Our Take: Reciprocal Gestures Mold Bankers' Future Pay Deals

The olive branch President Obama just handed Wall Street on compensation opens a new phase in a painful effort to reconcile the legitimate expectations of hard-working financial services professionals with the harsh dictates of public opinion.

If you work in a firm considered systemically important, the size and shape of your pay package is at stake no matter where you stand on the title ladder. That's why I believe it's worth watching where the political dust settles from the president's controversial interview published in the current issue of BusinessWeek.

Ever since Bear Stearns inaugurated the parade of public bank bailouts nearly two years ago, every banker's paycheck has been stamped with a glowing red bull's eye in the minds of most voters. Freudian theories about the deep symbolism of money aside, compensation is the most visible distinction between bankers and the rest of the population. And the masses won't be satisfied until they've got a piece of it.

Barack Obama has long understood this. "My administration is the only thing between you and the pitchforks," he famously told a group of bank CEO's at the White House in March 2009.

'I ...Don't Begrudge'

The industry's initial steps to reform itself - shifting pay from cash to restricted shares, and adopting policies that could claw back prior awards under certain conditions - only inflamed critics all the more. Only after 2010 began did managements begin showing "contrition" on a scale the public could view as more than symbolic. The slice of 2009 revenue used to compensate employees was slashed to 33 percent in the case of JPMorgan and 36 percent for Goldman Sachs. Then Goldman set CEO Lloyd Blankfein's bonus at $9 million, far less than expected.

This week, President Obama answered with what appears to be a well-planned reciprocal gesture. "I, like most of the American people, don't begrudge people success or wealth. That is part of the free-market system," the president declared, right after he'd praised Blankfein and JPMorgan CEO James Dimon as "very savvy businessmen."

It's the first clear signal that Wall Street's display of restraint has been duly noted. While political pressure on compensation won't cease, Obama's words indicate it will moderate for the time being.

Why does this matter for your career? At the margin, the truce could make it easier for large institutions to bid for talent now as well as begin allocating amounts for next year's bonuses with less concern they'll have to throttle back later due to "optics." The ongoing political ballet might even be influencing packages negotiated this very moment for professionals preparing to jump from one firm to another after collecting 2009 incentives.

Bonus Limits Trickle Down

This doesn't only apply to senior executives and rainmakers. A firm's upper pay levels influence compensation across the entire structure. Let's say a trading desk's best performer earned $10 million two years ago and its second-best trader earned $5 million. Then if management is compelled by external pressure to hold the top guy's payout at $6 million this year, they'll probably need to hold the number two to around $3 million, assuming their relative performance held steady. In turn, the resulting downward pressure on number two's pay flows through to number three, then number four ... perhaps even influencing the back office, to the extent variable compensation is part of their mix.

I don't know whether banking folks use a simple linear scale when assessing their own pay relative to colleagues. But since linear models seem to be our industry's default tool for relating any set of quantities, it's as good an assumption as any to apply to bankers' own economic behavior.

What's more, the tone of political discourse on compensation might affect how Congress resolves other matters important to careers in finance. Compensation levels are the industry's political underbelly that allows things like the Volcker Rule to exist. If the general public did not view finance pros - even modestly paid state employees who manage public retirement funds - as grossly overpaid, any push toward breaking up big banks would be pretty much dead on arrival. The more the public thinks bankers still make too much, the more support there will be for tougher reforms, and vice versa.

"It is shameful," versus "Success should be rewarded." At different times, President Obama said both about bankers' compensation. Eventually the president, his administration and political allies, and Wall Street, will all meet at a point somewhere between those two propositions. Where that line gets drawn is a matter of vital interest to you and to me.

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