Bonus culture datapoint of the day

By Felix Salmon
December 22, 2010
Jake Bernstein and Jesse Eisinger have a great story today about how Merrill Lynch persuaded its internal fund managers to buy the toxic nuclear waste spewing from its out-of-control CDO factory:

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Jake Bernstein and Jesse Eisinger have a great story today about how Merrill Lynch persuaded its internal fund managers to buy the toxic nuclear waste spewing from its out-of-control CDO factory:

Bank executives came up with a fix that had short-term benefits and long-term consequences. They formed a new group within Merrill, which took on the bank’s money-losing securities. But how to get the group to accept deals that were otherwise unprofitable? They paid them. The division creating the securities passed portions of their bonuses to the new group, according to two former Merrill executives with detailed knowledge of the arrangement.

The executives said this group, which earned millions in bonuses, played a crucial role in keeping the money machine moving long after it should have ground to a halt.

“It was uneconomic for the traders” — that is, buyers at Merrill — “to take these things,” says one former Merrill executive with knowledge of how it worked.

Within Merrill Lynch, some traders called it a “million for a billion” — meaning a million dollars in bonus money for every billion taken on in Merrill mortgage securities. Others referred to it as “the subsidy.” One former executive called it bribery.

The money went straight to a small group informally known as the “Super Senior Facilitation desk,” headed by an Asia hand named Ranodeb Roy:

The agreement, according to a former executive with direct knowledge of it, generally worked like this: Each time Merrill’s CDO salesmen created a deal, they shared part of the fee they generated with the special group that had been created to “buy” some of the CDO. A billion-dollar CDO generated about $7 million in fees for Merrill’s CDO sales group. The new group that bought the CDO would usually be credited with a profit between $2 million and $3 million — despite the fact that the trade often lost money…

Roy made about $6 million for 2006, according to former Merrill executives.

It would be fun to dredge up some contemporaneous Merrill statements about their culture of risk management. But my worry is that the culture of risk management at BAML, or whatever Merrill Lynch is calling itself these days, is unlikely to be much better.

Merrill’s antics are the reductio ad absurdum of bonus culture, and show why it’s so silly for investment banks to pay multi-million-dollar bonuses and reckon that they’re protecting their long-term franchise at the same time. Not everybody was as egregious as this. But the differences between Merrill and other investment banks were only of degree, not of kind.

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