There have been several articles written recently regarding stockbrokers and retention bonuses.
If you are outside the industry you may not know when brokerage firms are merged or acquired, the brokers (the salesforce) are sometimes awarded bonuses merely for staying. The reason behind the bonus is the broker/salesperson may face a drop-off in business, the bonus may help smooth the transition period.
Often times, the retention bonus requires a broker to stay at the firm for a long period of time. That’s usually good for his or her business, showing they are stable while the sign outside the building may be changing.
Larger producers may get these retention bonuses, while lower-end producers may see a significantly smaller bonus, or perhaps nothing. Some of these deals, in my opinion, carry staggering, eye-popping numbers.
This has been getting attention lately because many of these same firms that planned retention bonuses also received TARP money from the government.
It’s hard to justify (in my opinion) handing out retention bonuses as a worthwhile use of taxpayer bailout money.
Others apparently agree.
On February 20, 2009, it was reported Wells Fargo has decided NOT to pay retention bonuses to the Wachovia brokers they recently acquired. “With the environment we’re in, with all the attention we’re under — all the firms are under — and with clients down 20%, 30% and 40 % … a [retention] bonus didn’t seem to be the appropriate approach,” said Wachovia Securities spokesman Tony Mattera. You can read more about it here.
And also here.
Also, on February 11, 2009, retention bonuses were also picked up by the Huffington Post (and other news outlets). In that article, it discusses how some brokers were informed “There will be a retention award. Please do not call it a bonus” The Huffington Post article also contains an audio clip from the conference call for Smith Barney and Morgan Stanley.
The article also cites some comments describing the retention bonuses/awards as a “gratuitous expense” and even quotes a former chief economist at the U.S. International Trade Commission as saying “They are putting lipstick on a pig,” said Peter Morici, a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission. “Very often, retention bonuses are paid to undeserving executives who helped drive their enterprises into the ground…”
You can read the entire article (along with the audio portion) here.
And also here.
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Mark to Market Accounting: a basic analogy
by Thomas Mullooly on March 12, 2009
How mark to the market accounting helped kill Wall Street
Mark-to-market accounting is what’s used in your brokerage account — your margin account at a Wall Street firm. To understand mark to market accounting, let’s look at what happens in a retail brokerage account that trades on margin:
Suppose you invest $80,000 in cash in a brokerage account. You sign up for margin capability. Before you place a trade in your account, you have the ability to buy up to $160,000 worth of securities with only $80,000. You will pay margin interest on any outstanding balances, and your “margin maintenance” is recalculated every night – based on the gain or loss in value of the securities in the account. This is how a margin account works.
Using the above illustration, you have 50% equity in the account, and have an outstanding margin (or debit) balance of $80,000.
Suppose the value of the assets in the account drop from $160,000 to $145,000. You now have 45% equity in your account. You still have buying power and seem to be in no imminent danger of a margin call. Remember, you still owe $80,000. If you were to close the account now, you would sell the assets for $145,000. The margin debit balance of $80,000 would be paid (margin interest would also be included). The securities dropped almost 10% in value (from $160,000 down to $145,000) but you lost nearly twice that percentage, because you leveraged the trade. You would be left with the remainder… approximately $65,000.
But suppose the value of the assets in the account dropped from $160,000 to $100,000. You now have 20% equity in your account. Remember, you still owe $80,000. At this stage, you have no more “buying power.” This means you cannot take money from the account, nor can you buy any additional investments. In fact, at 20% equity you have a “margin call” and your broker would be contacting you requiring you to deposit more money (or other securities) to boost the equity in the account.
Margin works wonderfully when the assets in your account are rising in value. But margin will wipe you out when the assets in your account are falling in value.
The assets in the account are repriced every single night in a margin account. And the equity is calculated every day and the amount needed for “margin maintenance” is also calculated every day. And when your account gets upside down, you have a margin call, and it needs to be rectified right away.
Margin accounts are calculated using mark to the market accounting.
Banks (and brokerage firms) that own mortgage backed securities have been required — since November 2007 — to use mark to market accounting on these securities. Coincidentally, this was just around the time these mortgage securities started dropping precipitously in value. 2007 saw many mortgage firms get wiped out, and brokerage firms and banks holding these assets started realizing the volatility of these assets.
Remember banks and brokerage firms were required to employ mark to market accounting beginning in November 2007 for mortgage backed securities. As real estate values collapsed, and foreclosures began to rise, banks and brokerage firms no longer wanted to hold the securities as investments on their books. It is no wonder then, that six months later (March 2008) that one of the biggest holders of mortgage backed securities — Bear Stearns — was caught in a massive credit squeeze. The assets that they regularly borrowed against were no longer “borrow-able.”
Bear Stearns — which had traded at well over $100 per share months before, agreed to sell themselves to J.P. Morgan Chase for two dollars per share. This figure was ultimately increased to $10 per share.
By mid– 2008, Merrill Lynch had decided to unload a $31 billion pool of mortgage backed securities that they owned, and essentially announced they would take the best offer. These mortgage backed securities had been held on the books (it’s estimated) at $.80 on the dollar. This pool was sold for $.22 on the dollar in July, only after Merrill Lynch agreed to subsidize part of the losses that might be incurred by the buyer.
These are anecdotes and examples using vast over-simplification and are being used to illustrate how mark-to-market accounting works.
While not directly connected, mark to market accounting required that other banks and brokers investing in similar type investments market their own similar assets down to similar levels. Thus, the entire mortgage backed market froze. Trades were no longer taking place, because every time a trade would take place, it would require the values of similar securities to be repriced everywhere. These securities could no longer find a value and could not be borrowed against, hampering most lending capabilities at these firms.
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