For Goldman Sachs, A Slower Pay Day is OK

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On April 7, Lloyd Blankfein, the chief executive of Goldman Sachs Group, told American institutional investors that Wall Street must reform how it pays its executives. Two days later, China’s government said it would place a pay cap of 90 percent of 2007 levels on salaries at state run banks. The idea was comparable to the US$ 500,000 pay cap U.S. bankers, investment bankers and anyone else who took bailout funds have been operating under since earlier this year.



European regulators have also pushed pay caps down on their bankers. While no one believes U.S. or European pay limits will be permanent, they will likely hold in the U.S. until each firm that received money fro the Troubled Asset Relief Program pays it back to the U.S. Treasury. Even then, there would be such a public outcry if compensation shot skyward again that Blankfein’s remarks were seen as part of a new, more conciliatory attitude that Wall Street is using to woo Washington.



Goldman, which borrowed US$ 10 billion in bailout funds from the government, has made it known that it wants to raise funds to pay back the money as soon as possible. While in practice, this would free Goldman to do what it wanted with compensation levels, politically, it would be suicidal.

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One lesson Americans have burned to memory from the subprime crisis it is that Wall Streeters seeking every bonus payment from fee- and deal-making income were behind the wild lending, insuring and selling of subrime debt around the world. The math was simple. The more the deals you made – no matter how risky – the more you took home for yourself that year.


Against that background, Blankfein’s public remarks are part of the way Washington and Wall Street negotiate with each other while a nation of angry voters looks on. It is also a win for Goldman, because the firm has in place many of the “reforms” Blankfein proposed for others. In effect, the Goldman boss is trying to get Washington to push other firms in his direction so that outsized short-term compensation can’t be used as a competitive weapon in hiring top investment bankers.

He is recommending that compensation be based on an “individual's ability to identify and create value,” and that those at executive levels should be mostly paid in stock beyond a base salary. Stock payments would be stretched out over a three-year period so a one-year high gain would not be enough to drive big payments. In addition, most of the stock of top-ranked executives would have to remain with the firm until retirement.



Ironically, this is much closer to the old partnership arrangement that U.S. investment bankers followed until a decade ago when they decided to “cash out” their partnership stakes, go public and raise a windfall. Five of Goldman’s top partners each got stock worth more than US$ 200 million from the 1999 public offering, and that stock grew enormously in value. Before he became George Bush’s Treasury secretary in 2006, Henry Paul was worth some US$ 700 million in Goldman stock.



Goldman may win in another way too, but that outcome is less certain. For weeks, blogs and more sophisticated newspaper pieces have suggested that Goldman was one of the firms whose aggressive shorting of insurance contracts on subprime debt helped bring down AIG, Lehmann, and Bear Stearns

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Henry T.C. Hu, a widely followed law professor from the University of Texas, recently called Goldman an “empty creditor” of AIG – meaning the weaker AIG got, the better Goldman’s chance was to benefit from an insurance policy it held with AIG, since under the terms of the policy, AIG would have to payout. Blogs have suggested that Goldman was short-selling subprime instruments in a way that worsened the outlook for AIG, causing investors to dump AIG stock.



AIG has gotten US$ 170 billion in bailout funds from the Treasury – the largest of any firm. Last month, AIG paid off US$ 12.3 billion in credit default swap contracts to Goldman at 100 percent face value of the contracts. Since Goldman was also bailed out, American taxpayers are wondering why it collected the full amount, or any amount at all, from another company taxpayers had to rescue.



No one knows whether American lawmakers will dig into this further, but it is possible they might.


On pay reform, Goldman’s Blankfein is playing to the public and still showing Wall Streeters that if you take stock and wait long enough like Goldman executives do, you can get very rich. Much less is said about the AIG situation. Whether Congress will look into Goldman’s trading practices as hard as it has come down on executive compensation is anyone’s guess. The door is open.