Two-tier bonuses will sour banks' relations

FROM DETAILS already filtering out of the US investment banks it is clear that this yearend bonus season will be one of the grimmest on record in London and New York. It will also generate an unusual degree of fear and loathing within many banks because of the extraordinary imbalance in profits between different areas of business this year.

The roller-coaster ride in equity and bond markets has left many banks with huge losses despite the recovery in a number of markets.

The pain is greater than it would have been 10 or even five years ago because of the tendency for banks to bet more of their own money in the markets. Many proprietary trading desks saw the value of their holdings - particularly junk bonds, mortgage-backed securities and emerging market bonds - cut in half or worse. Bankers Trust was so badly hit it sold out to Deutsche Bank, but almost every investment bank and most of the big commercial banks have also suffered. As the biggest expense at banks is salaries, there are only two ways to cut costs: sack people, and slash the bonuses of those who are left. The layoffs in London and New York started in the summer. Now it is time to cut bonuses which, for many people, make up between 50% and 75% of their salaries. Many banks are priming their bond trading teams which lost heavily in Russia and in the US - to expect a 50% or more drop in bonuses. Some may get nothing at all. Merrill Lynch chairman David Komansky is muttering about bonuses at half last year's level for the firm's traders. Across the board Merrill's target seems to be an average cut of 25%. Goldman Sachs, headed by John Corzine, JP Morgan, Morgan Stanley Dean Witter, First Boston and Lehman Brothers will all be cutting bonuses, probably by not less than 25% for traders. Meanwhile, Salomon Brothers staff have been warned that, following the merger of its parent, Travelers, with Citicorp, bonuses will be paid a month later than usual. The last time Wall Street cut bonuses so severely was after heavy losses in the 1994 bond market collapse. But this year's losses have been higher, so the personal pain in bankers' pay packets will be greater. More of it is also likely to be borne by senior executives, who cannot blame the losses on unpredictable market movements. The fact is many made serious strategic mistakes in the Far East, Russia and the US. The big problem for banks is that their mergers and acquisitions departments have had one of their best years ever. Takeover mania has been a veritable cash machine for the advisers. So while traders lose their bonuses, the M&A artists are likely to see an increase. Unfortunately for them, it will almost certainly not be as much as it would have been if the trading departments had not lost so much money. The M&A departments will be subsidising the trading divisions. When one department sees its profits siphoned away to pay people in another, then resentment quickly builds up. Yet banks can hardly avoid this. Top traders who end the year feeling underpaid can easily be lured away to rival institutions willing to pay more. In recent years these market forces have given rise to "guaranteed bonuses" under which traders are promised a specified amount even if they do not perform well. The Bank of England and the Federal Reserve have criticised such arrangements as encouraging traders to take excessive risks without having to worry about potential losses. This year's unusually large losses may force banks to cut back on guaranteed bonus arrangements, which would please the regulators. However, many bankers believe the effect would not be long lasting. The pain of this year's losses is likely to prove temporary. As soon as profits start flowing again, market forces will push bonuses back up to their old levels.

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