Wednesday, October 22, 2008

What it Costs ...

  2007 2008
     
Base salary $500,000 $500,000
Cash bonus $2mm $0
Stock bonus $7mm $0
Total Comp $9,500,000 $500,000
     
Loan on equity    
In company $2,000,000  
Portfolio Value    
Incl company stock $9,000,000 $250,000
     
Taxes $4,750,000 $225,000
Maintenance/ Mortgage Park Ave $120,000 $120,000
Property taxes nyc $30,000 $30,000
Mortgage Hamptons $75,000 $75,000
Taxes Hamptons $30,000 $30,000
Lawn, Pool, etc in Hamptons $10,000 $10,000
Nanny and Driver $100,000 $40,000
Clothing incl Ball gowns $100,000 $10,000
Personal trainer 3 x weekly $18,000  
Food (including restaurants) $30,000 $10,000
Entertaining at home and summer clam bake $25,000  
Golf club $75,000  
NYC Club $15,000  
Hair, nails etc $5,000 $3,000
Charitable benefits, capital cpgn, annual funds $200,000 $100,000
Private School for 3 kids- 1 nursery 2 ongoing $78,000 $90,000
Christmas Vacation Palm Beach $15,000  
Spring Vacation Aspen $15,000  
20th Anniversary 4 couples villa st john $50,000  
20th anniversary diamond necklace $50,000  
     
TOTAL $1,411,000 $548,000
WHAT IT COSTS
by Alexandra Lebenthal


Above is an illustration of what the decimation in the financial markets means to a couple who would not have dreamed a few years ago that they would be hit by the financial tsunami of the credit crisis.

This is an imaginary personal balance sheet of an imaginary couple whom we'll call “Blake and Grigsby Somerset.” Blake worked at Lehman in Investment Banking, undergrad from Amherst, two years as an analyst at Morgan Stanley and then “B School” for an MBA at Harvard. When he finished Lehman snapped him right up and he has been there for the last 10 years, doing successively better year over year. Grigsby stopped working after their second child was born and has been at home ever since. Their kids are 4, 7 and 9 and attend one of the best nursery school and girls schools in the City.
She is also actively involved in several philanthropies and has been able to make some significant donations.

Of course an investment banker was all too aware of the credit crunch and how it had spread from the subprime mortgage world across the financial services sector, but Blake and Grigsby never quite realized how close to home it would actually hit.

Only 8 months ago the idea of a major firm like Bear Stearns or Lehman failing was truly, simply and utterly preposterous. Of course there would be bear markets – there always have been; but times get better. In the past those who already attained a certain level of success like Blake and Grigsby were never really affected in ways that made an extreme difference in lifestyle.

Carolina ...
Oscar ...
Manolo ...
How wrong everyone was! With Bear getting bought out ultimately at $10 a share, with Lehman effectively at $0, and Morgan Stanley, Merrill, and others trading at fractions of their previous highs, personal portfolios, net worth and lifestyles are being drastically and dramatically altered throughout Blake and Grigsby’s world as we speak.

The Somersets are in the habit of going out a lot. They attend many of the city’s most glamorous benefits each year. Grigsby loves Herrera and Oscar in particular for her ball gowns. She only wears Manolos - after all they are such a good value and so comfortable

While we think of most working people living paycheck to paycheck, Blake and Grigsby have lived bonus to bonus. Their annual expenses are pretty high -- if they had to live just on his base salary it would be impossible to live the way they have -- but luckily Blake’s annual bonus has been very generous and there was no sign that he wouldn’t continue to do even better. His mentor is the head of the one of the banking divisions and has said more than once he can see Blake filling his shoes.

They had that in mind two years ago when the new house they wanted in the Hamptons was a few million more than they could afford. They couldn’t sell the stock in the firm as it was restricted (since he was an employee, and besides, everyone was expected to hold on to their stock as a sign of commitment to the future so the margin loan was a great idea that enabled them to have the things they wanted.

It was so worth getting the house on the Bay -- the resale value of the house was only going up like everything else. If they needed to sell in a few years (or wanted the house on the ocean, they’d be able to sell at a profit. Also Grigsby had had her eye on a great house in Aspen which she hoped would be the next purchase they made.

Then 2007 arrived with signs of trouble in the housing sector. A few mortgage lenders had already gone out and Bank of America had to acquire Countrywide that Autumn. Yes Countrywide was a huge bank, but look, they should have been a lot smarter about whom they were giving mortgages to.

However, the effect for Blake was that his bonus which in 2006 had been $11 million total, and $8 million of that in cash, was less, in ‘07 but not terribly so ($9 million), but only $3 million was in cash, (the rest was in stock). They had usually counted on a big cash bonus to pay off the previous year’s expenditures and start spending on the coming year’s costs.

So the ’07 bonus meant no Aspen house this year. But at least with the stock trading lower at the end of ‘07 it was likely things would pick up in 2008 and the stock would be worth all the more. In general life didn’t change all that much for the Somersets.

Then this past March 2008, things took an unexpected and disastrous turn. Bear Stearns in the course of a few days lost the confidence of the markets and its customers. On St Patrick’s Day, it was announced that Bear would be bought by JP Morgan for $2 per share -- later readjusted to $10 per share but a far cry from its 20007 high of $184, or even its price several weeks before. Lehman, it seemed for a few weeks around the same time was in danger of suffering the same fate, but the firm hung on and over the next several months it raised billions more in capital.
In June Grigsby packed off the kids for the Hamptons ready to enjoy her summer. The fall would be busy. She planned to redecorate the house and it would be time to apply to the boys schools for her son. Blake would have to take time off from work to make the tours and interviews. Wall Street wise, the summer wasn’t great. Lots of rumors were still floating around and then in August all of a sudden things started heading downhill fast with Fannie and Freddie.

Then it hit. Early September, Lehman’s stock seemed as if it had a weight around its neck. From $17.45 the day after Labor day, it dropped steadily over the course of several days to $3.65 on Friday, September 12. The sale of the firm became imminent. It appeared more than likely that by Sunday evening September 14th, the start of the trading day in Asian markets, that the firm would be sold. Barclays or Bank of America would be the likely buyers.

The Somerset’s were upset and nervous but calculated their stock, while off significantly from its highs, would still be worth seven figures -- assuming there would be a deal at some premium to where it was currently trading.

Somehow that thought gave them some comfort. Grigsby at least was comforted by Blake’s explanation -- after all, advising financial companies was his business. Late that Sunday, however, as he was anxiously checking his Blackberry, the news came out: Barclays was walking away and Merrill had stepped in to take Bank of America as its partner, stranding Lehman without a rescue deal. And Lehman in fact was preparing a bankruptcy filing which it did in the wee hours of Monday morning. The stock that Monday traded in pennies. Markets went into a free fall.

A few days later it was announced that Barclays would buy Lehman from bankruptcy and the good news is that Blake will have a job and should do well.

His main clients didn’t work with Barclays as much as Lehman, so management is happy to have him on board. But their stock portfolio has been wiped out. There will be little to no bonus compensation at the end of 2008. At the same time, he received a margin call on the stock since his loan was tied to the value of his account. He owed $1 ½ million to cover it. Since the Lehman stock was at Zero he had to sell most of the other stocks they owned leaving a balance of $250,000. They haven’t had that little money since a few years after business school.

Total living expenses last year were over $1 million. Austerity moves in. What goes? Vacations for this year, trainer will be eliminated. Highlights and haircuts can be stretched out to last twice as long. No entertaining, as well as cooking at home more rather than the twice weekly restaurants.

Needless to say there won’t be the shopping excursions, and the new Oscar black gown with the gold stars Grisgby had planned on buying for the big gala for $9900 won’t be happening. She will pull out some old dresses -- Vintage is in. That is assuming they will still be able to afford the ticket. The number of benefits they attend will certainly have to go down. There are still three outstanding annual installments on the capital campaign pledge to several philanthropies -- some of which they are quite active in -- so their giving will still be high. And they don’t want to let on that they cannot pay.

The driver will have to go, but of course the nanny must stay. Also with a third child in private school next year tuition will go up to a total of $90,000. They have briefly discussed moving to the suburbs where the public schools are terrific- and free.

They have considered selling the house on the Bay in the Hamptons but cannot bear the thought of it. What’s more there are a lot of for sale signs out there, and they don’t want to sell into a falling market. By next year things should be better, they hope.

In the meantime, they assume they can get a home equity loan on the house to cover expenses. After taxes this year they are likely to have earned $250,000, although even cutting out many expenses, they will still spend over $500,000. So they have begun the home equity loan process, hoping, fingers crossed, that their current financial situation doesn’t jeopardize being approved. Surely they won’t be turned down…. Or could they?

Things come back. They always have; they always will, regardless of how big the bubble. The trouble is if you’ve been wiped out and set back ten years like Blake and Grigsby, you don’t come back as easily, or as if nothing had happened. While the numbers were made up for the fictional Somersets, their magnitude is on target for a lot of people on Wall Street. Those who took the jobs at Lehman or Bear and turned down Merrill or Morgan Stanley never could have dreamed that they were actually drawing the short straw.

Figuring out what must go when one is used to so much may seem like just desserts for those who lived high on the hog, however, it’s not only painful for them, but also those who work for them, and the community that depends on their expenditures — whether the Upper East Side, the Hamptons, Aspen or the many philanthropies in the City. In the future, a new group of people will ultimately reach success and the economy will come back. Who knows, a few years from now Blake and Grigsby may have recouped their losses. Nevertheless, it is safe to say that the times of 2007 and 2008 will be remembered as acutely as previous generations remember 1929.
(Alexandra Lebenthal learned from her Father Jim Lebenthal and Grandmother before that about the basics of finances and investments. Today she is the CEO of Lebenthal & Co., LLC and its wealth management division Alexandra & James Co.)