Monday, April 13, 2009

“Where it goes”

by Alexandra Lebenthal

“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to Heaven, we were all going direct the other way ...

... Along the Paris streets, the death-carts rumble, hollow and harsh. Six tumbrels carry the day's wine to La Guillotine. All the devouring and insatiate Monsters imagined since imagination could record itself, are fused in one realization, Guillotine. And yet there is not in France, with its rich variety of soil and climate, a blade, a leaf, a root, a sprig, a peppercorn, which will grow to maturity under conditions more certain than those that have produced this horror. Crush humanity out of shape once more, under similar hammers, and it will twist itself into the same tortured forms. Sow the same seed of rapacious license and oppression over again, and it will surely yield the same fruit according to its kind.”

-- Charles Dickens, A Tale Of Two Cities

We have gone from one extreme to the other. From the best of times, (was it only 18 months ago?), to the worst of times. Every day tumbrels rumble through the streets with the day’s take of once glorified, now disgraced executives heading to their public execution.

Some seem easy to declare guilty; the CEOs who we say should have been smart enough to have seen it coming, all the while paying themselves unimaginable sums. They are the ones whose heads we gleefully cheer for as they are lifted above the crowd, bloody and deformed.

But others appear more to simply have been in the wrong company at the wrong time: the salesman who’s bonus was based on a formula of revenues generated from bonds sold to institutional investors over the course of the year and who had his best year selling Treasuries to corporate treasurers and money market funds; the investment banker who helps companies raise capital, who worked 100 hour weeks, was usually on a 7 am to somewhere from Laguardia on Monday mornings, and who saw his children more often when they were sleeping, or on weekends; the institutional equities trader who managed a strong flow business based on relationships he has nurtured and serviced for years.

These are people who have generated tremendous amounts of revenues for their companies only to see it lost in a sea of write offs. The vast majority of these people had nothing whatsoever to do with the larger problems that created the insanity we exist in right now. They didn’t create the CDOs and subprime mortgage backed securities that have collapsed in value and threatened their company balance sheets. They weren’t the risk managers and senior executives who let a small profit center mushroom into a systemic problem. They are the men and women who did their jobs the right way, yet they are all painted with the same brush and declared guilty by the crowd. Ironically, they feel as violated by their own organizations as the general public.

Very few have had the courage to speak out and say they are deserving of bonuses, when it all has been branded as ill gotten gains. Can we blame them for staying quiet? Only Jake DeSantis, author of the now legendary “I Quit” Op Ed piece has done so.

The rest hide their identities, the Hermes and Bergdorf bags replaced by brown paper shopping bags, and the private jets mothballed in their hangars.

How would any of us feel if we were in the same position? Turn down the money for which we had worked all year? What about those who have obligations to which they were already committed be it tuition, charity, home improvement or living expenses?

What seems to be lost in this one sided argument is that the executive compensation that the populists want to claw back goes into the very economy we are trying desperately to get going again. Nearly half goes right to federal, state and local governments in taxes that pay for essential services. Mayor Bloomberg recently reminded us that 1% of New Yorkers pay 50% of city taxes. A good chunk is spent, which, regardless of what one thinks of consumer spending in a time of austerity, helps the economy. Money that is invested or saved likewise makes its way into the economy as the money in CDs and savings/checking accounts and money market funds is then lent out to individuals and businesses in need of loans. And a great deal goes to charities, which of course can then help the less fortunate, who are now needier than ever.

Several months ago we examined “What It Costs”. Now here are some observations about “where it goes.”

The Smithers waited all year for the bonus payment. Bill usually had a good sense by the late summer how things would turn out by year end.

While they did their best not to spend it before it was paid in January it was hard not to do so because of the typical bank compensation structure—relatively low salary ($100K to $250K per year) with the annual balloon bonus.

Bill is an investment banker at Citi who dealt with midsize companies. He had actually had his best year in 2008. He had sold a family owned business to a publicly traded company for $150 million. The fee on the sale transaction was $7.5 million. While Bill didn’t get a direct stake in the fee, it was credited to him as part of the bonus pool, and that same family also put the proceeds of the transaction in Citi’s private bank where it would generate additional income for the firm on the order of $7-$10 million per year depending on the asset allocation and performance.(The private bank wouldn’t pay an investment banker a bonus but it would be part of the “subjective” element of his formula.)
He had also gotten credit for working on several other deals that generated $25 million in investment banking fees. He actually missed his twentieth wedding anniversary dinner because he was stuck at O’Hare in a snowstorm. Penny usually was understanding of his schedule but she lost it that night. She had planned a weekend for just the two of them at the Mayflower Inn up in Washington Connecticut, with their 7 year old daughter and two 5 year old sons happily ensconced at Grandma & Grandpa’s for the weekend.

As 2008 drew to a close, Bill was furious that he worked as hard as he did and generated as much revenue as he did , while his firm lost billions of dollars. In any other year that revenue would have meant a multi-million dollar bonus, but not this year.

And this year the money was critical in a way it hadn’t been in the past.

The Smithers’ holdings in Citigroup stock built over the previous decade from stock options and equity grants had declined from $20 million to $2 million. They had a number of obligations for which they already owed payment. They had tried to cut back but it was harder than they thought. All autumn they just kept repeating: “Just get to January. Just get to January.” So when they found out his cash bonus would be $1.5 million, they were disappointed that it was about half of what it would have been in better times, but at least they figured that they would have enough to pay off their obligations and maybe a little bit left over. Of course they also reminded themselves that it could have been worse—it could have been nothing, as some of their friends found out, or a pink slip. So they didn’t complain.

Penny always paused when she heard what the number was and reminded herself that they would only net about half of it after taxes. It was going to get worse, too. They’d both voted for Obama without a second thought. They’d wept watching the news on Election Eve— out of happiness, but they also jokingly said to friends, “And we wept because we know our taxes are going to skyrocket!” With the economy and financial markets in a tailspin they knew New York City and State taxes were going to jump up as well. (In fact, the New York State legislature already approved an increase for the top tax bracket.

The Smithers gave a lot of money to charity. Some were organizations that they cared a great deal about, but others were for events they attended with friends or clients. From time to time they had a moment at a benefit where they remembered how lucky they were to be in fancy clothes at a nice party in a beautiful space and drinking champagne, and also in a position to help someone less fortunate. In other words, they took philanthropy seriously, usually making a donation even if they were invited as someone’s guest and bidding in a silent auction to help the cause further (though they rarely got around to collecting on the dinner at ‘21’, the cocktails for 12 or the spa day at Bliss they’d won).

When the bonus check came this year most if not all of it was already spoken for. They put some money into a CD (not at Citi; they decided diversification was a good idea and made sure that they did not have one account that was more than $250,000 for the FDIC coverage). They’d take the rate on a CD (a short one) rather than lose any more money.

So when all the talk started about giving back bonuses, they would have laughed were it not so horrifying. That money was already spent! Were they supposed to go back to all the charities, or their landscaper, or the kids’ schools and ask for the money back? They wondered if anyone had stopped to think about all the people that their money touched, and how many other people were like them. And what about next year, when executive compensation caps kicked in, and bonuses got even smaller?

They hoped that the anger would die down but also knew that until Citi back paid its TARP funds they, along with many others, would be in the cross hairs. Bill secretly began looking for another job at a non-TARP boutique like Greenhill or Evercore, but not many firms had “help wanted” signs on them.

So in 2009 the Smithers will not spend what they normally had in the past, but they still have obligations. Here’s their 2008 list of bills outstanding at year-end that ate up Bill’s bonus, which also gives a sense of what is at risk going forward:

$1,500,000 BONUS

Federal Taxes — Soldiers' salaries
$102,750 New York State Taxes — Annual legislative appropriation for MTA
$54,720 New York City Taxes — Police and Firefighter salaries
$682,470 Taxes Total *
$817,530 Remaining Balance
*NYS and NYC taxes may be deducted from Federal, making maximum combined top tax rate of 41.6%

Children for Children — Enrich and fund educational opportunities for underprivileged
New York City Ballet Toe Shoes; subsidies for traveling company
Unicef — 4,166 insecticide mosquito nets treated with insecticide to prevent malaria
$5,000 Central Park Conservancy Plant 5,000 Daffodils
Hale House — Educational and recreational activities for previously homeless children
$5,000 Mus. City New York — Free Saturday afternoon arts activities for New York City's neediest families: residents in municipal homeless shelters.
Mem. Sloan Kettering Cancer research
City Meals on Wheels — Weekend, holiday & emergency meals for two people for a full year
$5,000 Henry St Settlement — Job readiness workshop for 20 unemployed people
UJA-Federation — provide 14,068 rides to 650 aged to medical appointments, senior centers and synagogues for 1 year
$25,000 Alzheimers Assoc — Sponsor one year of a research grant
Spence — Cap Campaign Scholarship for one lower school student
$25,000 Collegiate — Cap Cmpn New auditorium chairs
$50,000 Princeton — (25th reunion) Full one-year scholarship for one student
$226,437 Charitable Gifts Total
$591,093 Remaining Balance

$200,000 CD, JPM Chase Bank loans to small business owner needing capital for expansion. Bank earns spread between what they pay on cd and loan interest rate
$391,093 Remaining Balance

$150,000 JR McGloughlin — GC Salaries for 5 men on apartment renovation
$50,000 Lawntastic Landscaping — Money spent by landscaper on Cedar trees, hydrangea bushes in anticipation of payment by client
$10,000 JBL Décor — Fabrics on order from Cowtan and Tout, Scalamandre
$15,000 Smith and Hawken — Teak beach chaises
$10,000 Best Buy — Wide screen TV, Apple computer for the kids
$2,888 Taxes on purchases — Taxes pay for debt service on municipal revenue bonds
$237,888 House Total
$153,206 Remaining Balance

$15,000 Brooks Brothers — Pays salesman commissions and funds inventory
$2,500 J Crew — Pays for rent and electric
$25,000 Bergdorf Goodman — Pays for customer perquisites, like bathroom attendants and store security
$3,506 Taxes on purchases — Taxes pay for funding parks maintenance
Clothing Total
$107,199 Remaining Balance

Collegiate School — X 2 Teachers' salaries, science and sports equipment, etc.
Spence School — Teachers' salaries, science and sports equipment, etc.
Education Total
$14,199 Remaining Balance


Bonus to Nanny — $2,500 sent home to Jamaica, $2,500 pay outstanding bills
$2,500 Tips for Doormen — building Xmas tips fund annual vacation for doorman
$7,500 Miscellaneous Total


We live in a culture where some people get paid for performing a function and some people get paid because they generate revenues for a business enterprise, whether it is banking, trading, hitting home runs or making movies. It is a basic tenet of capitalism that if you are responsible for generating that revenue you should not only get a portion of it but you should be able to provide your services to the highest bidder. These bonus agreements are governed by contract law. It is an “eat what you kill” environment in which it usually hasn’t mattered all that much if one department or even the whole firm doesn’t do well.

But this tenet apparently doesn’t fit anymore. It is also a tenet of capitalism that that companies survive or die on their own and don’t rely on the government to be saved. This is also, apparently, no longer true.

This is the conflict in our country right now, and it is painful for all of us to live through. But on a personal level, Bill Smithers and all of the other innocent bystanders never expected that their homes would be targeted by bus tours filled with protesters. It makes them feel un-American.
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.