Job insecurity at Goldman Sachs

By Felix Salmon
June 4, 2012

Mitt Romney likes to think of himself as a businessman, but in reality he’s not a businessman, he’s a financier, and there’s a big difference between the vast majority of employers, on the one hand, and financiers like bankers and private-equity executives, on the other. It’s a difference which makes it all to easy to read a bit too much into things like Goldman Sachs headcount cuts:

Goldman Sachs last week laid off roughly 50 people, according to people briefed on the matter but not authorized to speak on the record. The cutbacks have rattled some people in the firm, in part because a number of the employees were managing directors and on the higher end of Goldman’s pay scale.

The thing to realize here is that when firms like Goldman (and Morgan Stanley, and Credit Suisse) fire people, we often think that they’ve made a really tough decision — because in our firms, when people get fired, that’s a big and fateful day.

But banks aren’t like our firms.

Here’s Tim Noah, in his new book, explaining how the real world works:

One of the ways that the real-world economy differs from theoretical models is that bosses tend not to think about employee salaries as they relate to the labor market. Or rather, the boss doesn’t typically compare an individual employee’s salary to the labor market after he hires him. Instead, the boss thinks about how good a job the employee is doing, how much cash the company has on hand this year (or doesn’t have) for raises and bonuses, what the company’s internal (perhaps union-negotiated) compensation policies are, and so on. The moment when the boss does compare an employee’s salary to the labor market typically occurs when he makes the hire. I need a guy to do X, the boss thinks. How much do guys like that get paid? After that, the employee ceases to be an economic abstraction and is judged based on his own performance.

The point here is that banks behave much more like theoretical models than most companies do. In some dystopian capitalist universe, employers would constantly be alive to the nuances of the labor market. Never mind that you were hired at $60,000 a year: if someone just as good as you can be found to do the job for $50,000 a year, then you’ll either have to accept a pay cut or get fired.

Employers don’t act that way, because they generally have better things to do than be concentrating on the nuances of the labor market all the time, and also because it’s really expensive and time-consuming and unpleasant to hire and fire people. And, because they’re not evil profit-maximizing automatons. But banks are different.

If you’re Goldman Sachs, it’s actually really easy to hire people. And the cost of firing people, relative to how much they get paid, is actually pretty low. Moreover, at Goldman, the value of any given employee is far more quantifiable than it is at most other firms. The employees know it, which is one reason they get paid so much. And the firm knows it, too. That’s why banks have variable compensation: if you were worth $2 million last year and $1 million this year, your pay will go down this year.

All businesses are cyclical, which makes it hard to hire effectively. Do you hire lots of people when times are booming, only to find yourself overstaffed when times are less great? Or do you underhire in the booms, depriving yourself of growth? Places like Goldman solve that problem the capitalist way: they simply staff to the cycle. When profits are going up, they hire; when profits are going down, they fire.

Private-equity companies generally behave that kind of way once, when they first come in to a company. They’ll fire a lot of people, or make them reapply for their jobs, or otherwise reset the firm to the labor market at the time. But even they don’t then continue to hire and fire people continually across cycles: it doesn’t make sense to do that, when the cost of keeping someone on, even if they’re earning a few thousand dollars more than the prevailing wage, is so much greater than the cost of firing them and then re-hiring for the job.

But at investment banks, it’s different. If you’re not pulling your weight, you’re out. And when dealflow dries up, jobs get lost. It’s brutal, but it has a lot of internal logic. Which means that the real surprise here, as the global recovery sputters, is not that investment banks are firing. Rather, it’s that such activity is newsworthy at all, or that Goldman employees ever thought that managing directors had any kind of job security in the first place.

Partners, on the other hand…

Comments
12 comments so far

Another thing to consider that especially at the top end, I-bankers are kinda replaceable and there isn’t a lot of difference between working at GS or MS, you’re chasing essentially the same deals with the same basic work flow.

Contrast with a senior level manager in the real economy where they spent years or decades learning the intricacies of not just their industry but also supply chain and intra-company idiosyncrasies. At that point you cease to operate in the theoretical.

Posted by GregHao | Report as abusive

I’m not sure I buy your premise. The easiest way to get a raise in software engineering is to switch jobs. That’s because companies seem to not consider the value created by job performance when determining salary; rather, they are anchored by initial salary at hire time, and balk at raises (or cuts) that look too high in percentage terms.

Posted by BarryKelly | Report as abusive

BarryKelly – not really. I have seen / experienced how SW Eng. bringing critical knowledge are valued internally over a period as well as how those are fired because ‘pay scale’ went above the bracket as market shifted down. Nothing special here….

Posted by umeshgeeta | Report as abusive

It was always the premise that IB guys got the high salaries to compensate for the volatility of their employment. The lengthy boom has let us forget that, and entrenched an expectation culture. This should be a good opportunity to remind us we get paid not to buy Porsches, but to save for a rainy day. No sympathy from me I’m afraid!

Posted by Troyboy | Report as abusive

I have to agree with BarryKelly on SW jobs, although there’s also a great deal of regional variation which is only indirectly related to the cost of living. When people are let go from software companies, it typically has little to do with how much they are making.

And Felix, I don’t get your gratuitous jab at Romney, which you effectively refute at the end. And it had nothing to do with the topic at hand.

Posted by Curmudgeon | Report as abusive

@Curmudgeon I think you do Felix a disservice here… Mitt Romney does position himself (and I’ve heard some of his supporters referring to it on TV) as someone who understands how the economy works because he’s a businessman. Err, no. He’s not,he’s a dealmaker, as Felix says, and one that then asset strips companies. It’s practices like that which have pushed Western jobs to China in order to make companies more profitable – and that ultimately destroys your economy by reducing the number of people you have working in it.

Posted by FifthDecade | Report as abusive

FifthDecade, Felix seems to revel in inserting politics into most discussions. I try to keep it out of polite discourse, believing that all politicians are pretty much the same (namely, evil), with differences only in nuance.

Ultimately, it’s his blog, he can do what he wants. As for destroying the economy, what happened in the US starting a decade ago is happening in Europe now (for somewhat different reasons). When the rest of the world can meet your technical, manufacturing, and professional standards at a lower standard of living, nothing was going to prevent an a leveling of the value of that work. The developed world has managed it badly, but we manage most things badly.

I believe you live in Switzerland. I will be in Zurich the week after next, and love it there. If I had any excuse, I would live there in a heartbeat.

Posted by Curmudgeon | Report as abusive

I’m here in the real world as the CEO of a SW company, so I’ll chime in here. The ONLY thing that gets discussed is revenue when making these decisions. Revenue is down, revenue stays down, decisions get made. The first people to go are the people responsible for revenue if they haven’t been pulling their weight. SW people go when we scale back projects because the revenue was down. Frankly there’s so much institutional knowledge after a while that it doesn’t even make sense to look at who goes by wage. Most of the time we’d go for more lower-wage people and keep the top ones in all honesty. So if you’re a high wage earner and you’re let go, perhaps it’s because you felt entitled and weren’t judged to be producing at a capacity relative to what you’re paid. Period.

We don’t look at taxes (the Republicans lie about this constantly with the “unsure about taxes so they’re not hiring” meme), we don’t look at wages, we look at REVENUE. In fact the sales people are the first to feel the heat and possibly the ax. Perhaps even the CEO if he’s perceived to be not doing enough or leading in the wrong direction (that’s how I became the CEO in fact).

So all of this can be summed up in one question/answer: why are people getting laid off and companies are reluctant to hire? REVENUE. Incidentally what Mitt did has no relation to all of this Felix is correct. His job was to turn around/unlock value. That’s a whole different ballgame. He’s a car stripper for parts, if you like that analogy. I’m into designing and building the cars. Very different.

Posted by skyman123 | Report as abusive

If Goldman gets rid of 50 employees, it’s not a layoff, it’s getting rid of low performers. 50 is far less than 1%; companies don’t “lay off” 0.15% of their staff. They’re trying to ease the blow for the terminated workers, by letting them tell future potential employers they were laid off rather than fired.

And don’t assume they were all “investment bankers”. Yeah, that used to be Goldman’s main business, but now they have lots of traders, financial advisers, and gamblers, and those kinds of people don’t get laid off, they get fired because they aren’t pulling their weight.

Curmudgeon, the topic is already a political one, so Felix wasn’t injecting politics into it. Probably the biggest issue in the election this year will be jobs, or how to create more of them. Romney makes a big deal about how he knows how to create jobs and run a business, when his expertise is not in running a business (and certainly not in creating jobs), but in extracting as much value as possible out of an existing company,and then finding somebody else who wants to own and run what’s left. Not that that has lots of parallels with running a country.

I also run a company that hires SW engineers (or at least tries to), and I’m with skyman. The whole idea that uncertainty about the taxes keeps me from hiring more people is nonsense. The only thing that keeps me from hiring more engineers is that our industrial base moved overseas, and took most of the engineers with the expertise we need with it.

Posted by KenG_CA | Report as abusive

Goldman is not generally associated with big cuts, they tend to fire people yearly as part of their performance evaluation, so even a small number like 50 is making news.

The compensation and promotion process at big banks IS different (more brutal) then the rest of the economy, but they are making a mistake because the ultimate result is a broken culture of hyper-competitive back-stabbing pr*cks… see this for what I mean:

http://thatretiredguy.blogspot.pt/2012/0 5/some-day-financial-innovation-will-onc e.html

Posted by FinanceChicken | Report as abusive

Moreover, at Goldman, the value of any given employee is far more quantifiable than it is at most other firms.
This isn’t precisely true. Just because a trader made $5mil in trading profits and his colleague made $10mil in M&A doesn’t mean that it’s easy to just compare the two. Even within trading, luck and risk-taking can lead to higher returns for a given employee without their actual value to the firm being higher.

If you think about it historically, the modern bank bonus system is a creature of the past several decades, and is still more common in the US and UK than in Germany, Japan, and France. The ability of US banks to accurately assess employee value is a myth that’s part of their overall culture. It’s like assessing a journalist for their wordcount or a programmer by lines of code.

Your point about Romney is interesting though, because it’s almost amazing that someone with his background is competitive for the presidency. If he had started up some division at Citi, or done something more financial-looking than Bain, he’d have been thought of as a banker and likely had his chances diminished (rightly or wrongly, after all financiers like Corzine have been elected to governorships!). But through an historical accident of sort he ended up on the right line between wall/main street since private equity looks very businessman-like from afar.

Posted by MKCurious | Report as abusive

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