nyc-real-estate.jpgWhen I first starting trading equities professionally in 1998, stocks were listed on exchanges in fractions. What I mean is, the level 2 trading quotes that the trading software accessed showed bids and asks in fractions. For example, when EBAY was trading around $100 a share, the bid would be say 99 3/4 and the ask would be something like 100 1/8. The spread between the bid/ask was 3/8's (often spreads got as low as 1/6 or teenies as we used to call them). This spread, wider as a result of the equity trading in fractions, opened up the opportunity to trade and exploit the spread. It also made stock movements much more volatile, and as a trader, volatility is a very close friend!

Then came decimalization around 2002 I believe, can't remember. Stocks no longer traded in fractions, and instead started trading in dollars & cents. So, that same EBAY trade that I described above would now have a bid / ask more similar to say 99.98 x 99.99, giving us a penny spread. With spreads so tight, stocks just didn't move the way they used to; and a crash from the dot com bubble didnt help either. The game was over in my mind!

Back to the discussion so I can relate the analogy. The derivatives trade of securitizing loans and selling them off in pieces on the secondary mortgage markets generated billions in revenue for these banks & brokerages. Now that the housing bubble popped nationally, risk has been re-priced, secondary mortgage markets are not functioning properly, liquidity dried up for mortgage backed securities, and the announcement of billions in losses and potential insolvencies, THE GAME IS OVER! How will these banks and brokerages generate the kind of revenue that they got used to generating the past few years?

Now, 2007 still saw at least 4-6 months of great revenue before the sh*t hit the fan and the game ended. The game is not coming back for a long time folks. So, looking ahead to 2008, we must wonder about the hit to generated revenue that these guys are going to take. And with a hit to revenue for a full 12 months, comes a hit to bonuses; 2007 was only 6 months of trouble, 2008 will be 12 months.

Which brings us to maintaining talent. As Goldman Sachs prepares to take over the world after being on the short side of the mortgage backed securities trade, competing brokerages and investment banks will be forced to pay out bonuses this year to keep their talent in house or risk losing them to the sharks!

From an anonymous insider I keep in touch with:

Looks like the real bonus cutting will be next year since banking revenues were so high in the first part of 2007 and the bonuses are calculated off revenue - not income. "Ultra-Luxury" retailers are still reporting good numbers for Christmas even though the same people who are doing the spending are saying they expect bonuses next year to be down significantly.

Some of the banks started paying a bigger percentage of revenues as bonuses to try and keep up with Goldman - in the past they were paying 40-50% but it's up 10-20% in some cases. That can't last for long. Investors must be furious. They will have to cut headcount to get that "% of revenue" number back down.
Which brings us to the conclusion. Not only will 2008 prove a very difficult year for these guys to generate revenue anywhere near years before the credit crisis hit, but we are about to head into a period of layoffs as efforts to cut costs and restructure the company is a must to restore investor confidence and bully the stock price.

In my opinion, its next year's bonus season that will prove to be much less than expected as generated revenue is way down in this post-credit crunch world. Add in the fact that job losses are inevitable, and you start to think reality rather than fantasy. I'll leave it up to you to relate this scenario to wall street, the economy & New York City housing.

I welcome any comments regarding this topic, especially from those working at trading desks, investment banks, & brokerages!

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