Wall Street's Reality Deficit Continues

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Reality disconnects can be outrageously lucrative for the folks on Wall Street. Despite the nasty overall economic situation here in the U.S., and the government bailouts that saved these businesses from certain doom just two years ago, compensation at Wall Street firms is expected to hit $144 billion this year -- marking a second consecutive year of record high pay.

As a result, the painful reality check that these Wall Street companies' leaders so desperately need may be heading for their investors instead.

The end ... or only the beginning?
As lawmakers planned 2008's massive bailout of the financial system, many observers imagined that it marked the end of Wall Street. Today, all that angst seems forgotten, and talk of Wall Street's imminent extinction turns out to have been a bit premature. Large paychecks for dubious performance certainly never went anywhere.

According to a Wall Street Journal study, 35 publicly held financial companies are expected to pay out a 4% increase in compensation and benefits this year, with 26 of those companies boosting compensation. Counterintuitively, average compensation is expected to rise more quickly than these companies' revenue.

Additional data raises even more questions about record Wall Street pay. Although profits have improved at those firms since the 2008 crisis, the estimated profit at the firms remains 20% below 2006 levels, even though pay at these firms rose an astonishing 23% over that timeframe.

And this makes sense how?
Although Citigroup's (NYSE: C  ) revenue is expected to increase, the WSJ  notes that its compensation will fall. Notably, the government still retains a 12% stake in Citi, which may explain the financial giant's unusual frugality.

On the other hand, Goldman Sachs (NYSE: GS  ) and Bank of America (NYSE: BAC  ) are expected to report decreases in top-line growth, yet pay at those firms is expected to rise.

Even beyond the row surrounding publicly held bailed-out banks, private equity shows similar patterns of winners and losers (and compensation disconnects). Blackstone Group's (NYSE: BX  ) revenue is expected to climb far more than compensation, while at Fortress Investment Group (NYSE: FIG  ) , compensation's expected to increase far more than sales.

You'd think a post-bubble world would have brought more of these banks back to earth. Yet the Institute for Public Policy recently reported that CEOs of so-called "lay-off leader" companies tended to be more handsomely compensated. Citigroup and Bank of America ranked No. 2 and No. 3 on that infamous list, which also included CEOs at major corporations like Verizon (NYSE: VZ  ) and J.P. Morgan Chase (NYSE: JPM  ) .

Interestingly, many Wall Street investment banks have also been reducing their workforces, even if the remaining employees enjoy a compensation bonanza. But despite conventional wisdom, which tends to cheer pink slips as a means to cut waste and boost productivity, mass layoffs may signal that something about a company's long-term strategy has actually gone wrong.

(Reality) check, please!
Wall Street shares major accountability for the housing bubble and the ensuing financial crisis that wrecked our economy. Few of the folks now cashing fat paychecks saw the writing on the wall until disaster had already struck.

Right now, the long-term view for financial companies looks similarly ominous, despite the lucrative short-term pay for Wall Street firms. Banks' bad debts never went away, regulators are paying closer attention than ever, and low interest rates have allowed financial companies to benefit from an increase in short-term trading, instead of making hoped-for loans that would help boost the broader economy.

Financial companies' investors should start asking themselves -- and their companies -- whether outrageous compensation for underperforming execs will ultimately endanger their own possibility for long-term profits.

There's never been a better time to ask for the reality check.

Check back at every Wednesday and Friday for Alyce Lomax's columns on corporate governance.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community.

Alyce Lomax does not own shares of any of the companies mentioned. Try any of our Foolish newsletter services free for 30 days. The Fool has a disclosure policy.

Read/Post Comments (3) | Recommend This Article (14)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 13, 2010, at 3:02 PM, doncoyoteok wrote:

    The Fed is throwing lots of money into the system which, absent real demand growth, is ending up in the financial markets, giving financial firms high profits and payouts. Maybe they should give the Fed a piece of the action. Oh, wait. Don't they already have a piece of the action?

  • Report this Comment On October 14, 2010, at 12:47 PM, BlazerMania wrote:

    I'm not sure comparing compensation trends to revenue trends is a worthwhile analysis. In fact, it may even be a bit disingenuous. $1 of cost savings gained by an efficient cost center manager can be just as valuable to the bottom line (and therefore worthy of increased compensation) as $1 of new revenue.

    I don't know what the numbers look like, but I think comparing compensation growth to net income growth would be much more meaningful. Perhaps the conclusion would remain the same, I don't know, but it would be a more meaningful exercise.

  • Report this Comment On October 14, 2010, at 3:21 PM, neutrinoman wrote:

    But the banks have lackluster performance at best -- their compensation is a direct result of all that cheap liquidity being thrown at the system by the Fed.

    I think the reality check for Wall Street will come when the Fed's stimulus measures stopping having much effect. Interest rates will start to normalize, and the dollar will rebound. All this yield-chasing will give way to more prudent savings.

    BTW the fiscal stimulus is also boosting corporate profits, at least at the big companies, even though it's not doing much for jobs or most people's incomes. When that stimulus fades, more normalization will set in.

    America's problem is not liquidity; it's lack of savings and investment in productive activities.

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