UnRisk 7

Deutsche Banks Staff to wait for bonuses to make sure senior execs get more money.

The top executives at Deutsche have never liked the "Anglo-Saxon" bonus system. Yes, I know that Saxony is in Germany, but when you're as (self) important as Deutsche board director you have someone to do geography for you.

They want "multi year" bonuses for non-board staff, ie nearly everyone.

I don't think any of us really think they'd approve a scheme that left them out of pocket.

It may come as news to some here that board level executives are on totally different bonus schemes from their staff. What we are seeing here is of course what economists call "agency theory". IE managers enriching themselves at the expense of shareholders and more junior staff.

Let us step through how this will work. In the first year, your bonus drops hard, but you get told that your money "is safe, and to be 'patient'" It's hard to quit at this point because you now have been forced to invest your money in the bank at zero interest. Second year, more money gets sucked out of your pocket, but it's gone, not coming back. Then 'something' happens, and you get told that because a different department screwed up bonuses are low, so you get little to nothing.

Let us not pretend that the system by which you get your hands on your bonus money will be less opaque than alread,y with the extra complication that DB executives can manipulate the timing of payouts to make their own separate bonus scheme pay them well.

Also, there is tax, which of course Deutsche board members will let you know "is your problem". Since you pay is now more lumpy, you get to pay more at higher rates.

Try paying your mortgage with money that isn't there, see how far you get.

In British English, we have the phrase "there it was, gone"

So let us look at the ways your money can evaporate without trace. If a bank hits real trouble, you aren't a secured debtor. Indeed the idea would be seen as hilarious by the Deutsche board members if you happened to mention it on the golf course to them. Bear Stearns can die, so can Deutsche.

If Deutsche decided it does not need you any more, do you really think that your accrued bonus will be given to you without a fight, if at all ?

If you decide to leave, your bonus drops to somewhere between a joke and a rumour. Also you get hit harder on your choice of where to move to. This is in several parts. It is vastly more expensive for another firm to buy out your bonus, and of course if Deutsche does not like where you are going to, you have paid for them to have a much bigger stick.

Envy over Economics

The lame duck governor of the Bank of England has been sounding off against the bonus culture in financial markets. Partly of course to draw attention away from the gross failings of his organisation, and him personally.
The Bank of England is the last bit of the British Empire. It was once a grand and powerful body that did great things, both good and bad.
It may come as news to the self important people there that it is not in position to do this.

Firstly of course, they just ain't that smart, and could not work out how to do it. Managers of both BoE and FSA have publicly said they can't attract good people becuase the pay is so bad compared to real jobs.
One person holding a very important job in the government's financial section approached me for a job, and I was genuinely shocked at how little he was paid, less than what a good, but not outstanding PhD would expect in his first year.
Even though King has never had a job in a bank the various drinks parties and cricket matches he attends must have at some time brought him into contact with bankers, so he should know better.

London is now the most important financial centre, and has the ability to innovate around the simplistic controls his staff are capable of generating. There will be of course bureaucracy, which will give these mediocre people something to do, but let us not pretend that a gang of PhD mathematicians in debt markets would have a problem whatsoever in outwitting them. But of course it will get in the way of genuinely efficient incentive plans.

The low pay of BoE staff including King is of course an issue here, he's not entirely stupid, and he did quite well in academia, so naturally feels serious envy for people he feels as his inferiors earning 10 or even 20 times as much.

Economics does have much to say about "agency theory" where the difference between what you pay people to do, and what they actually do is modelled. It is easily the most cynical analysis of human nature I have ever encountered. But in my experience of neogtiating pay for bankers, I can say with complete confidence that this is rarely if ever used. Indeed many people who do money for banks have never heard of agency theory at all.
Agency theory of course predicts that manyjournalists, whatever their base political position go along with him. Many British journalists earn less per hour than I pay my household staff.

It is tempting, but naive to believe that senior staff can be precisely incentivised to get the "optimal" risk for the bank. First up, this is not a constant over time, are you going to calibrate it in real time ?
I can imagine a future where you don't get a contract, but a spreadsheet with a real time data feed. I can also imagine a future of alien invasion. My bet is on the little green men coming first.
Also, there is the obvious, but awfully difficult case of someone who does a good job for 5 years at a bank, then leaves. Why should he be hostage to what his successor does. Will the successor not have a huge incentive to load losses on the outgoing manager ?

Even if you get past this, the sums of money involved are such that financial engineering will quickly erode what in financial terms is a clear mispricing.
Share options can be bought from staff (at an appropriate discount), as can shares, etc. This happens already. Sure you can pass laws against it, but that just means an extra level. How for instance do you stop loans secured against future earnings ?

The BoE is neither feared, nor loved. Opinion is divided between those who blame the FSA for the Northern Rock disaster, and those that hold King himself personally responsible. Like most people I was truly surprised he survived the gross mishandling of this crisis, the first run on a bank in a generation.

This is not an idle threat to the working of the London Markets, which of course is a people business, and losing talent to NY and Chicago, even Paris would hurt.

Non-British readers may be surprised to know that the government that took Britain into the Iraq war, supports GW Bush, colludes with the CIA to torture British residents, deports children away from their parents to places like Libya & Nigeria and raises tax on the most lowly paid to make richer people pay less ,is actually the Labour party. Ie the left wing section of Parliament. The current situation is not unlike McCain being in charge of the Democrats. Except of course (right wing) McCain is an implacable opponent of torture, whereas (left wing) Brown sees it as a business process to be outsourced. But...
The Labour party is full of people who despise the rich, which they defined as couple of years ago as any household that makes > $100K a year. This sort of rubbish would keep Brown's backbenchers happy.

Travelling quants

As a headhunter, most of my work is helping people move to the larger financial centres, but it's not always the case.
On the forums, people have been talking about Dubai, and other Middle Eastern financial centres.
I can see why it is tough to get people to Dubai, even though of course it is radically different to places like Riyadh. Dubai has a much more liberal political and social climate, but even then there are issues. If you're trying to get people to go to any lower tier financial centre there are a few factors working against you.
Entry level people are looking to longer term issues like learning the core of their business, and getting good brands on their CV. That's hard to do outside London/NY/Chicago and Paris, let alone the Middle East, so we have a critical mass issue, it hard to get the best entry level people to help you grow, until you have grown. This doesn't just apply to the Middle East, few non-Germans show any enthusiasm for Frankfurt, and a large % of Germans want to come to London or NY.

Older people often have families and/or partners, and this makes any form of international movement non-trivial. Now that women have real jobs, they are a non trivial component of household income, so in a place where good female jobs are rare, you need a substantial pay hike just to get even. And of course a growing number of bankers are women.

Even the most politically correct educated western woman can become rather reactionary at the thought of having to live in any Moslem country. That cuts both ways of course, since the majority of quants are unmarried men, are they really going to want to go to Dubai for more than a few months ? Back when Britain had an empire, there were a huge number of military nurses, governesses and nannies...
Kids are an issue, although both Britain and America have amongst the worst education systems in the developed world, this makes quant-parents much more conservative about the quality in the location you want to move them to. Also, getting back into the system can be hard.
That doesn't just apply to education, but the careers of the parents, and you would not be sensible taking a job outside the major centres that did not leave you a path back in, even if you feel that the new location is a long term home. First of course, the liquidity of the labour market locally may be terrible, so there may be nothing for you to move to without seriously screwing with your personal life, and this can keep people in unsatisfactory jobs for years.

We also see what I call the Stargate Effect. When you set up shop, at first it's easy to find some locals with skills that you need, independent of what those skills are, and where you go. Quant finance has grown to the point where there are quants from every city on the planet. Locals are typically cheaper than staff in Western Europe and North America, which attracts some banks to the idea. That sets a price expectation in the minds of management. However, the next round of hires are from a smaller pool, and you may need to get in staff from other locations. That means the premium that RiskCapital rightly points out, but I fear it's not enough to do it well. Quality typically suffers, since management sees the earlier price as "fair".
Also of course, the first wave of hires see the newbies get more money, and because management hasn't offered enough you get later employees of lower value getting more than the higher quality low paid first wave. That can cause staff turnover, often to move clean out of the offshore location. We see this in India big time in other industries, with amazingly high levels of staff churn, but actually I call it "Stargate" because I first saw it happen in Stevenage, England, whose post code is SG1. Lots of firms moved to the cheaper location, vaccuumed up local talent cheaply, and hit a horrible wall as they expanded. Firms moved there to escape the high London cost base, but it was relatively close to London. So was seen as a good compromise. But once the local labour pool was used up the only nearby source of skilled workers, who actually wanted more money because travel was awkward.
So it's a pattern independent of country or industry.
These are all reasons why banks still have so many staff in horribly expensive locations.

The current market makes it easier for Dubai/Riyadh, but at the same time people are becoming more conservative, and the needs of Dubai will not really match the skillset people who've been dumped in this wave.

To all this we see a serious decline in the quality of of packages offered to staff who are asked to relocate offshore within their current firm. "offered" is actually the wrong word "threatened" is a better one.
Housing costs can make a big hole, and forget any useful allowance for partner and family. "Norms" for locations are set for rent, etc and they are usually much lower than you would pay for yourself.
Although air fares are much lower than they were 10 years ago when I used to travel a lot, (but higher of course thaqn 1 year ago), firms are now very tight fisted on trips home.
You will typically be taxed on housing allowances, which can hurt when you are maintaining a home, if your family don't come with you.
Even in foreign cities I have been many times, I cannot live as cost efficiently as one in my own country, and I think that is generally true, so even in a cheaper city, you may find yourself paying more for things.

It used to be the case that 'internal' expats were expected to make more money, but now they find that the detail of packages mean they are substantially worse off. Since we deal with the smarter end of the labour market, few I talk to are naive enough to believe the verbal promises that this experience will be valued by the bank, and will help their career.

The worst I saw was HSBC who said to a set of "non-critical" (ie non-executive level) staff that their jobs were redundant, but they could work in Indonesia at local rates.
Quite quickly they discovered that there were more critical people than they had first thought, and had to backtrack big time. We've seen JP Morgan do the same thing, but on a more individual basis.

Later, I'll share what can be done about this...