Monday, March 23, 2009

Latest Battles in the War Against Manhattan

We have highlighted for you recently that the US government in Washington has been engaged in attacks on Manhattan in the form of legislation and through the lack of leadership from the US Department of Treasury. Since we raised these concerns earlier this month, the situation has become more troubling.

Bonus Tax

Last week, the House of Representatives approved (by a very wide margin) proposed legislation that would tax all bonuses at a 90% rate for employees of companies that are recipients of TARP funds whose annual income is more than $250,000. This continues a very troubling trend that we saw in a provision that became law as part of the Stimulus Bill.

We have expressed concern that, in New York City where more than one-third of all employee earnings come from the financial sector, limitations on bonuses are an attack on our city and on the borough of Manhattan. The bonus limitations that are currently law limit bonuses to one-third of base salary for all employees of TARP recipient companies. The House Bill, if it becomes law, would essentially eliminate all bonuses and amplify the counterproductive impact of the bonus limitations already in place.

Because the vast majority of compensation at financial services firms is in the form of bonuses, the push by the House of Representatives to eliminate bonuses has some very negative likely consequences  - 1) in the near term, it will retroactively tax recent bonuses at 90% and thereby confiscate the wealth of thousands of employees, many of whom live and/or work in Manhattan or the rest of New York City; the confiscation will further burden the economy of our city. 2) firms may be forced to increase salaries dramatically for their best employees in order to compensate for the bonuses that have disappeared, thereby increasing the cost base of those firms and reducing the incentives for those employees to make the sacrifices ad supply to effort to achieve the very best results possible. 3) the most effective employees from the divisions and groups with the best prospects will leave the TARP recipient firms for non-TARP large firms and boutiques; because the US taxpayers have invested hundreds of billions of dollars in the TARP firms, policies that shift the best employees out of TARP firms into other firms should be avoided.

It is our hope that the Senate or the President will prevent this disastrous legislation from becoming law - in order to protect our nation's financial sector and to avoid increasing economic pain for employees in this troubled economy.

Quantifying the Attack on Manhattan

The New York Post calculated the cost to New York City of the 90% tax on bonuses for employees of TARP recipient firms as $12 billion. The New York Post arrived at the $12 billion figure by calculating the bonuses recently paid by Goldman Sachs, Merrill Lynch, Morgan Stanley and Bank of America. The New York Post estimated that 50% of all bonuses paid by those four firms would end up as revenue for the US government through this confiscatory tax. The New York Post's methodology is flawed, but it ultimately understates the impact on New York City. The Post includes Merrill Lynch, but Merrill Lynch never received TARP funds. Merrill paid bonuses before it closed its sale to Bank of America, a TARP recipient. In the other direction, the Post's $12 billion estimate ignores Citigroup and JP Morgan Chase (which now includes Bear Stearns and Washington Mutual). Citigroup and JP Morgan Chase are massive financial institutions and might have bonus pools as large as or larger than the group that the Post considered. The Post failed to consider that not all employees live or work in the New York metro area.

Whether the correct figure is $12 billion to $15 billion or as high as $50 billion or more, the loss of such a large amount of wealth is a tragedy for our city and for our borough.

TALF - A Victim of the Attacks on Manhattan

Late last week, investors showed a real reluctance to apply for funds from the Federal Reserve to purchase "toxic assets." TALF - The Federal Reserve's Term Asset-Backed Securities Loan Facility is suffering because of the attacks on Manhattan. The toxic assets are securitized loans that were previously purchased by financial institutions at values far, far above the values that they would achieve in the open market today. A solution to the toxic assets problem is the single most important ingredient in the recovery of the financial sector that we all seek and that is so crucial to the economy of Manhattan and New York City.

Investors have not taken advantage of the offer by the Federal Reserve to loan them cash at favorable rates because they see the danger of accepting government assistance. 

In the TARP experience, Goldman Sachs and Morgan Stanley did not want to accept TARP money originally. After being forced by the Bush Administration to accept TARP money, the ex post facto restrictions on those firms have caused those firms to regret caving into the demands of the Bush Administration. The restrictions seem to get worse every few weeks, and now both of those firms are aggressively moving to pay back all of the TARP funds they received in order to escape the restrictions. By forcing firms to pay back TARP early (because of the foolish restrictions imposed after the TARP funds were initially dispersed), the US government is reducing liquidity in the US capital markets at exactly the wrong time. Our economy needs credit to flow, and our government is attempting to impose restrictions on financial institutions that will result in less credit availability.

For TALF to succeed, investors need confidence that they will not regret accepting the TALF funds and that there will not be Congressional attacks on TALF recipients when the public realizes that TALF recipients are making millions or billions of dollars in profits from investments that were heavily subsidized by the Federal Reserve. 

Based on the experiences we've seen in the TARP experiment, investors are smart to be very cautious on TALF.


    Goldman Sachs announced today that it is repaying its TARP money ASAP.


    President Obama is now looking to reduce the criticism of the business sector by the political sector.


    A senior AIG executive quit today and expressed his disappointment that the government, the press, and the CEO of AIG had attacked himself and his colleagues in such a horrible way.

  4. I read your blog and I agree with you -- for the most part. The 90% tax is the wrong way to go.

    However, I will say this. AON bonuses (all-or-nothing bonuses) have a tendency to create a recipe for disaster. It is not surprising that highly leveraged bonuses have lead to a highly leveraged financial sector.

    90% of a person's compensation as a bonus (especially a manager) typically leads to very short-sighted, near-term thinking that is potentially ruinous to the firm long-term success.

    A manager in that kind of position probably can't see past the huge carrot dangling in his face. And with the stakes that high, the price of failure becomes too steep, and the whole notion of doing the right thing takes a back seat to "lifestyle preservation".

    Very few managers can fathom living on just 30% - 50% of their bonus when 90% of their compensation is bonus. I bet you that 8 out of 10 managers have already spent their bonus halfway through the year.

    So they usually adopt a "whatever it takes type of mentality." to ensure that they obtain their bonus. Corporate ethics and responsible, disciplined thinking takes a back seat while managers pursue what should have been a base of their salary.

    I think Compensation Committees and HR Managers alike need to carefully overhaul the type of packages they offer management. Leveraging management's compensation with AON bonuses shifts management's focus from long-term stability and growth to short-term survival and subsistence. This type of reward structure creates a recipe for disaster.

  5. Well stated, Anonymous. Bonuses should have more long-term elements and should never be all-or-nothing.

  6. We agree at Manhattan Viewpoint. Bonuses should be based on long-term and near term success, personal performance, overall company performance, and other factors that align the interests of the shareholders with those of management. All Or Nothing bonuses are very rare and very unwise.