As Banker Pay Declines, the Faustian Bargain Loses its Appeal

Aspiring investment bankers have long recognized the proverbial Faustian bargain of their prospective careers. In exchange for extravagant lifestyles and immeasurable wealth, they must first sacrifice their souls—that is, their social lives, relationships, health, and recently, their sense of morality. It’s a tough decision, but investment banking does have its takers.

It wasn’t always this way. After Franklin D. Roosevelt's New Deal, the profession was largely subdued by stringent regulation. Establishment of the SEC, fixed commissions for brokerage firms, the Glass-Steagall Act of 1933 and the Bank Holding Company Act of 1956 all worked to limit the size, leverage and risk of banks. Once upon a time, banks didn't trade on their own account or sell complex financial products. Bank profits were—well, normal. As a result, banker compensation was roughly identical to that of other private sector jobs.

By the 1980s, things had changed. A sluggish economy triggered complaints of overregulation and excessive bureaucracy. President Reagan responded with a wave of deregulation, allowing banks to compete for commissions, conduct proprietary trading, structure sophisticated financial products and absorb smaller banks. Bank profits skyrocketed. Adjusted for inflation, returns in the financial sector grew 800% from 1980 to 2005, compared to a paltry 250% by nonfinancial sectors. In 2007, the average banker salary of $100,000 was twice that of the private sector.

Investment banking had become the new “get-rich-quick” scheme. Bonuses in the millions were not uncommon. Banking was competitive, exhilarating, cutthroat and—of course—immensely lucrative.

The media only added fuel to the fire. In 1987, Oliver Stone’s Wall Street hit theatres, starring Michael Douglas as the infamous Gordon Gekko, a corporate raider and profiteer. Gekko’s memorable “Greed is good” speech, intended to portray the financier as avaricious and amoral, instead served as implicit justification for the entire industry.

Michael Lewis’ Liar’s Poker followed in 1989, in which he chronicled his experience as a trader at Salomon Brothers. Lewis provided an account of investment banking from within—one more tainted than the public had ever imagined. He painted a disreputable portrait of his colleagues as manipulative, immature and impulsive; he detailed the industry’s deep-seated grounding in corruption. But undergraduates, fascinated by the prospect of absolute power, instead read the book as a “how-to” manual, Lewis later said.

In 2000, American Psycho delivered the unadulterated stereotype of the megalomaniacal, profligate investment banker. Patrick Bateman, so desensitized by a life of luxury and power, resorts to murder as his only source of stimulation. Bateman is calculating, methodical, amoral and unemotional—traits so mechanically efficient, they virtually guarantee success.

In this high-status, hierarchical world, immense wealth became a reflection of financial clout. Bankers wanted money, not so they could purchase another house, but because each trade, larger than the last, signified their growing influence on Wall Street. They wanted to manage billion-dollar portfolios, oversee mergers which tied together superpowers and close deals that landed on the front page of The Financial Times. Like master puppeteers, they wanted to control the markets.

In 2008, everything changed. The housing bubble popped, Lehman Brothers declared bankruptcy and the United States fell into a recession. Investment banks posted record losses and by the end of September 2008, over 120,000 finance-related jobs were cut year-over-year. In October of 2011, banks announced another round of layoffs totaling over 100,000 across a dozen and a half major banks. HSBC and Bank of America cut 60,000 jobs alone.

As banks cut costs, compensation plummeted. According to Wall Street Journal reporter Dennis Berman, pre-crisis median pay for senior managing directors at budge bracket banks was $200,000 plus 2 million in bonuses, 1.2 of which was in cash, the other .8 in deferred compensation. This meant pre-tax earnings of 1.4 million. After the crisis, median salary increased to $400,000, but bonuses fell to 1.2 million, with only about $360,000 of that in cash. Pre-tax earnings had dropped to $760,000. Facing roughly 30% in income tax, 10% in state and local taxes, and another 10% between Medicare, Social Security and property taxes, that $760,000 quickly dissolved into a $380,000 after-tax income.

$380,000 is not chump change. But bankers didn’t become bankers just to live comfortably. They wanted to live luxuriously. Now, incomes could no longer support such lifestyles. And with layoffs so prevalent, bankers had to plan for a rainy day. They transformed from spenders into savers. Gone were the $200 dinners, first-class flights to Hawaii and prospects of sending children to private school. Bankers suddenly felt mortal. Like all Americans, they too were tightening their belts.

And then the fateful question was revived, but this time in a different context: is investment banking worth it? Hours remain unparalleled by any industry and the workload continues to be exceedingly stressful. Being identified as a banker is no longer a source of pride or status, but now of condemnation, especially as Occupy Wall Street gains momentum. As one former Goldman Sachs analyst explained, “the new status jobs aren’t at Goldman Sachs. They’re at Google, Apple and Facebook.” Management consulting and venture capital are now attractive alternatives.

Regulatory capture, political connections and good luck are keeping major banks above water. In increasingly volatile markets, the future of investment banks is uncertain. Many are heavily weighted in toxic assets, like delinquent mortgages and credit default swaps on European debt. Just last month, Jefferies was downgraded by rating agency Egan-Jones for its significant exposure to sovereign debt in Europe.

Investment banks are even more threatened by impending regulatory expansion. McKinsey, a consulting firm, expects bank returns on equity to fall from 20% in 2010 to 12-14% in the coming years due to tighter capital requirements, restrictions on proprietary trading and mandatory clearing of derivative contracts. Mohamed El-Erian, CEO of the world's largest bond investor, PIMCO, asserts that “the financial system will look more like a utility, shackled by politically driven overregulation that limits volatility at the cost of fewer productive activities.” Such a bleak depiction looks starkly similar to the mediocre, “boring banking” following the New Deal.

If the financial sector does contract, it will surely be reflected on the banker's paycheck. The modern Faustian parable has become twisted: the devil still wants your soul, but because times are tough, he can only offer half as much. Without a doubt, investment banks will remain essential players in a world that increasingly relies on credit flow. As the industry recovers, bonuses may eventually return to pre-crisis levels. But for the next several years, I wouldn't bank on it.

The views expressed in this opinion piece are the author's own and do not necessarily represent those of The Prince Arthur Herald.

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As Banker Pay Declines, the Faustian Bargain Loses its Appeal

by Alex Petralia

7 December 2011