Outside the Box

Are investment bankers communists in disguise?

Are investment bankers communists in disguise?

“This industry is run like a Marxist commune.” So began the unlikely theory of a senior banking colleague back in the late 1990s. Investment banking – a hard core bastion of capitalism – is not exactly something that you expect to be mentioned in the same breath as communism. But what did he mean? And is it still true?

Most working days of anyone’s life are pretty ordinary. You get out of bed. You take the kids to school. You go to work. You do something. You go home. You go to bed.

The day melts into the comfortable anonymity of your past history. Never fully forgotten, but unlikely to stand out in a crowd.

Repeat 10,000 times and you have a career.

… a senior colleague in the investment bank where I worked tried to convince me that the industry was basically, er, “communist”.

But just once in a while you get a moment that really sticks in the mind. In my case one of those moments happened when a senior colleague in the investment bank where I worked tried to convince me that the industry was basically, er, “communist”.

It was probably around 1997. I was still wet behind the ears, and only four years into the job.

But I had observed that certain colleagues, especially senior ones, seemed to be doing pretty well. Many earned hundreds of thousands of pounds a year, or even millions, as fees were clipped from the flows of global money shuffling.

This hardly seemed to be what Marx or Lenin had in mind.

(You can read more about how this eventually led to the global financial crisis here.)

And no one in their right mind would spend twelve hours a day, five (or six, or seven) days a week plodding up the slippery corporate slope unless there was a big, juicy carrot dangling in front of their noses.

Although admittedly, most of the time, there tended to be a whip not far behind the rear quarters as well.

Now, I’m no expert on the finer points of communist theories. But basically the aforementioned colleague of mine, a long serving pack animal, was making an unlikely observation.

I’ll show you what he meant by breaking down the profits of an investment bank.

Breaking down the profits of an investment bank.
Breaking down the profits of an investment bank.

Every $100 of top line revenue gets used roughly like this (individual banks vary slightly):

  • $55 is spent on employees’ salaries, bonuses and pensions
  • $20 is spent on other costs, like office rent, technology, business class flights, five star hotels, and the wining and dining of clients in fancy restaurants (or seedier, but no less expensive, nocturnal entertainment establishments…)
  • $10 goes to governments as corporate taxes
  • That leaves just $15 for the shareholders, the owners of the business

So there you have it. The people working at the bank, the labour, get 55% of the spoils and the capital owners get only 15%. Put another way, the insiders get nearly four times as much as their unsuspecting benefactors.

Now, of course, you need educated and hard working people to generate that revenue in the first place. Most of the work activities done at a bank are intensely repetitive and boring, but that doesn’t mean that they are easy. People need to be able both to do hard sums and know which knife and fork to use at the dinner table.

But you’d think there would be plenty of intelligent and ambitious people around the world who would happily step into the hand made shoes of the average City of London or Wall Street trader.

You might also think that pay levels would have fallen massively since the global financial crisis. The securities industry has slashed the number of employees. Surely there must be a glut of trained people looking for jobs, and bidding down pay levels in the process?

And many banks have reduced their balance sheet trading assets by half since 2007, while increasing their capital bases. This is mainly because of tighter capital regulations that are being phased in, with the aim of preventing a repeat banking crisis (and a major reason why credit growth is constrained in Europe and the USA). Although I believe this leaves the global financial system a long, long way from what could be called “safe”.

The result is much lower levels of bank profitability in relation to capital employed in the industry. Put another way, the typical return on equity has collapsed from around 30% in 2006 down to less than 10% in 2013 (sometimes much less).

Average pay levels must have collapsed as well in the investment banking and securities industry? Mustn’t they?

Not so fast! The communist dream still lives in the glittering skyscrapers of Wall Street, The City of London and the Central District of Hong Kong…

The following chart from Bloomberg shows the average bonus paid to bankers in New York over the past 20 years, using data from the oddly named New York State Comptroller. There’s been a definite secular (long term) bull market in bonuses.

The average bonus paid to bankers in New York over the past 20 years. Data: New York State Comptroller
The average bonus paid to bankers in New York over the past 20 years. Data: New York State Comptroller

The average Wall Street bonus was $164,530 in 2013. That’s the third highest level on record. It’s down 14% from the peak in 2006 of $191,369, a distinctly bubbly period in the money shuffling business. But you can see that it’s already 18% above the level of 2005, which was around the $140,000 mark.

Going back to 1994 the average bonus was around $32,000. So average bonuses in 2013 have gone up over five times in two decades, despite the crisis and the current low profitability of the industry. That’s a compound growth rate of 9% a year.

To put that into perspective, US consumer prices rose 57% in total over the same period, using the official CPI-U measure (“consumer price inflation for all urban consumers”), which admittedly understates true price inflation. That’s an average compound inflation rate of 2.4%.

US house prices went up 93%, or 3.5% compound, using the S&P/Case-Shiller US National Home Price Index.

And US median household income went up 68%, or just 2.7% a year. (Inflation adjusted median earnings in the US have risen just 7% in two decades.)

“All animals are equal. But some animals are more equal than others” George Orwell, Animal Farm (1945)

Now, of course, not all the animals feeding at the bonus trough get the same amount. “All animals are equal. But some animals are more equal than others”, as George Orwell wrote in his classic 1945 novel “Animal Farm”.

Most bank employees receive much less than the average, running in the tens of thousands. Some receive much more, many hundreds of thousands of dollars a year. And an elite few have their communist consciences challenged by multi-million dollar payouts, or even tens of millions. I personally know of at least one case where a senior trader made over $100 million in one year, in line with his contract.

Despite bringing the world economy to the brink of total collapse five years ago, the signs are that investment bankers continue to be highly paid for their endeavours. They’re money mad marxists.

The investment banks are dead! Long live the investment banks! Long live the communist revolution!

Stay tuned OfWealthers,

Rob Marstrand

robmarstrand@ofwealth.com

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.